Morning Notes — OIS Forward Curve

Indicator: Ten-year bond yields fell ~24bp last week to 2.75%, reflecting increased recession worries.  Following lagging indicators like GDP for signs of a recession will get you nowhere. Remember our negative feedback loop that occurs in a recession.  It usually starts with slower consumer spending, which leads to lower corporate profits, job layoffs and even slower consumer spending. Strong consumer savings and credit trends coming into the Fed tightening cycle should buffer the impact of higher interest rates.  And the massive current supply/demand imbalance in labor markets is another buffer, particularly for low/middle income jobs. The best high frequency signal on real-time business behavior is actually weekly jobless claims.  In the past, claims data above ~275,000/week has signaled business retrenchment, and we expect Fed language to become less hawkish if/when that occurs.

Forward: The Overnight Index Swap (OIS) forward curve is looking for another 175bp of rate hikes into year-end indicator taking the terminal Fed policy rate to 3.50%.  About a month ago, we explained the OIS curve had moved the terminal rate (when the Fed ends its hiking cycle) forward from March ’23 to December ’22.  The OIS forward curve now implies rate cuts by March 2023.  Lower interest rates and lower bond yields lead to higher multiples. Equity markets discount events 6-9 months in the future, which takes us to the Jan-April ’23 window.  And if today’s OIS forward curve is right, investors will be looking forward to recovery in ’24 sometime in that Jan-April ’23 window.

Tech: Ten-year bond yields will likely stay range bound until inflation data begins to disappoint.  We’re modeling broad range between 2.70% and 3.20%.  A break below 2.60% would slightly shift investor sector preferences in favor of growth over value. Sector preferences are ultimately driven by real yields, which subtract inflation expectations from nominal bond yields.  Lower nominal yields during the GFC drove higher multiples for growth stocks in general, but deeply negative real yields beginning in March ’20 is what drove 20 months of massive Tech outperformance. Ten year real yields peaked at +89bp in mid-June, and are now +44bp.  For us, the trigger for growth/tech outperformance sits below +11bps and accelerates at levels below -10bps.