USD Rates: Peak headline inflation

We see the terminal Fed Funds Rate at 3.50%.
Group Research, Eugene Leow11 Aug 2022
    Photo credit: Unsplash Photo

    Peak headline inflation is likely behind us. US CPI missed (actual: 0.0% MoM sa, consensus: 0.2%) by a sizable margin triggering position adjustments across assets. It also helped that the market was worried that core inflation (actual: 0.3% MoM sa, consensus: 0.5%) would prove problematic but the figure turned out to be better than feared. Our view on USD rates remains the same. We still expect a terminal Fed funds rate of 3.5% by the end of the year. This makes us a tad dovish than the current market pricing of 3.75% in 4Q22/1Q23. While market did pare bets of another 75bps hike in September, the overall move for the day was muted after an initial sharp dip in yields. Similarly, 10Y yields dipped below 2.7% (our lower bound neutral estimate) before closing about unchanged at 2.78%. 

    There are a few points to consider as the US crests peak price pressures and backward-looking measures start to align with forward looking ones (including breakevens and survey expectations). First, the current environment is a tentative step towards Goldilocks, a scenario we flagged up as a possibility on Monday. This explains why risk assets extended the rally that started early July. Inflation, while still uncomfortably high, does not look like it is out of control. Second, the Fed is unlikely to be dissuaded from just one CPI print. This print may be sufficient to argue for a downshift to 50bps (our current view) but a pause at this point is extremely unlikely, especially when the labour market is firm. With the shelter component and hourly earnings still running hot, more hikes are needed. Third, tail risks of much higher inflation and therefore an even more aggressive Fed has faded somewhat. This is also reflected in the fall in implied volatility in USD rates. Overall, the developments are broadly in with our overall view that we will crest the 3 peaks - peak inflation, peak Fed action and peak Fed rhetoric in the immediate few months. Strategy wise, we are still unconvinced that the Fed needs to backpedal quickly in 2023. We also prefer to fade extremes when 10Y yields deviate from our estimated neutral range of 2.7-3.0%.

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
    Subscribe here to receive our economics & macro strategy materials.
    To unsubscribe, please click here.

    The information herein is published by DBS Bank Ltd and/or DBS Bank (Hong Kong) Limited (each and/or collectively, the “Company”). This report is intended for “Accredited Investors” and “Institutional Investors” (defined under the Financial Advisers Act and Securities and Futures Act of Singapore, and their subsidiary legislation), as well as “Professional Investors” (defined under the Securities and Futures Ordinance of Hong Kong) only. It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. This research is prepared for general circulation.  Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies.  The information herein is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction (including but not limited to citizens or residents of the United States of America) where such distribution, publication, availability or use would be contrary to law or regulation.  The information is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction (including but not limited to the United States of America) where such an offer or solicitation would be contrary to law or regulation.

    This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) which is Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Singapore recipients should contact DBS Bank Ltd at 65-6878-8888 for matters arising from, or in connection with the report.

    DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E. 

    DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability.  18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.

    DBS Bank (Hong Kong) Limited, a company incorporated in Hong Kong with limited liability.  13th Floor One Island East, 18 Westlands Road, Quarry Bay, Hong Kong SAR

    Virtual currencies are highly speculative digital "virtual commodities", and are not currencies. It is not a financial product approved by the Taiwan Financial Supervisory Commission, and the safeguards of the existing investor protection regime does not apply.  The prices of virtual currencies may fluctuate greatly, and the investment risk is high. Before engaging in such transactions, the investor should carefully assess the risks, and seek its own independent advice.