February Has Quickly Changed The Rate Outlook

Heading into the 3 day weekend, we knew there was a risk that Friday's rally was driven by position squaring (i.e. traders buying bonds in order to cover short positions). Heading into the new week, new short positions are back in fashion.  While a certain amount of this selling pressure may have been our destiny regardless, it received a clear boost from stronger Eurozone services PMI data.  Yields were already testing their weakest levels since early November.  Then when US services PMI numbers came in stronger than expected, bond market weakness kicked into an even higher gear.   All of the above pertains to scarcely a few drops of paint against the broader backdrop of February.  This month has delivered a harsh new reality that has taken many market participants by surprise.  Surely, the rate spike of 2022 would be taking a bigger toll on economic data and the softer numbers would combine with tamer inflation to help rates ease back to lower levels. But in 3 short weeks we've seen one of the strongest jobs reports of the past year, a big reversal in Retail Sales, an uptick in core CPI (and PPI for that matter), and several other reports that have contributed to a surprisingly resilient economic picture.  The net effect is a rapid repricing of Fed rate hike expectations with the "farther out" meetings seeing the biggest revisions.   For instance, the chart below shows December's meeting expectations rising from 4.375% to 5.125%.  That's THREE additional 25bp rate hikes above previous expectations.  Looked at another way, the levels for June/September suggest the Fed will hike by 75bps over the next 3 months (25bps in March, May, and June meetings) and then hold steady for 5 months before cutting by 25bps in December.   Looked at ONE additional way, let's just focus on June.  It had been the terminal rate month (the month when the Fed is expected to hit its highest rate).  It still is the terminal month, but it's now seen 50bps higher than it was before the last jobs report.  50bps is a lot of ground to cover.  
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