This is Joe Lunardi’s Bracketology, which pits SMU against Texas. There is something delicious about making a Dallas school and an Austin school fly to Buffalo to play each other. It’s like when we travel to SoCal for volleyball only to play another team from our own club.
I wonder if Longhorn fans have the same unrealistic expectations on their basketball team that they put on Arch? Will the SMU booster Gulfstream land in Buffalo too late to make tip off (Sorry SMU). Don’t worry Stan, I won’t be taking up one of your parking spots this time…
Last Week This Morning
10T: 4.28%
2T: 3.73%
SOFR: 3.65%
Term SOFR: 3.67%
Inflation came in as expected, but everyone ignored it because it doesn’t reflect Iran issues
GDP: 0.7% vs 1.4% expected (which initially came in well below expectations of > 2.0%)
Oil vs Rates
This graph we put together got a lot of love when the Fed started hiking in March 2022. The basic message is that when oil and rates move up at the same time, it triggers a recession.
But when only one moves up, we can avoid a recession. That’s what happened from 2022-2024 with higher rates and falling oil. Now, the Fed is on hold, but oil is spiking. This suggests a recession could be avoided as long as the Fed doesn’t start hiking.
Powell is Off the Hook. The Fed Isn’t
To the surprise of no one with a brain, a judge shredded the DOJ’s case. Pirro said they would appeal, but why? Powell’s term ends in May! With each poke of the bear, the WH only risks Powell sticking around beyond May.
The Fed obviously isn’t changing rates this week, so what do I expect?
The current Fed is likely to view the oil shock through the same lens as tariffs (one-time shock), but I’m not so sure Warsh will. The FOMC is already slightly hawkish and if you’ve been reading this newsletter, you know Warsh is an apex inflation hawk. I wonder if Trump regrets the choice already? Warsh has been conspicuously quiet the last two weeks. Any chance he wants to avoid speaking his mind and costing himself the Fed Chair position?
Miran will obviously dissent, but everyone discounts his vote as a Trump yes man (although if you actually listen to him talk, he makes very legit arguments…he might be a yes man, but he’s not a quack). Waller might dissent, citing the continued weakness in the labor market. Everyone else will vote for no change.
In addition to Powell’s presser, the focus will be on the anonymous median year-end forecasts, the SEP.
Summary of Economic Projections (SEP)
Is this the last SEP we’ll ever see? There’s another meeting before Powell’s term ends, but the SEP is only released at every other meeting. Warsh will likely want to eliminate these forecasts under his watch.
Here’s what I expect in the SEP:
Will Iran/Oil Cause the Fed to Hike?
No.
“But JP, inflation! I’m back! Let’s make another bet!” – JMo
My dearest JMo, you beautiful idiot, answer this question for me, “Would hiking rates bring oil down?”
I asked the same question when supply chain issues were forcing ships to drop anchor off the SoCal coast, “Would hiking rates process more ships through the LA ports?” C’mon.
Would hiking rates get more ships through the Strait of Hormuz? C’mon.
Monetary policy is a tool, but it can’t fix everything. Raising rates is intended to dampen demand. Oil spiking because of supply concerns isn’t a demand side issue, it’s a supply side issue. Rates impact demand side.
I do believe it creates an optics problem to be cutting in the face of rising inflation, so the Fed is officially on hold.
But everyone’s an inflation tough guy until friends and family start losing jobs. If the labor market rolls over, the Fed will absolutely cut, even if the optics look bad with inflation rising.
I expect Powell to remind everyone that the “Core” in Core PCE means they strip out commodities for precisely the reason I mentioned above. Oil running up over $100/barrel isn’t because of demand, so why should the Fed react to that?
Rates
Markets now have a 40% probability of no cuts this year, which is a dramatic change since the two cuts fully priced in before the Iran strikes.
The 2 Year Treasury surged to its highest levels since last summer, which is bad news if you’re in the process of buying an interest rate cap. Caps are getting a double whammy: a 25bp surge in yields paired with a record-setting spike in vol.
CME data shows 2-year Treasury options trading has spiked to historical highs. These options suggest less about direction and more about volatility.
The news isn’t any better on the T10 front. We closed the week at 4.28%, matching last summer’s levels. The market is laser focused on inflationary pressures for now, but the longer the Iran conflict drags on, the more likely the story becomes the negative impact on the global economy.
For the T10 to push back to 4%, we need resolution in Iran or eco data weak enough to counter the inflation concerns. Friday’s weak GDP wasn’t important enough, so jobs data might be the only data point that could drive yields significantly lower.
Technicals
Higher: 4.35% and then 4.49%
Lower: 4.20% and then 4.10%
Week Ahead
It’s not often that an FOMC meeting is an afterthought, but here we are. No change to rates, but the dot plot and press conference will be the main event. Does the median dot still show cuts this year? Does Powell acknowledge the stagflationary risks from oil? And how does he address the DOJ situation without looking political?
It's going to be a busy week. Maybe the busiest of the year so far. Then again, I've said that about every week since January.