No Ceiling, just open sky

May 30, 2023

–After closing lower in 11 of the last 12 sessions, SFRZ3 is getting a small bounce.  Settled 9501.5 on Friday, now 9507.5.  On March 8 the settle was 9446.5, the high settle a week later, following SVB was 9616.5.  This latest sell-off started with a high close of  9579.5 on May 10, so on a settlement basis a drop of 78 bps.  The Fed’s March SEP pegged year-end FF target at 5.1%; Friday’s settle was 4.985% (getting close). The end-of-2024 estimate in SEP is 4.3%, and Dec’24 SOFR settled 9647 or 3.53%.   SFRZ3/Z4 is now the most inverted one-year calendar spread at -145.5.

–The debt ceiling agreement has sparked buying in stock index futures, though it also means a withdrawal of liquidity as the TGA is built back up (from fumes to $5-600 billion).  Additionally the end of student loan forbearance is, according to McCarthy, going to result in $5 billion a month being transferred to the government.  I doubt the number is anywhere near that high in reality, but it’s still a liquidity suck on the economy and consumer spending.  2/10 treasury spread at a new low of -75 bps (-78.5 this morning) is projecting much slower growth.

Feeling the blues

May 28, 2023 -Weekly Comment

*****************

As far as I know, David Zervos, Chief Market Strategist for Jeffries, coined the memorable catchphrase “SPOOs and Blues” a short time after the financial crisis.  It’s not always the case, but since the Fed began hiking rates, the two have pretty much traded in tandem, with moves in forward interest rates appearing to lead. (Blues are 4 years forward, SFRM6, U6, Z6, H7).*

Friend JC has steadfastly maintained that the back end of the SOFR curve has played the lead supporting role for stocks.  If forward rates are declining that will be a good tailwind for stocks and help juice up discounted forward earnings.   

So what happened in May?  SPX closed at a new high for the year (thanks NVDA).  However, from the high settle on 4-May the blue pack fell over 50 bps, to an average price of 9669.25 or about 3.3%.  This calendar year, the 30yr bond has ranged between 3.5% and 4%, edging just above 4 on Thursday.  For the past six months the blue pack has ranged between 9730 (2.7%) and 9650 (3.5%).  In other words, the four year forward 1-year rate has averaged about 3.1%, 200 bps lower than the current Fed Effective rate of 5.08%.  This week appears to have set off a silent warning that stocks are vulnerable to a setback (SPX that is).   

However, if you look at blues overlaid with the Russell 2000, the vulnerability is laid bare.  That index (R2K) has never really recovered following the SVB revelation that regional banks were walking around naked, having lost the garb of low-cost stable deposits to fund assets backed by CRE.  As Warren Buffett might say, the tide has gone out.  Depositors have flocked to the high rates and safety of t-bills, with yields likely to be further enhanced by another Fed hike and increased supply once the debt ceiling can pass Congress. 

We all know that “stocks” can mean a lot of different things.  NVDA added $200 billion in market cap at the end of the week, close to 10% of the TOTAL cap of Russell 2k ($2.6T).  Completely reasonable….right?

On the week, US yields soared as inflation data disappointed (Q2 GDP Price index +4.2% and PCE Price Index +4.4%).  The two-year (using WI from the previous Friday) rose 33.7 bps to 4.564%.  Tens added 12.2 bps to 3.81%.  The 2/10 spread is -75 bps.  On the SOFR curve, Whites (1^st year) down 32 bps with a rounded pack price of 9496, Reds down 33.75 to 9628, Greens down 20.75 to 9671 and Blues down 18.25 to 9669.  For this note, I focused on the forward part of the curve embodied by blues, but it’s worth a mention that higher US rates have also boosted DXY from a low near 101 in the beginning of May to 104.20 on Friday, with $/yen 140.60, a new high for the year, highest since last November.  August Fed Funds settled 9466.5 or 5.335%, 25.5 bps above the current Fed Effective of 5.08%.

News this week includes ISM Mfg on Thursday and Payrolls on Friday, with NFP expected 190k. The tentative debt-ceiling deal may be put to a vote on Wednesday.  

For your holiday barbeque listening enjoyment, here’s a fitting BLUES anthem from Albert King:  Born Under a Bad Sign.  (Full volume)

“If it wasn’t for bad luck, I wouldn’t have no luck at all”

	5/19/2023	5/26/2023	chg
UST 2Y	422.7	456.4	33.7
UST 5Y	370.5	393.2	22.7
UST 10Y	368.8	381.0	12.2
UST 30Y	394.4	396.7	2.3
GERM 2Y	275.7	294.2	18.5
GERM 10Y	242.7	253.8	11.1
JPN 30Y	123.2	124.9	1.7
CHINA 10Y	271.9	272.2	0.3
SOFR U3/U4	-152.5	-143.5	9.0
SOFR U4/U5	-35.0	-52.0	-17.0
SOFR U5/U6	2.5	1.5	-1.0
EUR	108.06	107.29	-0.77
CRUDE (CLN3)	71.69	72.67	0.98
SPX	4191.98	4205.45	13.47	0.3%
VIX	16.81	17.95	1.14

*A ‘PACK’ is simply the average of the 4 contract prices.  The blue pack starts with SFRM26 9670.5, U6 9669.5, Z6 9669.0 and H7 9668.0.  The average of the prices is 9669.25.

Washout

May 26, 2023

–Washout in rates continues.  SFRZ3 settled -15 at 9508.  Range on the month in that contract has been 108.5 bps and high settle to yesterday’s low settle is 89.5 bps.  New highs in near SOFR calendars as another near-term hike is priced: FFQ3 settled 9467 or 5.33%, exactly 25 bps above the current EFFR of 5.08% (there are 2 FOMC meetings in front of the August contract).  SFRM3/M4 made a new recent high of -126.25, while SFRH4/H5 made a new recent low of -121.5. I.e. weakness is concentrated in the 3rd, 4^th and 5^th forward quarterly contracts, H4 (-19.5, 9551), M4 (-21.5, 9594.5), U4 (-20.0, 9630.5).  Inverted spreads indicate that eases are still expected, but this price action suggests they are coming a bit later and perhaps less aggressively.  On the other hand, when something bad happens, the Fed USUALLY eases rapidly.  Of course, we’re in a bizarro world with a bizzaro Fed: Hike Fast and Cut Slow?

–2/10 spread new low -69 bps (2y +16 at 4.506 and 10y +9.8 at 3.815).  The thirty year bond yield ended at 4%, the top of this year’s 3.5 to 4% range.  High in 2022 was 4.4%. 

–Today we get the Fed’s preferred inflation measure, PCE prices, expected 4.3% yoy vs 4.2% last, with Core 4.6 from 4.6.

–SOFR option pit closes at noon Chicago today.  Box until 4.  

A soft, easy hike

May 25, 2023

I left a good job in the city
Working for the man every night and day

-Tina Turner   Proud Mary

–Jobless Claims today expected 245k. 7yr auction.  As Waller said yesterday, the labor market remains tight and inflation is stubbornly high, but credit conditions are a wild card which could lead to a skip in June.  My sense is that the Fed is likely to skip, but to continue to jawbone that hikes are needed, which will have the effect of bringing forward SOFR contracts nearer to the current FF rate.  In a way, that strategy serves as a “soft hike” and buys time.  SFRZ3 (weakest contract) fell another 8.5 bps yesterday to 9523 or 4.77 vs EFFR of 5.08%, while SFRH4 fell 8 to 9570.5. 

On Friday, we will be getting April inflation data based on personal consumption expenditures and then May CPI data on the first day of the FOMC meeting. These are two critical pieces of data I will be looking at between now and the June FOMC meeting to learn more about inflation dynamics and if we are seeing some easing in inflation pressures. (Waller)

https://www.federalreserve.gov/newsevents/speech/waller20230524a.htm

 –Good news, bad news:  NDVA exploded after hours on earnings and outlook, adding >$150b to market cap, while the US is looking at a credit downgrade by Fitch as debt ceiling talks drag on. 

–UK CPI yesterday was +8.7% vs estimate of 8.2%.  Huge drop in SONIA contracts with Dec3, March4 and June4 atll down 33 bps (9463, 9477, 9498).  BOE’s Huw Pill was right, “British people need to accept they are poorer.” from April 25.   In SOFR, new high in M3/U3 at -14.75 and in U3/Z3 at -34.5 as back contracts converge toward front.  SFRZ3/Z4 new recent low at -152; the lowest settle in this particular one-yr calendar was -158.5 just before SVB. The most inverted one-year spread remains SFRU3/U4 at -162.  Forward easing has been pushed back a little but is still being priced.

Front contracts weak

May 24, 2023

–Short end rates continue to press higher; weakest SOFR contract was SFRZ3 at 9531.5 (-3.0) but Z4 closed UP 2 at 9677 and Z5 UP 2 at 9691.5.  So, the curve flattened with 2/10 at a new recent low of -63.5.  Regarding SFRZ3, on May 10 the settle was 9579.5, and since then it has closed lower for 9 sessions in a row, printing 9530 (4.70%) this morning.  It’s worth noting that the last FOMC projections in March had the end-of-year 2023 FF target at 5.1%, exactly where the target is now (5.0 to 5.25%).  Currently, the market appears to believe the Fed will be able to hold the line this year on the FF target, and might even raise at the June 14 meeting.  Of course, some of the weakness may be related to the idea of a tsunami of bill issuance if the debt ceiling clown-show ends.

–From yesterday (MNI): Benchmark John Deere filed prospectus to issue $36b in medium term notes, details over timing and individual size TBA.  If DE does issue $36b at one offering, it would be the fourth largest on record, $5b larger than last week’s 8-tranche jumbo issued by Pfizer.  [Stock is down about 18% from the year’s high]

–Today includes the 5y auction (wi at futures settle was 3.715%), immediately followed by a speech by Waller and then the FOMC minutes.  NVDA reports today.

A quiet economic warning from copper

May 23, 2023

–ZH quotes Zoltan Poszar about banking issues:  “It’s basically lessons in not being able to run interest rate risk, not knowing how to make a loan that will be weathering a rising interest rate storm.”    Of course, deposit flight due to “bail-in” fears is a big part of the problem.  Jamie Dimon is also warning of more failures.  It’s not a surprise; costs of funds rapidly increasing while quality borrowers are sparse (except for the Federal Gov’t, and they’re doing their best to undermine THAT credit quality).

–Copper making new lows this morning for this calendar year at 3.63 (HGN3).  July WTI holding around $72/bbl as, according to BBG, “Saudi Energy Minister Tells Oil Specs to ‘Watch Out'”.

–No debt-ceiling deal yet.  

–Bullard yesterday said perhaps two more hikes would be in order, and says that “flush” households will keep the economy going.  Perhaps we’ll get a sense of consumer strength (or NOT) in some retailer reports today: Lowes, BJ’s warehouse, Dick’s Sporting Goods, Auto Zone, Urban Outfitters.  

–New high settled in SFRM3/SFRU3 at -18.25 (9480.25/9498.5) as Sept converges closer to the current EFFR of 5.08%.  Vol firmer across the board as debt negotiations drag.  Late new buyer of 10k SFRU4 9987.5/100.25 cs for 2.0.  Underlying SFRU4 settled 9654.5.  Revisiting the zero-bound next year?  New Home Sales today.

Pause

May 22, 2023

–Debt ceiling talks continue.

–Powell on Friday:  FED WAS EXPECTING FURTHER TIGHTENING UNTIL RECENTLY

@NickTimiraos   Powell: “The risks of doing too much versus doing too little are becoming more balanced.”

–From MarketWatch
“Fed’s Kashkari says he’s open to a pause in rate hikes in June”.  The tide appears to favor a pause at this point.  Bullard speaks at 8:30 today, followed by Daly at 11:00.

–Seller of 50k SFRZ3 9675/9775cs Friday at 10.  Settled 9.75 vs 9540.  Roll down of short 9775 calls. There are still 266k open in SFRZ3 9550c which settled 45.0. Recall a large buyer >50k Z3 9550/9750cs in February; seems to have adjusted top strike lower over time but still holds longs in 9550s.  SFRZ3 atm 9537.5 straddle settled 95.5.  Vol subject to progress on debt ceiling. 

–SFRM3/U3 settled new recent high -19.75 as expectations of ease are squeezed out of the Sept contract (settled 9504).  In early March this spread was above zero (high of 6.0 with SFRU3 settling as low as 9430.5) but with the mid-March bank failures the spread plunged to a low tick of -47.  Low settle has been -43, made on 4-May.  Since SVB range has pretty much been -40 to -20, current -21. Market still expects easing into the end of the year, but the magnitude is lessening.  

Rumbling beneath the surface

May 21, 2023 – Weekly comment

*******************************

In the past week, yields rose aggressively.  The five-year ended at 3.74%, up about 30 bps on the week.  The thirty-year bond added 17 bps, to 3.944%.  On the SOFR curve, June’24 (SFRM4) was the weakest, down 39 bps in price to 9625.5 or 3.735%.

The treasury curve flattened with 2/10 down about 6 bps to -60 bps.  On the SOFR curve the SFRM3/SFRM4 one-year calendar soared 30.75 bps from -173 to -142.25 (9482.25/9526.5) while SFRM4/SFRM5 fell 8.5 to -64 (9526.5/9690.5); both moves due to relative weakness of SFRM4.

All rates had plunged in March due to the SVB banking earthquake, but are now retracing as aftershocks become muted rumbles (though Yellen warned of more banking consolidation).  The 2y yield has retraced about 38% of the March swan dive from 5.07% to 3.77%.  The ten year yield about 50% from the March high of 4.06% to the early April low of 3.31% and the 30y bond nearly 90% from the March high of 3.99% to the early April low of 3.55% (now 3.94%).

In terms of Fed policy, officials appear divided on whether or not to pause in June.  For example on Thursday Logan said we’re not quite there in terms of evidence which would support a pause, but on Friday Powell said the balance of risks between tightening too much or too little were about evenly balanced.  July Fed funds settled 9487.5 or 5.125% which is 4.5 bps over the current EFFR of 5.08.  Of course, a hike in June would cause EFFR to go to 5.33 or 9467.0, and there’s another FOMC on July 26, worth 4 bps to FFN3 on a 25 bp hike at that meeting.  Ignoring the July meeting, FFN3 is reflecting odds of 18% for a hike at the June FOMC.

An issue for the Fed, which they have been jawboning against, is that when the market perceives an end to hikes, the next move is naturally presumed to be an ease.  Of course, that has been abundantly clear on the SOFR curve: even though SFRM4 fell 39 bps this week, it still is at a yield 142 bps lower than SFRM3.  If I were the Fed, I would want to convince the market that rates can be HELD at relatively high levels for a few quarters, in order to really tamp down on higher inflation expectations.  It’s not the exact level that’s critical, it’s the duration.  PCE prices are released on Friday, expected 4.3% yoy with Core 4.6% vs 4.6% last.  With FF 5-5.25%, one can easily argue the Fed is now in restrictive territory.  I would say that in the past week, the Fed has been successful in terms of paring back future easing expectations.  For example, SFRM3/SFRZ3 spread settled 12-May at -75, but rose to -55.75 by Friday, i.e. the forward rate reflected in the end of the year contract increased.  In my opinion, the Fed should continue to talk about higher rates, even after pausing in June.  As Powell alluded to on Friday, stricter credit allocation due to the banking shake-up cannot be quantified yet, and the Fed will just have to monitor how much restraint is actually imposed on economic activity and inflation.

However, there is another looming issue which could send shockwaves through markets, and that of course, is the debt ceiling.  VIX and MOVE are suggesting a complete lack of concern, with the former near 12-month lows and the latter well off the highs from March and slightly below the average for the past year. 

The Market Huddle with Kevin Muir featured a fascinating discussion with Jim Leitner covering the debt ceiling.  Leitner thinks the market is underpricing the risk of default and believes participants may begin to question the safety of treasuries.  If that were to happen it would have far-reaching negative consequences as treasuries are used system-wide for collateral.  He gives a hypothetical example of a futures broker suddenly declining to take treasuries as margin, causing massive forced position unwinds.  He also mentions the 14^th Amendment, which might allow Treasury to continue issuing debt even without a debt-ceiling agreement.  Here’s a link to a short article explaining that scenario:
https://www.ncsl.org/state-legislatures-news/details/the-debt-ceiling-and-the-14th-amendment-the-jury-is-still-out#:~:text

From the article:
Some scholars say that Biden could argue that the government is required to pay its bills and that the language of the constitutional clause supersedes the statute limiting the size of the federal debt.

The point is that things could get sloppy quickly.  Leitner mentioned he’s long TY 111p for end of June (I assumed he means TYN3 111p which settled 10/64, -0.11d).  He indicated that he had bought for protection as opposed to a high expectation of ‘win’.  A couple of weeks ago I suggested buying otm US puts as the yield on the 30y approached the recent range low of 3.5%.  On the next page is a chart showing bond (US) vol overlaid with the yield on the 30-yr.  From August to October of last year, vol strengthened right along with the surge in yields.  In the March SVB fiasco, vol screamed to new highs as yields plunged.  Currently the 30y yield is marching higher, but it’s not yet through the upper end of the recent range.  However, if that’s what vol did when a regional bank couldn’t meet its obligations, imagine where it might go if the Federal Gov’t fails to honor the sanctity of its debt.

Apart from the debt limit, other things to watch this week are:
Fed speakers:
Bullard and Daly on Monday.  Might cancel each other as Daly typically parrots Powell.
Logan (again) on Tuesday
Waller on Wednesday followed by the FOMC minutes

PCE price data, the Fed’s preferred measures, are released Friday.

I don’t typically follow earnings reports closely, but NVDA, which has a market cap of $733b reports on Wednesday; the stock has more than doubled from the end of last year, from 146 to 312 as AI fever builds.  There are also a lot of retailers reporting next week which might provide more of a read on the consumer.  Some of them:

Monday: Nordstrom
Tuesday: Lowes, Dick’s Sporting, BJ’s Wholesale
Wednesday: Kohl’s, Petco
Thursday: Costco, Best Buy

OTHER THOUGHTS / TRADES

Though the curve flattened, USM3 appears more inclined to an upside breakout in yield terms.  July option expiry is June 23, which is after the June 14 FOMC.  With USU3 settle at 127-11, USN3 120p settled 0’14 with a delta of -0.08.  DV01 on the contract is approx $147, so a full point is ~6.8 bps.  Current 30y yield is 394.4, so 4% should equate to 126-16 or so.  A breakout above 4% would likelly result in another 25 bps relatively quickly.  The 30y high yield from last October was 4.38% and the front contract at that time traded below 118. 

There are a tremendous amount of option trades predicated on the settlement of SFRM3 on 16-June.  My bias is for a settle above 9493.75, though I think it’s quite unlikely at this point to get above 9506.25 (unless the debt-ceiling wheels fall off).  On the put side, SFRM3 9493.75 puts have the most open int at 650k, settled 13.5 vs 9484.25.  On the call side the 9500s has 309k open, settled 3.25. 

   

	5/12/2023	5/19/2023	chg
UST 2Y	399.1	428.5	29.4	wi 423.0/22.5
UST 5Y	344.3	374.2	29.9	wi 371.0/70.0
UST 10Y	345.5	368.8	23.3
UST 30Y	377.5	394.4	16.9
GERM 2Y	259.4	275.7	16.3
GERM 10Y	227.6	242.7	15.1
JPN 30Y	123.9	123.2	-0.7
CHINA 10Y	270.6	271.9	1.3
SOFR M3/M4	-173.0	-142.3	30.8
SOFR M4/M5	-55.5	-64.0	-8.5
SOFR M5/M6	2.5	-0.5	-3.0
EUR	108.50	108.06	-0.44
CRUDE (CLN3)	70.02	71.69	1.67
SPX	4124.08	4191.98	67.90	1.6%
VIX	17.03	16.81	-0.22

Brainiacs

May 19, 2023

–Lorie Logan yesterday (Dallas Fed President and former head of the NY Markets desk).

“The data in coming weeks could yet show that it is appropriate to skip a meeting. As of today, though, we aren’t there yet.”

–August Fed Funds (FFQ3) closed down 6.5 at 9485.5 or 5.145% vs current EFFR of 5.08, while FFN3 settled 9484.0. SFRU4 led the decline, closing at 9661.5, down 18 on the day. Several Fed speakers (Mester, Bullard, Barkin, Logan) have indicated that a pause is not necessarily in the cards.  Weakness in nearer contracts reflects that sentiment; the ‘pivot’ is being less aggressively priced and slightly pushed forward in time.  New lows in one-year spreads M4/M5 at -68 (9630/96.98; -3 on the day) and U4/U5 at -38 (9661.5/9699.5, -5.5 on the day)… moving a bit farther back.  SFRM3/U3 hit a new recent high of -21 as SFRU3 has sold off and is converging toward the current FF target.  SFRU3 settled yesterday at 9502, more than 100 bps lower than the highs registered during the SVB fiasco (high settle on 3/15 was 9598.5 while the high tick was 9647.5).

–Against this backdrop Powell and Bernanke speak today and will likely repeat the paternalistic mantra that the banking system is ‘sound and resilient’ and that the Fed will not stop until it’s sure that the scourge of inflation has been vanquished.  Is there irony in an environment where money is pouring into a few big tech stocks associated with Artificial Intelligence, thus masking weakness across the broader equity landscape, while at the same time the brain trust of the Fed discusses inflation?  With apologies to Jules, “Check out the big brain on Ben”.  After all, Bernanke, in a tenacious effort to fight deflation, stoked the embers that led to the current fire.

–The Fed’s balance sheet, having temporarily blown up in March as banking problems flared, is back below $8.5 trillion.  Attached chart shows balance sheet and SPX.  The good news is that the debt-ceiling is being raised, the bad news is that t-bill issuance is going to drain liquidity to replenish the TGA.  Eleven months ago, at the June 15, 2022 FOMC, the committee decided to raise the FF target to 1.5-1.75%.  They talk about policy having an effect 6-12 months after the initial moves.  3.5% of the rate hikes have been in that window. 

Feel-good

May 18, 2023

–June’23 SOFR options expire 16 June, four weeks from tomorrow.  SFRM3 settled 9486.5, or 5.135% with EFFR pegged at 5.08% (9492.0).  The contract has 1.296 million open.  What is pretty amazing is the amount of put open interest on SFRM3, a total of 5.146 million.  Over 900k puts traded yesterday.  For example, a buyer of >50k SFRM3 9493.75/9487.5/9481.25/9475p condors bought for 2.0.  This trade has max value of 6.25 bps between the middle strikes, and max loss of premium paid.  It’s not that I believe there will be some sort of squeeze; it’s pretty clear that the Fed has squashed expectations of an ease at the July 26 meeting with August FF settling exactly at 9492.0.  However, it is somewhat interesting that SFRM3/U3 calendar is -25, with SFRU3 9511.5.  Attached below is an image of players from @PNTOptions.

–Overall, vol down pretty hard.  Example, SFRH4 settled 120.5 (9600^ vs 9602.5) vs 9612.5^ on Tuesday at 122.5.  Just considering atm puts:  SFRU3 settled 9511.5; 9512.5p 27.75, breakeven at 9484.75.  SFRZ3 settled 9552.0; 9550p 46.0, b/e 9504.0.  SFRH4 9602.5; 9600p 59.0, b/e 9541.0.  Clearly expecting eases over time, and if one thinks the Fed can hold the line, there are some attractive put structures.

–Jobless Claims today expected 252k from 264 last.  A print above 270 would be more indicative of weakening labor.  Both HD and TGT (yesterday) have warned of slowing retail sales trends. Powell and Bernanke tomorrow, but the groundwork has already been done by various speakers: no reason to think rate cuts will occur and the banking system is sound and resilient.

–Feel good rhetoric on the debt ceiling helped spark a bid in stocks, with continued flows into AI.  For example NVDA closed above 300, more than doubling since the start of the year.

–To their credit, not even trying to hide it any more.  Here’s a proposal from members of Chicago Mayor Brandon Johnson’s transition team.

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.