Yesterday's market action has me wondering if I've misread the street's expectations. I had figured that a cut was priced in by June, and that any minor change in the statement now would only be a set up for a June cut. In fact, the only real change in the statement was to describe the slowdown in the housing market as "substantial."
But the market gave us a bull steepener, meaning that rates in the short end moved lower by a greater degree than in the long end. As I said last week, a bull flattener means that the market expects Fed cuts sooner rather than later. While I agree with the idea that the Fed may cut 1 to 3 times in 2007, I just do not see that the Fed is setting up a series of cuts in 2007. And having Bernanke's crew publicly state the obvious about the housing market hardly changes my mind.
One idea that I keep coming back to is that the curve will eventually steepen. I believe that will take most of the upside out of the 10-30 year part of the curve. If the market has correctly anticipated the Fed's actions, then the long-end will be priced right first, and the short-end will catch up. I'm building a short-end barbell, with some floating-rate positions and some 5-7 year positions. I'm light in the 20-year area. I have some positions in the 30-year area, as protection against a big bull flattener.