BofA holding the hawkish line.
Themes: more restrictive Fed policy needed to restore price stability
Economic pain likely will be required to restore price stability and the Fed appears comfortable with that trade off. The Fed continues to revise the terminal rate higher which reinforces our core view: clients should remain underweight the front-end and slightly overweight the back end.
The front-end underweight is due to an increasingly hawkish Fed and the slight overweight back-end is due to rising recession concerns. We expect the curve to keep flattening and duration longs will gain support as inflation falls and recession fears rise. We continue to believe the best time to initiate outright duration longs is after the last Fed rate hike which the Fed dot plot suggests will occur in early’23.
Our economists expect the Fed terminal rate to be 4.75-5% but risks skew to the highside. Risks also skew to a faster delivery of the hikes and a longer period of 75bp rate increases. The Fed doesn’t know how high they will have to hike. They will keep hiking until the economy shows signs of slowing and the labor market cracks.
Forecasts: 2yT and 10yT end ’22 forecast risks skew higher
We project end ’22 2Y and 10Y rates at 4.4% and 3.65% but risks skew to the high side. We see 75bps of 2s10s curve inversion at end’22, consistent with high recession odds. Our end’23 forecast has 2Y and 10Y rates at 3.25% and 3%, respectively. A strong economy means Fed terminal funds may be higher which means forecast risks are to the upside.
Risks: a Fed overshoot seems inevitable
We see risks of a Fed overshoot. The Fed is hiking at the fastest pace in recent memory while they are at max uncertainty on the macro outlook. The market is likely to keep pushing real rates higher and we think theFed won’t stop until something breaks.
