Morning Notes — Terminal Rate

Focus: Terminal rate expectations are down -12.1bp this morning to 4.41% and are still the dominant cross market for equities.  Expectations are derived from the Overnight Index Swap (OIS) forward market and levels below 4.50% should provide broad support for equities. For perspective, consider the S&P 500 declined ~10% over nine sessions when terminal rate expectations rose from 4.41% on 9/12 to a recent peak of 4.67% on 9/23.  The most important near-term catalysts for terminal rate expectations are this Friday’s September Jobs Report (10/7) and next Thursday’s (10/13) October CPI print.

When? Yields tend to peak about 2-3 months before the end of a tightening cycle. The OIS forward market implies the Fed will be stop raising rates by March ’23.  Real yields (nominal yields – inflation breakeven yields) are now in positive territory across the curve and cooler inflation data will cause the Fed to soften its hawkish message more quickly than it has in the recent past.  Recall last week’s warning from Vice Chair Brainard about the financial stability risks that central banks “could face as they raise rates rapidly.”  More comments like this and lower expectations will cause an extended period (1-2 months) when investors will ‘look across the valley’ when it comes to downbeat growth data.

Contrarian: Equity positioning remains at historically low levels with equity long/short hedge funds is in the 1st percentile (not seen since 2016) and CTA positioning in US equities back to levels from 2009. Today’s encouraging deceleration in the ISM manufacturing Employment subindex has the SPX up more than 100 points with volume running above the monthly average.