Morning Notes — Fed Preview

The Fed Preview does not contain surprises. A 25bp rate hike tomorrow is already priced into the OIS forward market along with 25bp expected in March before a pause. This would take the upper bound of Fed funds to 5%, which is where terminal rate expectations have stabilized since October.  The relative stability of terminal rate expectations has led to lower realized bond and equity market volatility.  This, in turn, has helped ease financial conditions seen in lower bond yields, higher stock prices and a weaker dollar.  For context, a 30-year fixed-rate mortgage has declined ~100bp since October. Powell’s speech will likely be on the hawkish side as he attempts to back against easier financial conditions. Powell will likely stress that downshifting to a 25bp rate hike doesn’t suggest an imminent pause and that market pricing of rate cuts later this year is inconsistent with committee expectations.

Markets: A more hawkish message from Powell and 50bp hikes from BOE and ECB meetings on Thursday should keep gentle upward pressure on short-end bond yields. This will likely translate into a slight widening in the 5/10-year curve inversion and drive incremental concern for a more severe policy mistake. As expected, the 5/10 curve failed to sustain a break above technical resistance near -9bp.  An eventual break above this level will be an encouraging technical signal for an eventual positive spread and imminent Fed pivot.  The good news is that the 5/10 curve inversion reached a cycle peak back in mid-October. The bad news is that a positively sloped 5/10 spread likely requires sharply lower inflation and/or lower asset prices.  For now, any widening of the 5/10 curve inversion will likely reinforce strong technical resistance for the S&P 500 in the 4000-4100 range.  We continue to see increased likelihood for a retest of last year’s low, which implies 12% downside from current levels.