The Rate Cut Regime Begins!
FOMC to cut 50bp tomorrow
Its FOMC time again and tomorrows meeting will truly be a historic one. The time has finally arrived for the FOMC to begin leading the inverted yield curve out of the negative carry darkness, a darkness that has been record breaking. We have sustained a negative carry environment for the last few years and now the time has come to finally reverse that trend. When we speak of negative carry we are referring specifically to the yield differential between the US Govt 10 Year note and the Federal Funds rate. The following chart will encapsulate this record negative yield inversion and the time we have spent undoubtedly purging predatory leverage across multiple industries (CRE specifically):
Will we make it thru a record breaking 3rd straight year? I believe so because there are 3 meetings between now and the end of the year and I will assume we will be cutting 50bp at each one of them moving Fed Funds down to the 3.75-4.00% range. At that rate the US Govt 10Y should be closer to 3% or 3.25% so we will close the year in negative carry for the third straight time barring some emergency 75bp or larger cut.
As the prior chart shows, the reversal of this type of situation can be severe and prolonged and almost assures a negative economic environment. How severe the recession will be is anyone’s guess, but given the starting point and the absolute dislocation between economic fundamentals and organic supply/demand growth coupled with insane amounts of concentrated capital, its anyone’s guess how stingy the money hoarders become.
The data won’t show up in layoffs at first, but new hiring will certainly slow and it already has, and then the layoffs will come. This time around the fix may not be as easy as cutting rates, my guess is they will continue to the zero bound and ramp up the printing presses and expand the FOMC balance sheet greater than $10T over the next 2 years.
There is a tremendous amount of work still ahead and ground to cover, so let’s keep things in perspective. The equity markets have held in very well and it will not surprise us to see an initial rally off of the rate cutting news, CNBC will spin it as a win for the market funding side as money cheapens (very simplistic approach and certainly wrong) but they will spin it that way anyway.
We can see that the next data chart shows just how well the equity markets have performed as Fed Funds has stayed flat YoY:
Just now the 5Y yields have started to reverse down and now sit about 160bp below Fed Funds!
We can also see the RRP usage continues to plummet as money flows out and moves into declining yield TBills and other duration securities. The next chart shows this and also shows the $1.45T in decline of the total FOMC assets, I bet we have seen the end of this decline in FOMC assets:
Another reason and one many don’t really understand as to why the FOMC is rushing to cut rates, but we hope these next two charts will explain their up coming cuts very plainly.
The FOMC deferred asset is nearing $200bn, this is problematic for a Treasury that continues to push yearly $2T deficits and the only cure for this is to plunge the Fed Funds rate back below 2.5%:
The next chart is of the Unrealized Losses on the banks balance sheets. These too will lessen as the FOMC cuts rates and US Treasury yields plunge commensurately. As the economy turns and the banks see waves of defaults, well their capital ratios will be put to the test and how better to solve a few of those issues but to shed some assets, its a lot easier to do when those assets aren’t under water any longer:
So that pretty much lays out our base case for continued and successive 50bp cuts over the next 3 meetings this year starting with tomorrow. We know the FOMC will not want to disappoint as the bond market players now put the odds of a 50bp cut at 63% based on the CME Fed Watch Tool:
Once they cut 50bp we will start to see the US Govt 10s/Fed Funds spread start to narrow from those record wide’s and this will just be the beginning of the long road back to ZIRP:
The US Govt 30Y is just getting started but veteran players know you buy the front end, 2s3s5s and 7s and short longer duration during these times and those that try to fade this move, well, you will be carted out feet first. Once they FOMC cuts the banks will come after short duration paper like no tomorrow, bringing in all the fast money sharks along side them, this is where career money is made, during these times.
You can already see the US govt 5s30 has exploded from a -50bp or so on its lows to now +52bp steeper as of today’s settles!
Ok that is a lot to unpack for today, but let’s finish with a couple of charts and today’s markets settlement sheet. First lets look at the equity futures and as we said, we will not be surprised to see a face ripping equity rally off of this cut which would bode well for a future counter slap in the face of recession reality. As far as the Nasdaq futures, we like longs there but on the weekly below 19338 is bearish set up wise and will open the downside, but at least the low side support is obvious there for you bulls:
As far as the SP500 5995 in the futures is still the target anything near those levels would be a lovely reversal spot and support is way below at 5450 so you can be your usual bulls above that but below, we suspect the sellers will sniff blood:
As far as the last chart we have its Gold futures, we like the extension target of $2825/35 area for a final blow off top before the economy turns and investors dump assets to raise cash, so above $2500 is bullish but below will act as resistance and drive sellers to continue to probe this market should it dip back below that level:
Finally, we feel that JPM is in its last legs of its ability to hold above $200, with competition going to be stiff and margins compressed due to the decrease in spread product or vig they get from their deposit/ONRRP, the ZIRP environment will be catastrophic should defaults mount and the bank sector will not be friendly if that comes to fruition:
Ok that is it, here are today’s updated settlements, look at that 2Y down 66.8bp from last years settle and there are those that think the FOMC is behind the ball…come on:
Ok that is it, we hope you learned something from our letter today, our goal is simple to inform you of all the things that we believe matter in today’s markets. To look at the data and the narrative and deconstruct it so that we eliminate all the noise that exists to sway your senses. We have over 25 years of expert market trading experience, spent mainly in interest rate arbitrage and studying monetary policy and its affects on markets and pricing across that same time frame. Trading isn’t easy, in fact you have better odds of making it as a professional sports athlete or just simply going to the casino, but we can tell you this, an informed trader a trader that has their priorities and goals in line, that deciphers data in a way that makes sense to them, then implements a sound strategy, you will find you niche and tilt those odds in your favor. We hope to assist you in that matter and its why we put out our letter and our audio casts, so that you learn from all that we do and have done for all these years navigating these complex markets. Alright please share our work and think about subscribing, we would greatly appreciate it!