Last night on the globex open, the S&P futures opened at 2072.00 and maintained a sideways offer after the open for the duration of the Asian and European sessions making a low of 2066.75 at 2:45 CT and failed to hold the bounce and drifted lower into the U.S. cash session open.
At the US regular trading hours open, the S&P opened at 2067.25 and immediately traded lower, making an early low of 2061.50, which was yesterday’s opening print. From there the S&P failed to maintain a significant rally and looked like it wanted to re-test the lows all afternoon while maintaining a 7.5-handle range until 2:30 Central Time, when what was probably a large order dropped the floor on the S&P futures amidst the low volume and lower liquidity, and quickly took the contract down to the 2053 low. The index tried to rebound but failed late in the day on an MOC buy imbalance of $153 million. For the most part, the equity indexes retraced much of yesterday’s gains with the S&P setting to day at 2055.00.
Heard across the news wires today was very little as far as trading was concerned, but did include a noticeable pending home sales miss at 9 a.m. CT which likely contributed to the damper on the day. Going into tomorrow, the final trading day of the year has been lower 13 of the last 20 occasions and historically could trade in a tight sideways range or could be volatile.
“Looking ahead, we forecast 10-yr benchmark Treasury yields to rise to 3% by end 2016 – or 50bp above the forwards. This expectation is built on the following set of assumptions.
1-An ongoing above-trend economic expansion: US 10-year Treasury yields currently compare with a ‘fair value’ estimate of 2.7% (i.e., are around 1 standard deviation too low) based on our Bond Sudoku model.Factoring in our economists’ macro forecasts for above-trend GDP growth, an acceleration of inflation and higher policy rates in the US alongside macro developments abroad, our model ‘fair value’ estimate increases to 3.4% by end-2016. In forecasting a 3% yield by next December, we presently assume the ‘valuation gap’ to remain the same as today’s, to reflect the ongoing QE in the Euro area and Japan.
2- Fed hiking more than priced into the forwards: An important ingredient in our estimates is our US Economics team forecast of the Fed hiking four times this year, or by a cumulative 100bp to 1.30%. The market instead sees rates at 90bp after the 14 Dec 2016 FOMC meeting, with two-thirds of the probability mass in a 60-110bp range. Using the market pricing for the effective Fed Funds rate, our measure of ‘fair value’ for Treasuries would be around 10-15bp lower (or 3.25%), all else equal.
3- An upward shift in medium-term inflation expectations: We see CPI inflation picking up during 2016, led by the services categories.Although this is already reflected in the fair value estimates discussed above, an increase in service inflation (ex-energy) from the trailing 2.9% towards 3.5% (levels last seen in 2007-08) may well act to lift medium term inflation expectations, and thus the term premium. Such an outcome underpins our view on that the 2-10-year nominal term structure will steepen over the next couple of quarters. To be sure, the high volatility and downward pressures in crude oil prices continues to keep the term premium depressed. But we expect these effects to wane and reverse during the course of 2016, as crude oil prices increase towards our 12-month forecast of US$ 50 per barrel on WTI, from US$ 37 per barrel at the time of writing.
4- A higher expected terminal rate and an increase in term premium: An historical analysis of the behaviour of the US yield curve during previous four Fed tightening cycles reveals that the market has always progressively revised upwards its view on the ‘neutral’ level of rates as the Fed pushed policy rates upwards (see ‘How Will Bond Yields Move in the 100 Days After the First Hike ‘, 11 Sep 2015). In other words, expectations on the degree of monetary tightening the economy could withstand have in the past tended to be adaptive. We judge the current market-implied level of neutral rates (around 50bp in real terms) as too low. By contrast, as the hiking cycle extends, the norm is for the ‘term premium’ to decline from relatively high levels in proportion to terminal rate expectations (on the average of the past 4 cycles, around 75%), a phenomenon particularly evident in the 2004 cycle (here we use the NY Fed’s ACM estimate of the term premium). Presently, the term premium is zero. Although there have been periods, like in the 1960s, when the term premium was very low, it has not been negative outside short periods of time.”
Francesco Garzarelli – Goldman Sachs
Danny Riley of MrTopStep has been asked to make an appearance on the radio at 7:55 a.m. CST and 11:55 a.m. CST Monday, January 4th, at www.rmastars.com. Danny is hoping that all of his followers will come out and listen to him as he discusses relevant market news and timely commentary on the S&P 500 and all tradeable markets.
Seen Today In The IM Pro Trading Room:
Top Notch ( 8:10:39 AM ): – good morning. opening bond thoughts / RIGHT BEFORE NOON THIS FUTURE MADE A MOVE SOUTH FALLING OVER A FULL POINT BY DAYS END TAKING NO PRISONERS ON THE WAY. SWOOPING UNDER LAST WEEKS LOW OF 153.24, FOLLOWED WITH A HIGH LAST NIGHT AT 153.23, A KEY FOCAL POINT IF THIS FUTURE HAS ANY INTENTIONS OF WORKING BACK UP THE LADDER. THAT MOVE LEFT BEARISH IMPLICATIONS TO SEE FURTHER EROSION HEADING INTO THE YEARS END. 152.19 KEY!