Morgan Stanley Recommend SFRH3/H4 Flattener

Morgan Stanley write “investors and the Fed continue to be at odds with each other when it comes to the forward path of interest rates. Last week, the fed funds forward curve flattened significantly, with rates by year-end 2024 lower by ~35bp while terminal remains anchored around 5%. This puts market expectations of 8 cuts by YE24 further away from the December dots, which show 4 cuts.”

• “Even though it seems that the market might be getting carried away and that we are due for a reversal, one could argue that current pricing is not so extreme given that: 1) the market is working with a different set of assumptions for the future path of inflation vs. Fed, 2) pricing incorporates the risk of a hard landing, which has increased post ISM, and 3) labor market tightness is showing initial signs of cooling.”
• “Current pricing suggests a pace of 25bp quarterly cuts, which is at odds with a hard landing scenario and is more consistent with a Fed moving back gradually toward neutral. At the same time, the FOMC's commitment to beat inflation will further increase growth concerns as the year progresses.”
• “We enter into SFRH3/H4 flatteners at -93bp as investors price in deeper and faster cuts and the Fed keeps expectations of terminal anchored and potentially higher depending on how data evolves.”