Macro Digest: Confusion reigns supreme

What: The cost of Silicon Valley Bank’s implosion was 100 bps lower forward rates and an indication of an earlier Fed cut.

Why: Market assesses that this means tighter credit as bank vulnerabilities suddenly laid bare: the probability of a recession has risen to a consensus of 65% (survey by Bloomberg LLP for probability of a recession within the next 12 months)

What could go wrong:  That 65% probability of a recession is most likely too high, certainly against an economic reading which still sees high inflation, full employment, and resilient consumers. The market seems to want to force a recession, but the most likely path is one of a grinding deceleration rather than a collapse.

Where does this mean for Fed expectations: The market is aggressive in pricing rate cuts already starting as early as Q3: with September FOMC expectations priced about a half-cut below the current Fed Funds Rate and 30 basis points below the terminal peak rate. This path for Fed policy is not supported by incoming data nor Fed rhetoric. If anything, the Fed has echoed the ECB approach, by maintaining focus on communicating to markets that the inflation is not over and the fight continues, with the added language in the most recent FOMC statement that the risk of tightening credit conditions could possibly doing some of the work to bring down inflation: in place of further hike.

The SaxoStrats View:

We see no Fed rate cuts between now and September. If anything, we would be short the June and September SOFR’s (the three-month interest rate futures vs long December-23 or March-24)

We are fading the early cut and moving our rate cut expectations into Q4 of this year or Q1 of next year instead of June-September.

We have a strong view that the timing issue for what is set to unfold from here is the difficult “known unknown” that could get the market into trouble. Things generally take far longer to play out, and with the huge variety of potential directional paths from today and into a recession or rate cut, the market looks over-confident on cuts and recession.     

The market is impatient and has been quick to extrapolate an incoming recession from impulse changes, but the economy is coming off higher than expected growth, jobs and consumer spending and if SVB had not happened, the Fed would have moved 50 bps on its last meeting and would be looking for a terminal rate above 6.00%.

For the Fed to so quickly turn 180 degrees while the stock market is up between 5-18% (S&P & Nasdaq) would be major mistake.

Conclusion/Action: We would be short June and/or September SOFR  vs December-23 or March-24 SOFR futures, anticipating the market is forced to punt the recession call further down the road.

The market is almost day-by-day on data dependency which will keep volatility elevated.

Our Technical Analyst Kim has sees mixed outlook for the S&P 500, while the Nasdaq 100 is bullish technically. But looking across the market, the small-cap Russell-2000 is still bearish. We also note that the present rally, especially in the Nasdaq 100, is carried by the “Big 5” – meaning this rally is very narrow and does not giving equity allocations a big lift unless they are in these big names.

Below is a chart of the SOFR pre-and-post SVB.