Morning Notes — More Forward Curve

Forward curve: The peak inflation narrative really began back on May 9 when ten-year inflation breakeven rates traded below support at 280bps. The theme is now gaining credibility as realized data disappoints and inflation expectations in consumer/business surveys start to miss.  Unfortunately, the recession narrative is gaining credibility at the same time as the Fed seems committed to rate hikes/policy tightening.  Terminal Fed expectations (when Fed ends tightening cycle) are derived from Fed fund futures pricing.  Several weeks ago, we noted the pulling forward of terminal Fed expectations from June ’23 to December ’22 was a positive development for equity markets.  And last week, Fed fund futures began pricing in a Fed pivot in March ’23. Markets discount events 6-9 months in the future and investors should begin focusing on this part of the forward curve.

Sectors: We began adding value sectors (Financials, Materials and Energy) when 10-year real yields made a double bottom in late-August ’20, which was when markets began pricing in potentially positive vaccine data later that fall. Inflation breakeven yields and nominal bond yields made new cycle highs on the November 9 vaccine data and we became tactically overweight value. That now seems to be unwinding with inflation breakeven yields, nominal yields and real yields all descending from recent peaks. An eventual Fed pivot should favor growth sectors, specifically Tech. If we wait for a Fed rate cut, we’ll be too late.  Instead, we focus again on 10-year real yields with levels below +11bp (now +42bp) acting as a trigger.