Tuesday's Market Minute: Hey Equity Traders, the Bond Market is Not Pricing in a Pivot…Yet

The recent pop in indexes has been accompanied by an already better-than-expected earnings season, technical indicators screaming that the market is oversold in the short term, and this pesky narrative that seems to reappear once we make new lows: “The Fed may pivot”. Narratives are great: they capture the attention of investors and can be a great conversation starter around the watercooler, but when the narrative does not correlate to market positioning, that could spell trouble. We’ve seen this fake out before.

When trying to gain an understanding of the market’s thoughts on future rate hikes, there is no better product in my opinion to keep an eye on than the 30-day Fed Fund Futures (/ZQ) offered by the CME Group. Fed Fund Futures are used by institutions to hedge short-term interest rate risk. Without getting too deep into the weeds, the product is priced against a reference value of 100. To see where the market is pricing in Fed Fund rates at any particular time, you subtract the price of the contract from the reference value of 100. The current Fed Funds range is 300-325 basis points, or 3-3.25%. The market has already priced in a 91% chance the Federal Reserve will hike rates by 75 basis points in November, bringing the range up to 3.75%-4.00%.

Before this “change in narrative” that the Fed will pause, pivot, or even slowdown the pace of rate hikes, the market priced in a 75-bps rate hike in November, 50-bps in December, and 25-bps in February 2023. What is the market pricing in now? 

November Fed Fund Futures Price=96.205=3.795% Fed Fund Rate 

December Fed Fund Futures Price=95.82=4.18% Fed Fund Rate 

January Fed Fund Futures Price=95.56=4.44% Fed Fund Rate

February Fed Fund Futures Price=95.243=4.757% Fed Fund Rate

November is pricing in a 75-bps rate hike, December 50-bps, January 25-bps, and February 25-bps. Yes, you read that correctly, the January contract is pricing in an off-cycle 25 basis point rate hike. Now, don’t be too concerned, this happens in the Fed Fund futures market. You could add that off-cycle rate hike to the February rate hike estimate, making it 50 basis points. But even then, do these implied rate moves on one of the most rate-sensitive rate products reflect a change in tone? No, institutions are still positioned for aggressive Fed action though April of 2023. In the recent past, we have seen the fixed-income market influence Fed policy. Equities, on the other hand, haven’t had the “juice” to impact Fed policy for almost two decades.

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