I've written about this before, but for those new to following the yield curve, here's a simple way to think about the dynamics between long and short rates. I think this will show you why this bear steepener has an expiration date. 🧵 We start with a basic assumption: each yield along the Treasury curve reflects the market's assumption of the average Fed target rate over that period of time, plus some risk premium.

Why would this be? 2/

OK, so let's play this through... (spoiler alert, I think this trade is dumb) 1/

https://twitter.com/real_bill_gross/status/1595070378681974794

For the 10yr TIPS to trade with a breakeven of 3.00, markets have to assume that the *average* inflation rate will be 3% over the next 10 years.

Is that possible?

I suppose in an infinite universe all things are *possible* but boy... seems quite *implausible*. 2/

If I were running comms at the Fed, I'd want Waller giving this speech. But since I'm an investor, I don't think there's any signal here. 1/
reuters.com/markets/us/fed… First, Waller is throwing a bit of a strawman out there. "This isn’t ending in the next meeting or two." The market knows that. It has priced a 50bps hike in Dec and 2x 25bps in Feb and March. The market isn't "way out in front" in the way he's claiming. 2/

One fascinating question in the next few years is whether the so-called "term premium" will return to the U.S. Treasury market. This is amt of extra yield you get paid simply for holding longer maturities independent of your future expectations. Some thoughts: There isn't much people agree on IRT the term premium, but there is general agreement that is seemed to decline in the post-GFC period. IMV, the reason *why* it declined is the key to determining if it might come back going forward. 2/

Lost in all of the "pain" talk from Powell yesterday, there was some interesting signals about their reaction function. A🧵on my takes: First let's remember that Powell's *current* job is to talk as tough as he can. They can't risk markets thinking that falling stocks or signs of a recession will cause them to lose their nerve. I don't think we get much signal from his tone right now. 1/

In macro, we never get definitive information from any data point. There's random noise, measurement problems, seasonality, etc.

OTOH, investors can't wait until there is enough data for absolute proof. The mkt will have long ago moved. Ergo we have to operate on the margins. 1/ Here's one way to think about it. Say I handed you a die and just told you to roll it. You roll a 6. Would you draw any inference there? Of course not. A 6 is just as likely as any other number. 2/

Jackson Hole was nothing new. Powell's JH speech on the left, July FOMC presser on the right. 2: Jackson Hold on the left, July FOMC on the right:

Powell is committed to rate hikes... for now. He isn't married to them.

A brief 🧵on Fed communications. Perhaps the worst thing the Fed could do rn is ease policy prematurely. At the moment the Fed has only suffered minor reputational damage from the whole "transitory" business. But if they seem to lose their nerve while inflation is still high, the damage would be much greater. 2/

I've been thinking about this piece from @NickTimiraos and what is good and bad about forward guidance. Here's hoping the Fed (and the ECB too) keeps the good and throws out the bad. 1/
wsj.com/articles/after… People often deride CB guidance, but it has been a crucial tool for the last 14 years. It helped keep rates low in the post-GFC period, helped get rates rapidly lower after COVID hit, and recently helped get financial conditions to tighten *much faster* than prior periods. 2/

If we posit that tightening fin conditions are why the economy may be slowing, then the best case scenario becomes obvious. Inflation needs to subside quickly enough such that the Fed can stop tightening conditions further. 1/ Bear in mind that current fin conditions incorporate anticipated Fed policy. If inflation were to recede now, the Fed may well hike as much as is priced in currently, but pause thereafter. In such a scenario, there's no marginal tightening of financial conditions. 2/

I'm usually not that guy, but I told you so. All the post-minutes pieces are about how hawkish the mins were, but what did you expect?? They did a last minute pivot to the largest rate hike in decades. Give how they value Fed guidance, an incredibly hawkish move. But ... 1/

https://twitter.com/tdgraff/status/1544655039792398337

We really need to separate the Fed rhetoric from how they actually think:

- They know the econ is slowing
- They know a decent slowdown will "solve" inflation
- They aren't going to keep blindly hiking forever under such circumstances

BUT THEY CANT SAY ANY OF THAT OUT LOUD! 2/

This is a good thread from @bigbluebugcap who is a 1st rate macro thinker. Couple thoughts.

1) Agree💯 that "Fed put" is the wrong way to think about it. If the Fed slows rate hikes, it will be bc they think econ is slowing enough to possibly quell inflation. Not to save stonks.

https://twitter.com/bigbluebugcap/status/1544664024729755648

2) Also totally agree that the Fed won't cut at the first sign of economic trouble. That's the big difference btw now and '18-'19. Fed can't afford to equivocate on inflation. That prob means they stay somewhat too tight somewhat too long.

I know stocks are getting smashed still, but I am pretty encouraged by the Income/Spending/Core PCE release today. Quick 🧵 First, spending came in below expectations w/ downward revisions. Normally that's bad news, but until household spending slows, inflation will remain a problem. If spending is indeed slowing now, that would be a good sign that inflation has already peaked. 2/

I think it is *possible* that people are overestimating how much demand destruction is needed to bring inflation down. I'm introducing this as a *possibility* not as a forecast or anything I'd bet on per se. But here's the case (🧵) OK let's say that households see a boost in their nominal income (Y). Econ 101 says the aggregate demand curve will shift outward (D0 to D1), and if there's no reaction from supply, prices will rise. Hence inflation. 2/

Here are my thoughts on the yield curve inverting, what it means and what it doesn't mean. Please feel free to fight me on any or all of the following points... 🧵 1) A curve inversion tells us one thing and one thing only: that markets expect longer-term CB policy rates to be lower than near-term policy rates. So w/ the 3yr > 10yr, market is saying that 3yr avg ff > 10yr, hence implying the Fed cuts rates sometime in that period.

Credit markets were absolutely on fire yesterday after two weeks of selling off hard. This has become a permanent feature of the cash credit market. "Market makers" aren't so much making markets as just playing a matching function. (🧵) Right now flows out of real money bond accounts are sharply negative. This isn't really about it being risk-off so much as investors fearing ever higher interest rates. 2/

There was a question in yest FOMC presser about the curve being flat already (sorry can't remember who asked it). Related I've heard some claim that given how flat the curve is already, it will somehow hinder the Fed's ability to tighten policy. That's circular logic (1/) The curve slope isn't divined by magic. It is (mostly) a combination of future Fed policy expectations and uncertainty thereof. The reason why the 2/10 slope is already relatively flat for this early in a hiking cycle is precisely bc traders don't expect a lot of hiking. (2/)

Here's my take on the bigger picture of Retail Sales. Take a look at this chart of the Control Group, with the 2016-2019 trend noted by the dotted red line. (🧵) At the end of 2020, it looked like stimmy was fading and overall sales were probably going to *fall* such that they returned closer to the pre-COVID trend. See the first arrow in the chart. 2/

With plans for QT apparently being discussed, and the prospect thereof probably the catalyst for the big bear steepener so far this year, I thought I'd do a quick 🧵on why I'm skeptical QT will matter that much. 1/ First let's look at the QE/QT period post GFC. This is the 10-year yield, with QE buying periods marked in 🟢, tapering in🟡 and outright QT in🔴

US Bonds caught in a narrative that Fed's about to make a mistake by hiking rates. What could change that narrative and how would curve react? Here's my take. Looking forward to your pushback. (🧵) First how do we know that market thinks rate hikes will be a mistake? It isn't just FinTwit chatter. The curve is bull flattening (i.e., long bond yields fall more than shorter bonds) on hawkish news. That's saying that growth/inflation will subside after rate hikes. 2/

Biggest question in US rates is how the Fed will deal with decelerating but still high inflation, especially if it coincides with decelerating but still solid growth. Here's my take. (🧵) If by mid-'22:
-Core PCE is high 2s
-UE is 4% or lower
-LFP has not meaningfully rebounded

Fed hikes immediately and probably hikes another 1-2 times later in calendar '22.