Daily Economic Update: January 22, 2024

Friday's University Consumer Sentiment index far exceeded expectations with strength everywhere and slightly lower inflation expectations.   As people who have read this blog for a while know, some believe this report is highly negatively correlated with gas prices which are holding fairly steady at levels that are at least 10% lower than a year ago and well off the highs.  How continued tensions in the Middle East might impact oil, nat gas, and gasoline prices remains unknown, but the data shows the U.S. has somewhat stealthily become the world's leading producer of oil and gas.

Stock prices hitting all time highs despite rising yields.  The 2's10's un-inversion watch is getting real with 10Y yields only ~20bps below 2Y yields.  Entering a steepener (betting on an increase in the difference between long-term yields and short-term yields) trade back in March or July/Aug 2023 when the 10Y was yielding 100bps below the 2Y, looks like it would have been a pretty good trade. For the uninitiated a 2s10s Steepener trade can be constructed using interest rate futures (Treasury Note Futures...it can be traded with other products as well) in one of three ways: 

1. Duration Neutral - you Buy/Long 2Y Treasury Note Futures while simultaneously Sell/Short 10Y Treasury Note Futures with both legs of the trade sized to have the same Dv01 (generally you are short a lower quantity of 10Y note contracts than you are long 2Y note contracts).
   
   
2. Bull Steepener (you think short-term yields will fall more quickly than long-term yields) - you Buy/Long more Dv01 in 2Y Note Futures than you are Short Dv01in 10Y Note futures.  The idea here is you think the steepening of the curve will come from lower 2Y yields.  You run risk that the curve steepens but the steepening is a result of the 2Y falling moreso than from the 10Y rising.
   
   
3. Bear Steepener (you think long-term yields will rise more quickly than short-term yields) - you Sell/Short more Dv01 in the 10Y Note Futures then you Long Dv01 in the 2Y Note futures. The idea here is you think the steepening of the curve will come from higher 10Y yields moreso than lower 2Y yields.

A summary of this can be found here, courtesy of CFA Refresher Reading: Yield Curve Strategies

I'm not sure how much more room the steepening of the 2s10s curve has to run, but we've certainly have had plenty of years of experience with a "normal" yield curve shape where 10Y yields were over 100bps or more higher than 2Y yields.  If I had to build a case for why trading a steepener might not work well from here it would probably be a narrative that tied to a central bank policy that the market believes is overly restrictive, leading the market to price in higher 2Y yields and lower their future growth and inflation forecast leading to lower 10Y yields.  Alternatively a scenario where the Fed embarks on Yield Curve Control or QE could plausibly also lead to further flattening/inversion.

Of course if you strongly believed that the steepening would occur from just the 2Y yield going lower or from the 10Y yield going higher you could just make a bet simply on one leg of the above "steepener" trades.  And if you believe the Steepener has run it's course, you could trade Flatteners by reversing the direction of the trades above.

The week ahead features PCE, a look at 4Q GDP, Treasury Auctions, some PMI's and Bank of Canada and ECB rate decisions.

XTOD: So if you're a Davos class type — in finance, private equity, multinational business, certain think tank/academic/nonprofit types who depend on political connections — your gut instinct is to SURVIVE at all costs.  If that means a deal with the populist, well then...Suddenly we have — as at the start of this thread — Blackstone's CEO saying, "Hey... we can't afford another Biden admin. Maybe we should keep an open mind about alternatives..."  Or Jamie Dimon of JPMorgan saying "Actually, Trump WAS right after all..."  It's still early days, but you can see the line of thinking is taking form with some of the cannier Davos types:

"I want to survive and stay in the game, so it's time to dump progressives, neoliberalism, and woke stuff, and play ball with Trump."  Watch this space people.

XTOD: Theres no fucking way the Fed eases 150 bps into ATHs in both equities and RE, so if you are an RIA get ready to switch your bullshit narrative from 'Fed cuts' to 'The market can handle higher rates'.  No charge for the advice 

XTOD: The S&P 500 closed at an all-time high.  The Russell 2000 is still in a bear market*, down more than 20% from its high.  That's never happened before.

XTOD: Jill Biden trying to distract from her comments about Hunter’s drug abuse, and ending up under a giant banner reading “Hunter High,” is straight out of a VEEP episode

XTOD: 2008: Wall Street has a bust, the whole U.S. economy crashes 2023: Tech has a bust, the U.S. economy ignores it completely and does great  Finance is more systemically important than tech, which is why it should be regulated more.

XTOD: Like everyone else, at one point, I had zero readers and zero listeners. We all start out naked and afraid. Then your mom starts checking out your stuff, or perhaps a few friends give a mercy-listen, and the fragile snowball grows from there.

XTOD: Opening day is just 69 days away!

https://x.com/Smug_editing/status/1748539183516332330?s=20

https://x.com/Jimmyjude13/status/1748552738445660614?s=20

https://x.com/AngelaLMorabito/status/1747462261185114289?s=20

https://x.com/jasongoepfert/status/1748455766565031958?s=20

https://x.com/Noahpinion/status/1748250741607924002?s=20

https://x.com/tferriss/status/1748094065554395305?s=20

https://x.com/HeidiWatney/status/1748460716158603301?s=20