May 23, 2022
–In my opinion Modern Monetary Theory is working exactly as advertised. I’ve had several conversations with people complaining about one boneheaded government program or proposal after another; they typically close by saying, “And we’re the ones paying for it!” as if they get a specific tax bill for a specific program. That’s not how it works. Taxation seems to have less and less to do with specific programs or spending. It’s simply redistributive. Constraints on government spending are not related to taxation but on borrowing. When viewed through that lens, it’s all about political choices, as Stephanie Kelton herself articulates. It’s not financial decision-making, it’s political. However, Kelton did identify right up front what the constraint on MMT would be: inflation. That’s how we pay for boneheaded decisions: by everyone paying more for everything. The logical extension, in my opinion, is that the federal government begins to have trouble borrowing. We’re not there. Yet.
–Friday featured initial weakness in stocks that took SPX down to a 20% decline from the high, followed by a ripping rally. While the equity bounce was nice, rate futures still signal a rocky economic road ahead. Near one-year calendars made new lows. EDU2/EDU3 fell 4.5 to 56, down from 86 on May 6. EDZ2/EDZ3 plunged 7 to -7.5; it was +23 on May 6. SFRZ2/SFRZ3 closed at just +0.5. Here’s what the spreads are suggesting: economic brick wall straight ahead.
–There was a little blurb over the weekend that Visa and Mastercard were having outages. https://downdetector.com/status/visa/map/ That’s where the panic sets in.
In: Eurodollar Options
Barely Squeakin’ By
May 22, 2022 – Weekly Comment
Retail can be a tough business. Consumer spending accounts for 2/3rds of GDP, as we’re often reminded. In any case, retail stocks have taken an absolute shellacking in the past month or so. From April 18 (this year’s tax date) to Friday, May 20, here are some changes on a closing basis:
Target (TGT) -37%
AMZN -30%
Macy’s (M) -29%
Costco (COST) -28%
Nordstrom (JWN) -26%
Walmart (WMT) -23%
Best But (BBY) -22%
Misses from WMT and TGT accelerated last week’s carnage. Reporting this week are COST, M, JWN and BBY. Powell constantly marvels at the strength in the labor market. Yes, it’s true, the JOLTS data shows more openings than people looking for work. But there’s something else going on… if only there were some clues. On the earnings call, TGT’s CEO said there was a “dramatic change in sales mix” in Q1 with more customers buying private-label goods. Consumers are stretched. BBG notes that US net worth hit a record $142T at the end of last year and cites JPM with an estimate that $5T has been shaved this year, “and could reach $9T by year-end.” I’m guessing JPM might be a bit conservative. Total stock market cap to GDP ended 2021 at a record 200%. Below is a chart of the S&P 500.
It’s not super easy to see on this chart, but the 2018 tightening cycle ended with a 20% decline in SPX. At Friday’s low, SPX had declined 20% from the high at the start of the year. The intervening sell-off associated with Covid was a plunge of 35% culminating in March of 2020. Friday’s low in the index was 3810. The 38.2% retracement from the March 2020 low to the start of this year’s high is 3815. So, there were two big technical levels which suggested support: the 20% decline off the high, and the Fibonacci retracement. Friday’s late bounce was exacerbated by May option expiration. This price action suggests (to me at least) that the retracement levels are a good guidepost for the rest of the year. The 50% level is 3505. The 61.8 retracement is 3195 which is close to a 35% decline off the high (which would equal the percentage decline seen in 2020). The 200 DMA appears to have rolled over.
Last weekend I spent some time on the one-year Eurodollar calendar spreads. In the past week the message has become a bit more dramatic: EDZ2/EDZ3 settled -7.5, down from +6.0 the previous Friday. This is the nearest one-year calendar spread to have inverted. Partially the weakness in EDZ2 reflects credit concerns and end-of-year pressure. However, SFRZ2/SFRZ3 settled at just 0.5 bp and was printing zero, vs +15 the previous Friday. FFF3/FFF4 settled 11.0 and should probably be sold vs SFR spread (although in looking at the chart history, a level of 15 to 18 is the more appropriate level to enter a short, with a target of 0 to 3) [this is NOT A RECOMMENDATION]. Also worth a note is that FFQ2 is exactly pricing the idea of 50 bp hikes at the June and July FOMCs, which would take the Fed Effective rate (EFFR) from the current 83 bps to 183 bps by the end of July. FFQ2 settled at 9817.0 or 1.83.
5 and 10 yr inflation breakevens have been coming down. The 5yr peaked in March at 368 and is now 290. The 10yr peaked in April at 303 and is now 258. For a bit more historical perspective, the ten-year spread spent the first three quarters of 2018 between 200 and 220. The average in 2019 was about 175. On Friday U of Mich releases the final May survey of 5-10 year inflation expectations. From 2017 through 2019 it ranged between 2.6 to 2.3%. The peak this year is 3.1% and it’s expected at 3.0. More importantly, Friday is also the release for the Fed’s preferred measure of inflation; PCE yoy prices expected 6.2 from 6.6 and Core expected 4.9 from 5.2. FOMC minutes on Wednesday. Auctions of 2, 5, 7 year notes Tues-Thursday.
On Tuesday Powell makes introductory remarks at an economic summit, and Brainard speaks Wednesday. (Fighting inflation Is JOB NUMBER ONE). The June 15 FOMC is three and a half weeks away. I no longer pay much attention to regional Fed Presidents, however, Esther George is speaking at an Ag Summit on Monday evening. With widespread forecasts of food shortages (and many other much more dire projections), this event may be of particular interest (though the title is ‘Help Wanted in Agriculture’). From The KC Fed website Q1 survey, farm credit conditions are strong, with farmland values up approx. 25% yoy. However, here’s an excerpt: “The outlook for ag credit conditions remained optimistic alongside persistently strong commodity prices. However, many lenders expected conditions to soften in coming months alongside pressure to profit margins from higher input costs and harsh drought conditions in large portions of the country.”
Can’t get fertilizer. A friend of mine said it’s hard to get a certain hydraulic oil for the tractors (so the idea now is to stockpile). Oh that’s right, we’re working on the demand side. Time to put that donut clerk on a crash diet.
OTHER MARKET THOUGHTS/ TRADES
EDM3/EDM4 is the lowest one-year calendar on the strip and it settled at a new low for the move of negative 40.5. The high of the year in this particular spread was positive 36 on Jan 10. SFRM3/M4 is also the lowest, settling at a new record low -39.0. These forward one-yr spreads are screaming recession. Since 1999, the low in the first red to first green (5th to 9th quarterly contracts) has been -16.5 in 2019. In 2006 the low was -12.0. In the 4th to 8th the current level is -33.0 (EDH3/EDH4). In Dec 2006 the low was -26.5 and in 2019 the low was -25.0. There are several analysts who are somberly predicting recession, as if they’ve run all the data through a proprietary econometric model which dispassionately spit out high odds of declining activity. Let me say it again: short end dollar futures spreads are SCREAMING recession.
| 5/13/2022 | 5/20/2022 | chg | ||
| UST 2Y | 259.7 | 257.9 | -1.8 | WI 262.0 |
| UST 5Y | 288.4 | 280.3 | -8.1 | WI 280.2 |
| UST 10Y | 293.1 | 278.1 | -15.0 | |
| UST 30Y | 308.8 | 299.2 | -9.6 | |
| GERM 2Y | 10.6 | 34.2 | 23.6 | |
| GERM 10Y | 94.8 | 94.4 | -0.4 | |
| JPN 30Y | 99.8 | 98.9 | -0.9 | |
| CHINA 10Y | 281.9 | 281.9 | 0.0 | |
| EURO$ M2/M3 | 148.5 | 149.0 | 0.5 | |
| EURO$ M3/M4 | -27.0 | -41.5 | -14.5 | |
| EURO$ M4/M5 | -6.0 | -6.5 | -0.5 | |
| EUR | 104.13 | 105.63 | 1.50 | |
| CRUDE (active) | 108.63 | 110.28 | 1.65 | |
| SPX | 4023.89 | 3901.36 | -122.53 | -3.0% |
| VIX | 28.87 | 29.43 | 0.56 | |
In: Eurodollar Options
Two short-end interest option trades lean in opposite directions
May 20, 2022
–Yields declined on yesterday’s equity market weakness, with ESM having tested the previous week’s low of 3855; yesterday’s low was 3856. May opex in equities. The ten year fell 3 bps to 2.851%, though TYM2, with a settle of 119-225 was well off the early morning fear-induced high of 120-10. EDZ2/EDZ3 traded as low as -5 but came back to settle -0.5 (9686/9686.5), a new closing low and the nearest 1-yr spread to have inverted. The Fed stoically vows to ignore asset prices in its inflation-fighting campaign, but it may become impossible to dismiss other data. For example. existing home sales -2.4%. From NAR’s chief econ Lawrence Yun, “higher home prices and sharply higher mortgage rates have reduced buyer activity.” From WSJ: “The share of subprime credit cards and personal loans that are at least 60 days late is rising faster than normal, according to credit-reporting firm Equifax. In March, those delinquencies rose m/m for the eighth time in a row, nearing their prepandemic levels.” China cut its 5yr Loan Prime Rate to 4.45% from 4.6%, widely seen as a measure to support the real estate sector. In the US, a friend was just quoted 5.75% for a 30y mortgage loan…
–Open interest in EDN2 9737.5 call sprang to life with a new buyer early yesterday. The call settled 12.5 with open int +62k to 66k. EDU2 settled 9736.5 or 2.635%. This option expires on EDU2 on July 15, before the July FOMC on July 27. From settlement, breakeven is 9750 or 2.5%. If the market’s perception shifts to the idea of two 50 bp hikes and then a long pause, with EFFR stalling at 1.83%, then EDU2 could easily surpass 9750. Another notable trade in the opposite direction, a buyer of 15k 0QM3 (mullet) 9550/9500p spread for 5.0. This is a midcurve option which expires in June’2023 (13 months) based on SFRM4 (2yrs forward) which settled 9728.5 (and was around 32 when it traded). So the top strike is 4.5%, but the contract itself is forward enough that perhaps the idea of persistently higher inflation will have taken deep root.
In: Eurodollar Options
The Fed affects demand…for stocks
May 19, 2022
–Ouch! Am I bleeding? DJIA -3.6%, SPX -4.0% and Nasdaq Comp -4.7%. Big retail stocks were hammered. Since last month’s highs WMT -23%, TGT -36% and COST -29%. Oh, is that what Powell means when he keeps saying the Fed can affect the demand side? All of a sudden the tenuous relationship between stocks and the destruction of consumer demand appears to have some sort of nebulous link. No one could have seen that coming, right? As of this writing ESM is 3862.75, down 60. SPX is nearing a decline of 20% from its high. Recall that in 2018 that’s when Powell folded (at a 20% decline in SPX) and Mnuchin deemed it necessary to convene a group of bankers to assure continued liquidity. Fed officials have guided market participants to a “base case” of two more consecutive 50 bp hikes. At yesterday’s close, August Fed Funds were 9811.5 or 1.885%, pricing a dollop more than 100 bps over the current Fed Effective of 0.83. Paraphrasing Mike Tyson, “Everybody has a plan [base case] until they get punched in the mouth.” We’re starting to see a bit of capitulation…Gabe Plotkin is shuttering Melvin Cap … it used to be “Capital” but he lost the last four letters. Next thing you know, Bullard’s going to be out front advocating a pause in policy. There was a buyer yesterday of 20k EDM2 9825/9831.25 c spread for 0.75 ref EDM2 9818.5. Could one of those 50 bp hikes be trimmed back to just 25 or iced altogether? It’s four weeks until the June FOMC.
–Fixed income is starting to question the Fed’s resolve. Not so much in the front end, which seems to accept the base case, but a bit further out. Twos fell 3.7 bps yesterday to 2.665% while tens lopped 9 bps off the yield to 2.882%. I can’t help think that a Doomberg piece yesterday was also instrumental in focusing people on “custodial credit risk” with an article on Coinbase and the possibility that clients with funds on deposit at that august institution might be deemed general creditors in the event of bankruptcy. We’re back to the idea of “bail-ins”, and I don’t like the sound of it. All of a sudden the idea of gold coins in mason jars buried in the backyard (of a friend of mine, of course) doesn’t seem so stupid. Neither does parking money in short term treasuries.
–Philly Fed expected 15 from 17.6. Existing Home Sales.
**************************************************************
“People were asking me [before a fight], ‘What’s going to happen?,’ ” Tyson said. “They were talking about his style. ‘He’s going to give you a lot of lateral movement. He’s going to move, he’s going to dance. He’s going to do this, do that.’ I said, “Everybody has a plan until they get hit. Then, like a rat, they stop in fear and freeze.’ “
https://www.youtube.com/watch?v=hOHvMqAgcmc
In: Eurodollar Options
May 18, 2022
–Saw this on twitter: “Wall Street is heading into a summer from hell – a period of extreme volatility that top investors say will bring a near-biblical reckoning.” I like it, Even if it WAS churned out by a bot. I might have modified it a bit by substituting ‘The US’ for Wall Street and omitting ‘near’. In any case, the volatility part has a ring of truth to it, as moves in the red eurodollars for example, seem to be greatly exaggerated recently. Yesterday the red pack (2nd year) led the strip lower, closing down 17.5 as Powell reaffirmed inflation as enemy number 1. George Austin from Pricing Monkey also put out an interesting tweet about heavy buying in VIX 75 strike calls for September and October, noting that 100k Sept 75 calls traded yesterday and closed 89 cents. VIX closed 26.25. An options market-making friend told me that NatGas Jan/Feb/March 50 dollar call strip has been active…with the underlying contracts averaging 8.12. The reach for what previously seemed like unimaginable strike prices across markets is astonishing. For now, anyway.
–The five year yield surged 13.7 to 2.95% yesterday and 30s rose 8 to 3.16%. I.e. the curve flattened, pulling back from its recent pop. When the Fed changed the framework in August 2020 to make unemployment the primary concern, it set on a course which in hindsight (thanks Ben) led policymakers to overshoot the goal (by standing still). Now Powell has made inflation-fighting the number one goal, (“restoring price stability is something we HAVE to do”) and we’re supposed to believe that the man behind the curtain can engineer a smooth ride back to Kansas. Yes, over at the Fed they have one thing I don’t have, a diploma.
–EDM3 settled 9655.5, essentially at the midpoint of April’s high – 9689 – to May’s low – 9619. Bouncing around in a 70 bp range in the first red. It’s no wonder that keen observers have identified volatility as a new watchword, along with its insidious cousin, illiquidity.
–Housing data today. The current 30 year mortgage rate is 5.42%. On average, the rate in April was about 50 bps higher than March, which in turn was about 50 higher than Feb. I don’t know what April Housing Starts will show, but I do know that higher mortgage rates are starting to price buyers out.
In: Eurodollar Options
Destroy demand by Christmas
May 17, 2022
–Low volume Monday. The ten year yield eased 5.8 bps to 2.873%. New lows in several of the near one-year eurodollar calendars. I’ll focus on Dec’22/Dec’23 which printed -0.5 and settled 0.0, down 6 on the day from Friday; it’s the nearest one-yr to have slightly inverted. In early January, this spread was as high as 68.5. The trend lower gives some indication of how the Fed’s rhetoric to front-load hikes and destroy consumer demand has caused a continuing reassessment of the need to tighten in 2023. For a comparison with other contracts, SFRZ2/SFRZ3 settled 8.5 (high of this year 67.0) and FFF3/FFF4 settled 17.5 (high of year 65).
–July WTI crude settled 111.82, a new high settle for that contract, and July Wheat settled limit bid at 1247 1/2, up 70 cents. Fed’s going to have to destroy a lot of demand to keep up with the supply destruction.
–Implied vol was lower across the board in rates. Powell interviewed today by WSJ’s Nick Timiraos starting 2:00 EST. This follows Bernanke’s assessment that it was a mistake for Powell to wait so long to start hiking. (Thanks Ben). Retail Sales today. Dollar is easing this morning and stocks have a nice bounce to start the day. There continues to be a block buyer of FVM2 at the futures settlement time of 2pm CST, yesterday a buy of just over 6k. Open interest has fallen in FVM by a like amount on each purchase, although yesterday total FV OI was around unchanged, as a decline of 14k in FV2 was nearly offset by a rise in FVU. I would again mention that in Nov 2018 the five-yr topped at 3.09%. On May 6, two Fridays ago it hit 3.08%, and since then the yield has generally declined, to 2.814% yesterday (FVM2 settle 113-090).
In: Eurodollar Options
State hoarding
May 16, 2022
–This morning it’s all about China. And Wheat. China’s data was terrible due to covid lockdowns, with April Industrial Output -2.9% yoy. Retail sales -11.1%. The yuan continues to weaken with CNY 6.794. July Wheat is up over 50 cents at 1230. High on March 8 was 1278 1/4; today’s high is 1247 1/2 as India declared an export ban. Recently it was Indonesia with a ban on exporting palm oil. Mohamed El-Erian warns about the cumulative impact of a series of “little fires” in the developing world, but the prospect of state hoarding adds another dimension. NatGas currently trades around 7.70 to 8.30. A market making friend tells me that the winter months $50 call strip has been trading.
–China’s data sent stock futures into negative territory this morning. There are a lot of cracks developing…for example, Danielle DiMartino Booth tweeted “Corporate bonds and loans trading distressed spiked to $139.1b on Friday from $83.1 a week earlier.” Zombies that have been dependent on generous capital markets to stay afloat are seeing flows evaporate.
–Rate futures fell on Friday and the curve steepened. The 2-yr yield rose 7.7 to 2.597% and tens rebounded 11.7 to 2.931%. 2/10 closed 33.4. Recent high was one week ago at 46. Lowest contracts on the Fed Funds strip over the near term are in Q3 of next year, with June’23 to October’23 settling between 9693.5 and 9695.5 or just over 3%. This perceived “terminal rate” has fallen since the last FOMC, where FFQ3 traded as low as 9649.
–Empire Mfg today and TIC flows. Retail Sales and Powell tomorrow.
In: Eurodollar Options
Forward growth expectations worsening
May 15, 2022 – Weekly comment
Even as inflation data released this week were worse than expected (yoy CPI 8.3%, Core 6.2% and PPI 11.0%) calendar spreads for next year declined substantially on the week. For example, EDZ2/EDZ3 one-year settled at a new low of 6 bps, down from 23 the previous Friday. The high of this year on January 10 was 68.5.
Below is a graph showing the stark change in tightening expectations (or lack thereof). The white line is August’22 Fed funds vs January’23. That five-month calendar captures three FOMC meetings, Sept 21, Nov 2 and Dec 14. August is a ‘clean’ month with no meeting. This spread settled 88.5; it started the year below 30. There is a bit more than 25 bps per meeting priced into this spread. The red line is FFF3/FFF4 which captures 7 FOMC meetings next year. That spread settled 21.5 bps, down from 68 on April 8 (the high of this year) and 39 last week. For all of next year, the market is expecting less that one 25 bp hike, and that’s expected to come in the first half. (FFN3/FFF4 is -11).
The lowest contract on the euro$ strip has been EDM’23 which is the last contract that reflects libor rather than sofr. It settled Friday at 9668.5 or 3.315%. The lowest settle was just prior to the May FOMC meeting, at 9631.5 or 3.685%. The June’23 SOFR contract is also lowest on the strip at 9697 or 3.03%, vs a low just before the FOMC of 9663.5. Since the FOMC, about 3/8% of forward tightening has been taken out of these contracts.
A note on ED vs SOFR: EDZ2/EDZ3 is 6.0 vs SFRZ2/SFRZ3 at 15.0. What accounts for the difference? After June 2023 there is no credit component embedded in euro$ contracts as they will transfer to SOFR. While the spreads SOFR to ED in Sept 23, Dec 23 and March 24 are all static at 26, the spread between SFRZ2 and EDZ2 is 35 bps (9725 vs 9690). EDZ2 reflects both credit risk and a ‘turn of the year’ premium.
Former NY Fed President Dudley defined financial conditions as incorporating 1) short and long term interest rates 2) equity prices 3) the value of the dollar 4) credit spreads. The SF Fed’s Mary Daly said last week she would like to see financial conditions tighten further. Let’s take a quick look. On 12/31/2021 SFRZ2 was 9818.5 and it settled Friday at 9725. 93.5 bps of tighter conditions. The ten year note was 1.51% now it’s 2.92% for 141 bps. The dollar index DXY was 95.67, now 104.56, a rally of over 27%. SPX 4766 to 4024, a loss of nearly 16%. The BBB/Baa spread to treasuries has gone from 121 to 187 bps. HYG and JNK have both fallen about 12%. For good measure, the front WTI contract has gone from 75.21 to 110.49. These tighter financial consitions have contributed to a fierce decline in U of Michigan’s Consumer Sentiment index from 101 pre-covid to 59.1 last week. Since the year 2000 sentiment has only been lower in the heart of the financial crisis in 2008/09 and in 2011. Any indication of just how much tighter you’d like to see Mary?
A quote from Daly in 2020: “I think we need to learn what full employment in the US is experientially as opposed to guessing and then stopping short of fully realizing it.” A quote from the NY Times 12/31/21: “My community members are telling me they’re worried about inflation… What influenced me quite a lot was recognizing that the very communities we’re trying to serve when we talk about people sidelined from the labor market are the very communities that are paying the largest toll of rising food prices, transportation prices and housing prices.” Just now getting familiar with the idea of trade-offs? Here’s an idea: look at what forward market prices are telling you. One other quick note, employment is a lagging indicator.
The last cycle highs in treasury yields were set in 2018. In November 2018, the Five-yr topped at 3.09%. This month it equaled that level, reaching 3.08% on May 6. All other maturities have fallen slightly shy of 2018 highs: Two-yr in 2018 hit 2.97% vs 2.78%. Ten-yr 3.24% in 2018 vs 3.13% and Thirty-yr 3.45% vs 3.23%. In terms of technical targets, 2018 levels are a fairly high hurdle. Recall, these highs were posted just after Powell’s famous “nowhere near neutral” utterance, and the Fed had just ratcheted up QT to $50 billion per month. SPX had started its 20% decline following Powell’s neutral comment but accelerated in December. We’re following a similar script.
GDP in Q4 2019 was $21.694T. Q1 2022 was $24.382 (St Louis Fed). Change $2.688T
Fed’l Govt debt outstanding 2019 $19.040T. Q1 2022 $25.314, a change of $6.274T
Market Cap to GDP Dec 2019 149%. Dec 2021 199%. End of 2019 Wilshire mkt cap $33T. End of 2022 $48.6T. So stocks gained $15T in value. To get back to 149% of GDP would suggest a market cap of $36.3T; we’re currently at $40T. Of course, the ten year yield ended 2019 1.93%, while the end of Q1 2022 was 2.46% (now 2.84%) so future cash flows should be more heavily discounted in the current cycle.
The market is telling us that the economy is likely to cool, slowly bringing down inflation expectations. Yield levels from 2018 aren’t likely to be surpassed in the near term, though strength in food and energy costs in the face of a powerful dollar will mean actual inflation stays sticky. Equities are in a challenging environment.
OTHER MARKET THOUGHTS/ TRADES
Aug FF settled 9815.0 on Friday, a discount of 2 bps from the idea of two 50 bp hikes in June and July which would put the Fed Effective at 1.83% or 9817.0.
News this week includes Retail Sales and Industrial Production on Tuesday, expected 1.0% and 0.5%. Housing Starts Wednesday and Existing Homes on Thursday. Powell interview with WSJ Tuesday.
| 5/6/2022 | 5/13/2022 | chg | ||
| UST 2Y | 271.6 | 259.7 | -11.9 | |
| UST 5Y | 304.0 | 288.4 | -15.6 | |
| UST 10Y | 311.2 | 293.1 | -18.1 | |
| UST 30Y | 319.2 | 308.8 | -10.4 | |
| GERM 2Y | 32.0 | 10.6 | -21.4 | |
| GERM 10Y | 113.2 | 94.8 | -18.4 | |
| JPN 30Y | 100.8 | 99.8 | -1.0 | |
| CHINA 10Y | 283.0 | 281.9 | -1.1 | |
| EURO$ M2/M3 | 175.0 | 148.5 | -26.5 | |
| EURO$ M3/M4 | -30.5 | -27.0 | 3.5 | |
| EURO$ M4/M5 | -8.5 | -6.0 | 2.5 | |
| EUR | 105.48 | 104.13 | -1.35 | |
| CRUDE (active) | 109.77 | 110.49 | 0.72 | |
| SPX | 4123.34 | 4023.89 | -99.45 | -2.4% |
| VIX | 30.19 | 28.87 | -1.32 | |
In: Eurodollar Options
It’s the little things
May 13, 2022
–Yesterday I mentioned that EDZ2/EDZ3 one-yr calendar had made a new low at 13.0 on Wednesday’s close. Thursday’s settle was another new low at 6.5 bps (9698.5/9692.0). In fact, the first three one-yr spreads settled at new lows, with EDM2/EDM3 at 140 bps (high had been 182). While FF contracts still indicate two consecutive 50 bp hikes in June and July, the picture gets murkier from there. EDM3 remains the lowest contract on the strip at 9677.5 or a yield of 3.225%, which is consistent with a ‘terminal’ rate of around 3%. Again, consider EDZ2 and EDZ3 contracts which bracket EDM3…both are at higher prices, lower yields at just under 3%. With the sell off in equities and carnage in crypto, the market is both paring back estimates of the terminal rate and moving it somewhat forward in time. On a related note, the euribor one-year M2/M3 calendar is 163.5 bps (more tightening priced than US?!) and sonia is 100 bps, having declined from a high of 133.5. Sorta makes me want to dip my toe in the water by buying EUR.
–Yesterday I had also mentioned the expiring midcurve May straddle, 0EK 9662.5^ with EDM3 as the underlying contract. May midcurves expire today. On Tuesday, it had settled 16.5 with a breakeven of 9646 to 9679. On Wednesday, we traded a low of 9645.5 before coming back to settle 9662.0, and on Wed the straddle settled 12.0. I had thought perhaps on Thursday we’d test the new upper breakeven at 9674.5. As it turned out, we exceeded that level with a high of 9678 and a settle of 9677.5. So, both ends of the breakevens from Tuesday’s settle were essentially met. (That, as I recall is a Todd Schaefer line: ALL PRICES WILL BE MET). Yesterday, (Thursday) with just one day left, 0EK 9675 straddle settled 9.0. I guess we’ll see if 66 holds today.
–While inflation figures this week were higher than expected, the ten yr treasury vs inflation-indexed note spread declined to a new recent low 259 bps. In other words, by destroying asset prices, the Fed is succeeding in lowering future inflation expectations. Bravo. The meltdown in terra/luna stablecoins was dismissed by Yellen as not being large enough to be systemically threatening, although the WSJ notes that $1T of crypto ‘wealth’ has vanished in six months. On a human level it’s awful as message boards are now including suicide hotlines. Often, people comment that money from one sector is being pulled out and is flowing to another sector, as if the total remains the same. This isn’t a flow. It’s just gone. The other aspect of markets which is constantly underappreciated is that in some cases, a relatively inconsequential pocket of stress can be easily absorbed, and in other cases, it can spark a series of wildfires — if the tinder is dry enough. It’s always the stuff at the margins. And that’s the stuff that the experts typically shrug off. “Subprime: it’s a mile wide and an inch deep.”
–This is from the latest Cass Transportation report. It’s a sobering shift in tone:
“North American freight volumes went negative in April. And with spot rates falling and contract rates expected to follow suit, pricing power is shifting from fleets to shippers. In short, the freight cycle has downshifted with a thud, and the prospect of a freight recession is now considerable.”
https://www.nbc.com/saturday-night-live/video/jimmy-carter-on-inflation-cold-open/3007609
In: Eurodollar Options
EDZ2/EDZ3 posts a new low at 13
May 12, 2022
–CPI higher than expected 8.3% caused a sharp break in interest rate futures, which was then erased as the session progressed, with weakness in stocks persisting. Treasury vol declined as bonds rallied, with TYN down 0.5 to 7.3, TYN 119^ settled 2’27 vs 118-245s.
–On Tuesday, 0EK 9662.5^ settled 16.5, and yesterday morning I commented on the wide breakevens with just three days until expiry, 9646 to 9679. These guys are good! …yesterday low was just 0.5 outside of b/e at 9645.5, and the contract came back to settle exactly at strike 9662.0. Yesterday, with TWO days left, this 0EK 9662.5^ settled 12.0. Will perhaps take a look at upside b/e today!
–Attached chart shows EDZ2/EDZ3 which settled at a new low of 13.0. In a rough way, that prices the amount of Fed hiking for next year, and it’s obviously being squeezed out. This was the only 1-yr spread to post a new recent low. I’ve also kept an eye on FFN3/FFF4 which prices Fed activity in the second half of next year and it had been around 0…but has trended negative and is now -10.5. If a Fed-engineered fight against inflation crushes the economy, then we’ll be looking at easing in a year…
–Late FVM block right at futures settle was a buy of 20k at 112-3125. The contract settled 112-305 and is 113-075 this morning. Open interest fell 28k. The five year, of course has seen tremendous pressure as the Fed became increasingly hawkish.
–PPI today expected 10.7 from 11.2 with Core 8.9%. Job Claims expected 192k. Thirty year auction.
In: Eurodollar Options
