Goldman: Less Now, More Later Dynamic Would Carry Implications For Curve, Vol.

Goldman Sachs note that “while the Fed decision itself was largely as expected, Chair Powell’s statement that the committee is not actively considering a 75bp move drove a sizable front-end led reaction. The statement should reduce the range of potential outcomes for the upcoming meetings, and FOMC OIS responded accordingly following the comment, with near-term meeting gaps compressing and implying a peak pace of around 50bp (down from over 60bp in the days leading into the meeting). Upper right volatility also underperformed, reflecting a compression of right tail risk in that part of the surface. Price action on Thursday hinted at a broader potential shift in front-end dynamics, as 2023 forwards led the selloff without much reassessment of the very near-term pace. One interpretation is that the reduction in the potential for even faster hikes in the near term may increase the prospect for more hikes in aggregate. A similar dynamic was visible in the 1994-1995 cycle where a slower peak pace of hikes was correlated with more aggregate tightening being priced. So far this cycle, the reassessment of the terminal rate has been fairly correlated to the front-end, with the market repricing both levels in the same direction. Moving forward, however, to the extent that 50bp is established as a credible upper bound on hike increments, the degree to which the very front-end can participate in future selloffs is limited. This moves the pressure point further out the forward curve, thereby producing a steeper curve than we previously assumed. For similar reasons, we would expect steeper volatility curves as well.”