Performance of the S&P500 is receiving attention. At the close of 6th February, the index was 3.3 standard deviations above the mid-point of our ‘Estimated Fair Value’. This is widest deviation from our ‘EFV’ in more than 20 years! This merits further discussion. Notice I’ve marked 7th November 2023 as a vertical line on several of the following charts – this marker goes some way to explaining the behaviour of the S&P500.
What is gathering special attention is that short term rate futures clearly monetary easing is are no longer expected at the March FOMC meeting. The May meeting now reflecting the highest probability of policy easing (66%). Even as the anticipation of an easing of conditions has been pushed back, the S&P500 has continued higher.
It is true that monetary conditions have been normalising and the S&P500 remains broadly in line with behaviour of the dollar and global money supply (in USD).
And I would further suggest the short term rates futures do not convey the entire rates story. As the S&P500 has deviated from our value estimate, the USD interest rate swap rates have remained substantially lower than they were in early Q3 2023.
The standout point from swap markets is how net receiving of duration has ramped up massively compared to the previous 12 months. This signals willingness of investors to protect against lower rates. Even as the expectation of a March rate cut has diminished, the net receiving has continued across the swap curve at levels generally well in excess US$ 14 million DV01 per day. The US$14 million net DV01 receiving was exceeded on 7th November 2023 – the vertical yellow line in the charts. Nor is this just a New Year hedging against debt issuance thing. The net receiving so far in 2024 exceeds historic hedging needs.
It is striking the S&P500 excess valuation (above our corridor of ‘fair value’) closely matches the higher level of net receiving in the swap curve.
What does this mean? The short term rates futures market may have wound back expectations of a March cut from the FOMC, but the OIS market is telling us there is an strong confidence of a turn in rates cycle. So far, the FOMC have not done a great deal to endorse that confidence. And given the extent of the gap between our estimated fair value and the actual S&P500 level, there is room for disappointment.