Focus
Gregory (Greg) Faranello, CFA
Head of US Rates: Trading, Strategy, and Economics | LinkedIn Top Voice
January 15, 2024
Good afternoon, everyone. Martin Luther King, Jr. was special. A once in a lifetime. Amongst so may attributes a prolific writer.
My favorite quote from him: "I believe that unarmed truth and unconditional love will have the final word in reality. This is why right, temporarily defeated, is stronger than evil triumphant."?
We live in changing times. It requires adaptation every day. An open mindset (2024). The strength to make prudent decisions in a world filled with distortions and seemingly easy answers. The ability to care when you may not have the ability to do so. To understand and disagree at the same time. And be willing to fight for the simplicities of right from wrong in a time and day whereas the temptation is to do otherwise.?
Big week ahead: more earnings, issuance, tons of global data. In the US, housing and retail sales. Rate cut Fed Governor Waller. 20-year US supply. Eyes on geopolitical developments. And yes, the Iowa Caucus. I'll take the political developments this year over Jay Powell any day of the week in 2024.?
Yep, we're just getting started in 2024.?
Let's Take a Look
This pandemic hit everyone in different ways. It shouldn't be underestimated. Certainly, the extremities felt back in 2020 have waned. But the implications, practicality, and direct outcomes are real. It's impossible for us to view 2024 outside the context of the past four years: 2020, pandemic. 2021, extreme response. 2022, shocks, 2023, aftershocks. 2024, testing boundaries. And boundaries are being tested at every level: geopolitical, fiscal, and monetary.?
It's hard to imagine a world that can be changing so quickly. I have college age kids. Just visited my Mom for her 89th birthday in an assisted living facility. The challenges on both ends complex. And as an middle-age guy find myself sitting well, in the middle. Digesting the variables and trying to balance it all out. The conclusion arrived to: stay focused. All walks of life, markets included.?
Focus has never been more important. We believe the fiber of success. Not just in our personal lives but with markets and career. Easy? Not even close. There are so many ways to become distracted in today's day and age. Social media, to all its benefits, challenged the fiber of our global society. And the darts of geopolitical and domestic risk are coming from all angles. The will of the people will need to speak louder than the few selected leaders. That process takes time. But if you want opinions and thoughts plenty are flowing each day.??
We are sorting through some heavy stuff here in the United States. The one thing we are seeing of late is clear: big stakeholders are standing up. And they're standing up because they feel, like we do, it's needed. It goes back to right or wrong. Simple things. Staying focused (our country). And understanding that underneath the complexity of divide resides a common ground. Those onion layers will be peeled. And ultimately the United States will find a way to stand strong as work through an election season in 2024.?
Practically, our fiscal equation is unsustainable. Reality, every political party has had their hand in the debt load we own. Many have written about fiscal dominance. Our up-and-coming generations just don't view the world and life the way our grandparents did. But Chair Powell's skew on November 1st was needed and real. Our "overall" economy won't tolerate significantly higher rates. There was a plethora of duration shedding since the regional crisis of March, 2023. The wounds will take time to heal. Consolidation is coming at many levels in 2024. In the end, a lower (but higher) rate structure likely prevails and will help.?
On the monetary side, political outreach to abolish the Fed noted. We live in a different world. The outreach from this Federal Reserve has grown. It will grow, not shrink in presence, in the years ahead. We all received a glimpse of it from Chair Powell in the last two months of 2023. "No higher rates". The dissemination of our debt matters. Dynamics have changed we wrote over the past two years. The Fed likely won't expand the balance sheet unless needed but they can ringfence rate levels if they have to. They likely have no choice given our political climate. And the US dollars reserve currency status is on display and notice.?
This year is bumpy. Not to be viewed outside the light of the past four (2021 was a once in a lifetime). Globally, geopolitical forces are flashing red, red, and red. Yes, we are being lured into a broader conflict. The looming election this year is without question expediting the timetable for action. We have our own issues here domestically. On the fiscal side just about used all our bullets. And for the bad participants on the global stage, it's time. Higher energy costs support the cause.?
For us, despite the decline in inflation from the peak, we see risk factors the other way. Putin and Xi have fully exploited global changes with energy policy. That's not a political statement it's a fact. Iran, they fund through reserves which have exploded with their one trick ticket: energy. And they understand that although merits exist to a more balanced energy efficient world, time is on their side. Because one switch doesn't shut off for another to open. And political forces come into play. We're seeing the issues in the Red Sea and how dynamics play out. It's less about interest rates and more about resources.?
We felt the setup for this year was better. Chair Jay Powell set that stage in late 2023 heading into this year. Rollover levels. But it will be a year to be earned. Opportunistic all the way. Some unbelievably good things going on for the economy on the ingenuity side. A year of transition, nonetheless. It will pay to remain open minded. We've written at length over the past few years ahead of the current narrative: de-globalization, geopolitical, inflation, onshoring, aggregate supply side central bank challenges. A different inflationary environment (higher skew) is everywhere you look despite the progress.?
It's an election year too. Surprises are on the way. Any money that can be spent this year will be (understandable!). The Treasury General Account is flush. QT will end. The Fed will begin the process to lower rates at their pace. Waller tomorrow to push back on timing (We think after silly rate cut euphoria. Was he drunk?). The financial more than real economy requires lower rates and a steeper curve. But we don't want the financial economy spilling over to the real like 2008. Balancing act. Powell knows it. And so does this Fed. They will begin hedging the growth and employment side. The 100-basis point move lower in real yields over the past few months was the opening gesture with doing nothing. This is how Chair Jay Powell runs his Federal Reserve.?
On the Ground
What a start, 2024. We've favored 2's and the curve since the short end was dragged along with the duration shed into late October. We've written throughout the cycle, in general, 2's peak in and around terminal. Touched around 5.25% a few months ago. Three times, regional bank pocket 2023 (March, April, May), tested the 3.75% region and rejected (bull, bear whipsaw UST 2/10). Of course, the Fed back then initiated the bank lending program and shifted back to rate hikes. Rising geopolitical tension weighing in too. The short end has done nothing wrong, but it's come a long way. 2020, pandemic. 2021, extreme response. 2022, shocks, 2023, aftershocks. 2024, testing boundaries.?
We're stretched on short term levels. Curve and outright. But the move now counter to early 2023 much more methodical and practical, Fed cycle. We picked out spot in October after Hamas attacked Israel. Multi-year shift in view. Rate level versus terminal a big factor. History. We missed a few basis points but have caught this broader move. Bumpy. Not going to be a straight line. And yes, the Fed is pushing back on rate cut timing no surprise. We are in the midst of a recalibration. Testing boundaries after many years of ZIRP and QE. Neutral, fiscal influence unlike anything we've seen. The Fed left room back to 3.25%. It's a matter of time and speed. But that overall skew and conviction should keep the rate market well supported. Geopolitical escalation a continued focus.?
Have a great week ahead!?