Interest Rate Derivatives Rates, unlike the economy, are not...-110224114

1Srini Ramaswamy AC (1-415) 315-8117srini.ramaswamy@jpmorgan.comJ.P. Morgan Securities LLCIpek Ozil (1-212) 834-2305ipek.ozil@jpmorgan.comJ.P. Morgan Securities LLCPhilip Michaelides (1-212) 834-2096philip.michaelides@jpmchase.comJ.P. Morgan Securities LLCArjun Parikh (1-212) 834-4436arjun.parikh@jpmchase.comJ.P. Morgan Securities LLCNorth America Fixed Income Strategy06 September 2024J P M O R G A N•Recent data corroborates the assessment that labor market is cooling but not breaking, and markets’ expectations are more clustered than ever around an accelerated path of rate cuts ...•… however, an aggressive pace of easing is by no means a foregone conclusion and the pace will ultimately depend on upcoming data and evolving economic outlook. There-fore, our approach to trading the markets is based on a recognition that the weights on less aggressive easing paths could increase in coming weeks, simply due to the fact that the weight on aggressive cuts is now significantly large •One attractive way to position for a shallower cycle (relative to what is priced in) is to take advantage of the steepness of the 2s/3s swap curve - initiate 2s/3s swap curve flat-teners with a 10% long in 3s to hedge against the prospect of a more aggressive easing pace•We also maintain our bullish stance on volatility given that expectations surrounding the pace of easing will likely remain quite sensitive to upcoming inflation data as well as Fed-speak •On a relative basis, we recommend selling 10Yx10Y straddles versus 3Yx3Y straddles as this volatility curve appears mispriced and is relatively immune to a broader reshap-ing of the implied volatility surface •We turn more cautious in our expectation that term funding premium and zero duration spreads will correct towards fair value in the near term. Bond fund AUMs continue to rise, providing a demand-side counter-balance to the increase in UST duration supply, which could help keep term funding premium stable near current levels. Similarly, GC repo rates continue to remain elevated, and with O/N RRP now near ~$300bn, it is plau-sible that they remain elevated and thereby keep zero duration spreads from widening back towards fair value. Therefore, we now turn neutral on outright swap spread posi-tions and on spread curve flatteners premised upon a rise in term funding premium•On a relative basis, we recommend initiating weighted 20s/30s swap spread curve flat-teners based on valuations relative to the broader term structureRates, unlike the economy, are not yet in “equipoise”The most important event of the recent past for market participants was without doubt Fri-day's employment report, which produced a largely consensus outcome. NFP came in at 142K (cons. 165K), and the unemployment rate ticked down marginally to 4.2%. Taken along with other recent data, this corroborates the assessment that the labor market is cooling but not breaking. In his comments on Friday, NY Fed President Williams noted that the economy is "in e