Interest Rates Commentary-No pain, no gain
October11,2022 GlobalTracingSolutionsCREDITSUISSE InterestRatesStrategy Americss InterestRatesCommentary Nopain,nogainTRADINGSTRATEGIST Developedmarketyieldshavereboundedoverthelastweek,with1Oyyields JonathanCohn 2125388713 acrosstheUS,Germany,andUKretestingtheircyclehighs.Challengedliquidity.elevatedintradayvolatility,andcontinuedweaknessinriskappetitehasgivenoffafeelingofgeneraluneaseinthemarket,oneworsenedbypolicyconflicts/trade-offsintheUKamidongoingmarketdysfunctionandfearofasimilarsituation emergingelsewhere. Inthisissueoftheweekly,weupdateourUSyieldforecasts.Weexpectyieldsto to4%.However,through2023,weexpecttheFed'sasymmetricpolicyreactionfunctionbenttowardbringingaboutarecessiontosucceedandforcutpricingto manifestinforcelaterintheyear,sendingyieldsacrossthecurvewellbelowcurrentimpliedforwardsandthecurvesteeperbeyondthe5ypoint.Outsideofexceedinglypersistentinflation,theprimaryrisk,inourview,isamarketdysfunctioninducedpolicychange(e.g.,forcedswitchtoQE)thatjeopardizesanchoredinflation expectations. Additionally,theevidentBoEcommitmentissuesinbackstoppingthegitmarketisalsodiscussed.Thecentralbankisdoublingdownonitsprovisionofhalfmeasurestoamarketdemandingmore,withstllalmostthreeweeksuntilexpectedclarityonthebudget.UKratesseemdestinedtounderperforminahighlyvolatilefashionandpassonadegreeofinstabilitytotherestofdevelopedmarkets. WealsopreviewthemainUSeventsthisweek,whichincludeCPI,theFOMCminutes,and10yand30yauctionsupply. Figure1:VolacrossassetsremainsuncomfortablyFigure2:Achievingonlyagradualriseinthe highunemploymentrateisatallorder 15 G103mimpliedFXvol 160 Chginunemploymentratearoundcycicalmovehigher;x-sxisinmonths 5.0+ 14150 3m10yimpliedvol,rhs140 13 130 12120 111102.5 10100 690 08 700.0 FedproJYE23andYE24 Jan-22 60-10102030 Mar-22May-22Jul-22Sep-22196919731979159020002007 .--Average Source:CreditSuisse,theBLOOMBERGPROFESSIONALTMserviceSource:CreditSuisseLocus SUISSEREPRESENTATIVEFORMOREINFORMATION. 11October2022CREDITSUISSE Nopain,nogain:Usyieldforecastupdate WeupdateourUSyieldprojectionsthroughyear-end2023(Figure6).Weexpect yieldstoremainelevatedthroughyear-end,revisingupour10yyieldprojectionforYE2022to4%.However,through2023,weexpecttheFed'sasymmetricpolicyreactionfunctionbenttowardbringingaboutarecessiontosucceedandforcutpricingtomanifestinforcelaterintheyear,sendingyieldsacrossthecurvewellbelowcurrentimpliedforwards.Outsideofexceedinglypersistentinflation,the primaryrisk,incurview,isamarket-dysfunctioninducedpolicychange(e-g. Thepathofpolicyshouldremaintheprimarydriveratthefront-endoftheTreasury reactionfunction,oneinwhichitwouldratherriskrecessionthanpersistentlyelevatedinflationandthusoneinwhichitwillcontinuetohikeuntilmultipleprintsshowsufficientevidenceofdisinflationaryprogress,Oureconomistsexpectanother 125bpofhikesthisyearandanadditional25bpinQ12023,pushingthepolicyrate to4.5-4.75%,inlinewiththedotplotmedian.Weseemoreupsidethandownside servicesmoregenerally),areasonablyhighlikelihoodthatthehikeincrementisgraduallyreduced,andwideuncertaintybandsaroundtheneutralrate.Forourprojections,wejotdownateminalrateof4.75-5.00%. Furtheroutthecurve,heightenedrecessionfearhasbeenacriticalsupportforduration.TheFed'sreactionfunctionpromotesthisbydesign.However,whilethe dotploteconomicprojectionsofferarelativelysanguineandgradualweakeninginthelabormarkettocomealongsidebelowtrendgrowth,historicalevidencesuggestsachievingsuchanoutcomewouldverymuchbeanoutlier.Indeed,historicalinstancesofincreasesintheunemploymentrateshowsignificantmomentumandanorderofmagnitudedifferencebetweentheaverageincreaseintheunemploymentrateduringacyclicaltrendhigherandtheFed'srelativelymoderate0.6pptprojectedincreasebetweenYE2022andYE2023(Figure2) Figure3:HomeaffordabilityhasfallenoffacliffamidFigure4:Collapseinhomesalesamidlow thespikeinmortgageratesaffordabilitypresagesfallinghomeprices % 220 Homeaffordabilityindex OSNewhomesales(y/ychg.3mavg)[25 200 180 40FHFAhomepriceindexy/y%20 15 20 1010 16000 140 120 -100 -20-5 OE- -40-10 100 066L1995200020052010201552020 -50 1990199520002005201020152020 -15 Source:CreditSuisse,theBLOOMBERGPROFESSIONALTMservioeSource:CreditSuisse,theBLOOMBERGFROFESSIONALTMservice InterestRatesCommentary2 11October2022CREDITSUISSE Thoughdeliveredinflationdataremainuncomfortablyhigh,therehasbeenawealth includefalingsurvey-basedandmarket-impliedinflationexpectations,leading classes,andaslumpinhousing.Thoughthepass-throughofthelatterintoinflationwilltakemoretime,theleadingindicatorsforhomepricesappearquitepromising.Homeaffordabilityhasfallenaggressivelyamidthesharpriseinmortgagerates,as havehomesales(Figure3).TheFHFApriceindexposteditsfirstm/m%decline sinceMay2020inJulyandhasalotfurthertogo,accordingtoitsrelationshipwithhomesales(Figure4). Theurgencyassociatedwiththeinflationthreat(andtheFed'sintermalizationintoits reactionfunction),however,dullspolicymakersensitivitytomediumtermrisks,regardlessofthehistoricalrecord,andinsteadheightenssensitivitytonearterm inflationdataadynamicthatjustifiescontinuedrecessionanxiety.
