· Market participants signal the Fed is done hiking

• Rate cuts are expected in Q1 or Q2 of 2024

This week, abetter-than-expected Consumer Price Index (CPI) report hammered bond yields as rate cut expectations jumped, signalling the end of the hiking cycle. 10-year US treasuries dropped below 4.5% on the news.

The Fed’s 2-year battle with inflation seems to be approaching the finish line. Unsurprisingly, the main culprit for the decline in headline inflation has been the nosedive in money supply (dipping below 0 for the first time in many decades), which has dragged down the CPI to 3.2%, displaying not a perfect, but decent enough correlation between the two variables.

Source: ZH

Market participants declare a victory lap over inflation as the final countdown to rate cuts begins. If history is any guide, and the above statement is true, it takes, on average, eight months from the last rate hike to the first rate cut (courtesy of Apollo’s Torsten Sløk). Hence, a rough estimate of the start of the cutting cycle would be March of next year.

Interest rate cuts are also priced in future contract trades, which give zero chance of extra hikes; expect cuts as soon as May 2024, indicating the hiking cycle is over.

Further, soft data only adds confirmation to that hypothesis, with the BofA Global Fund Manager Survey showing that Wall Street has never been so optimistic, with 76% of all surveyed anticipating the Fed is done hiking this cycle.

Source: BofA Global Fund Manager Survey

Lastly, the US debt has been ballooning in response to the pandemic, then the Russian-Ukraine War, and now the Israeli-Hamas geopolitical conflict, adding 1 trillion in the last three months alone and reaching the astronomical figure of over $33 trillion.

If that was not enough, nearly a third of it is maturing within the next 12 months, according to Apollo. And raising with it are the annual interest payments on that debt, skyrocketing passed the $1 trillion mark for the first time ever! That’s totally unsustainable.

Hence, the US government will greatly benefit from lower rates, and its main knight (the Fed) will make sure inflation is slayed as soon as possible.

The market consensus seems to be that the worst is behind us. One key trade likely playing out is the long TLT (Long 20y+ Bonds). As rates go down, bond prices go up and disproportionately more on the long end, as long-term bonds are more sensitive to interest rate changes.

TLT is an excellent example of what could happen once the expectations of rate cuts get priced in. It has bounced off its $82 level, the lowest since 2007, and -2SD (standard deviations) below its mean.

The trend seems to be finally reversing, as indicated by the red arrow, quite possibly towards its long-term average of $115.

This dynamic has been anticipated by market participants for quite some time, especially given the unimaginable drawdown of nearly 50% that it has experienced since the Pandemic days.

Source: Koyfin

The colossal volume spikes, as of late, signal that there are lots of dip buyers in the $80-$90 price range, implying that bond bulls are back!

Investors can long the TLT using our 5x 20+ Year Treasury Bond

Alternatively, they can short the TLT using our -5x 20+ Year Treasury Bond