Everything’s at 3%

July 1, 2022

–Eurozone inflation record 8.6%.  Yesterday’s PCE prices were slightly lower than expected with headline at 6.3 and Core 4.7 vs 4.8 expected.  Chicago PMI 56 vs expected 58.  Weakness in equities to close out June (worst first half in 50 years) helped yields fall.  Tens sank just below 3%, down 11.8 bps to 2.97%.  As shown on the attached chart, SFRU2 settled 9704.5 or 2.955%,  So positive carry in treasuries has evaporated. (SOFR is the repo rate on treasuries). 

–There were a lot of new recent highs and lows in various spreads.  First, the ten-yr treasury to tip breakeven fell below 235 bps, i.e. inflation expectations appear to be compressing.  Second, EDU2/EDU3 plunged another 14.5 bps to settle barely positive at 4.0.  That’s down 50 bps from FOMC day on June 15 (54.5).  EDU2/U3 is now the only positive 1-yr calendar on the ED strip until EDU4/EDU5 which settled +2.0.  The most negative spread is EDH3/EDH4 which settled -64.0.  Consider the prices on the first 5 ED contracts:  EDU2 9679.5, Z2 9631.0, H3 9638.0, M3 9656.5 and U3 9675.5… subsequent prices are higher (lower yields).  It’s clear that the market perceives end of hikes at end of year.  Third, with reds (second year forward) the star performers at +20.875 on the day, reds to more deferred steepened.  Red/gold (2 nd to 5th) finally settled positive at 2.375.  FFF3/FFF4 settled -44.5; nearly 1/2 percent of easing priced for next year.

–Treasury curve steepened as fives led the yield decline, falling by 14.6 bps to 3.002.  Thirties down 8.8 to 3.121.  Almost every yield on the curve is clustered within 15 bps of 3% excluding the first few ED contracts which reflect the front-loaded Fed obsession.   

–Atlanta Fed GDPNow was marked down to -1.0% for Q2.  Already in recession territory.  Today ISM Mfg is released, last at 56.1.  It’s expected 54.9 but there has been some talk of a sub 50 number. 
–Happy 4th!!!

A bad first half

June 30, 2022

–Stocks on their back foot this morning to end the quarter, with ESU -50.25 at 3771.0 (down around 17% on the qtr).  Yesterday I mentioned that the Fed’s preferred measure of inflation, PCE prices, was coming out Friday…actually today.   PCE inflation yoy expected 6.4% from 6.3 last, Core 4.8% vs 4.9% last.  Jobless claims expected 225k.  Chgo PMI 58 from 60.3.

–Attached is a chart of SFRH3/SFRH4 at a new low -61.  EDH3/EDH4 settled at a new low of -62 and is the lowest 1yr calendar on the ED strip, down 14.5 on the day!  Central banker emphasis on fighting inflation is keeping near contracts under pressure, but the short end indicates that the economy is going to look sickly by the second half of next year.  With eases being priced for next year, the spread between reds and deferred contracts is steepening.  ED pack changes at settle: Whites +0.375, reds +14, greens +16, blues +11.125, golds +9.  Red/gold pack spread settled at a new recent high -4.75.   Futures settles for December contracts: EDZ2 9617 or 3.83% (cheapest on the strip).  EDZ3 9670 or 3.30%, EDZ4 9696.5 or 3.035%, EDZ5 9692.5 or 3.075% and EDZ6 9683.5% or 3.165%.  Most straddles fell by a few bps, though absolute levels are still historically high. 

–Buyer on exit yesterday of 50k EDZ2 9650/9600ps for 26.0 covered 9617.5.  Settled 26 vs 17.0, OI down 30k in both strikes.  There continues to be buying in TYQ 114/113ps, yesterday about 15k with OI now 53k and 35k.  Settled 4/64 vs 117-165.  To give a sense of vol, there was a block seller of 7500 USU 137p at 3’03 vs 136-24 or 5’54 in the straddle.  The straddle settled 5’56, but yesterday the atm 135^ was 6’06.  

Equity market jitters

June 29, 2022

–Yields were little changed yesterday but stocks were under pressure with SPX falling 2%.  Ten year yield essentially unchanged at 3.198%.  TYU settled 116-22+; there are continuing buys of put spreads: +10k Week2 July 114/113ps (settled 3), +10k TYQ 114/113ps (settled 6), +15k TYU 115/113p 1×2 for 1 (settled 2).

–Mester says that the Fed is just getting started on hikes, and would like to see 3 to 3.5% by the end of this year (which is priced) and 4% by the end of next year (which is not priced, as the market is leaning towards ease next year). FFF3 settled 9654 or 3.46%, right in line with Loretta.  FFF4 settled 9676.5 or 3.235%. Back end of the dollar curve steepened slightly, with red/gold pack spread settling -9.75, up 2.375 on the day.  Not much of a move, but if the Fed is ending hikes this year, then there’s a significant amount of flatteners that need to be reversed.

–The ECB Forum at Sintra is occurring with comments expected from Lagarde and Bailey.  Powell is speaking this morning.  Richmond Fed Mfg Index plunged to -19; Dallas Fed Services Index plunged to -12.4.  There is some talk circulating that Friday’s Mfg ISM could see a sub-50 print; it was 56.1 last.  Fed’s preferred inflation data, Core PCE prices are also released Friday.

Treasury demand eases

–Treasuries lower this morning in front of the seven year auction.  Yesterday’s 5-yr was soft, with bid to cover at only 2.28, lowest since Feb 2021.  Yield was 3.271, tailing by 3.5 bps. While Durables were solid at 0.7%, the Dallas Fed Mfg number plunged to -17.7, lowest in six years outside of the covid plunge in 2020.  Ten year yield ended up 7 bps on the day, to 3.194%.

–Today we get Conference Board Consumer Confidence, expected to drop to 100 from 106.4.  That too, would be the lowest number since 2016 outside of the covid malaise. The ECB forum in Sintra is taking place, with Lagarde, Powell and Bailey comments expected tomorrow.  Today Lagarde said, “We have markedly revised down our forecasts for growth for the next two years, but we are still expecting positive growth rates…  “If the inflation outlook does not improve, we have sufficient information to move faster.  This commitment is, however, data dependent.”  If the sufficient info is lower growth and higher prices, how fast can the ECB backpedal? 

A little over 3%

June 27, 2022

–EDU2 on Friday settled +6 at 9675.0.  EDU4 settled -6.5 at 9687.0. (Two years apart and nearly the same price).  The curve steepened as UofM’s longer term inflation expectation number was revised down to +3.1% from the mid-month initial print of 3.3%.  Of course, the 3.3 release was a major factor in the decision to hike by 75 bps, with the sudden Fed realization that inflation expectations were becoming un-anchored. (NO ONE could have seen that coming). The other revision concerned UofM’s Consumer Sentiment, which notched a historic low of 50 (from initial mid-month 50.2).  From the survey director Joanne Hsu, “The final June reading confirmed the early-June decline in consumer sentiment… Consumers across income, age, education, geographic region, political affiliation, stockholding and homeownership status all posted large declines.”  Perhaps the revision lower resulted from the survey responses of some crypto bros:  On June 10, BTC was 29000, a week later it was 20500…. which might have the effect of deflating a puff of confidence.  

–Back to the euro$ curve.  The market is still leaning heavily towards the idea of another 75 bp hike one month from now on July 27.  That would put the funds rate at 2.25 to 2.50%, where it topped out in 2018.  However, Fed officials mostly talk about a level at around 3.25% for neutral, and hope to get there by year end.  So, after July, there are three more FOMC meetings for a cumulative 75-100 bps.  Long-term expectations in the eurodollar curve synch-up with this idea.  EDU2 settled 9675 or 3.25%.  The red pack (starting with EDU3) settled 9666.75 or 3.3325%, the green pack (starts EDU4) settled 3.095%, blue pack (starts EDU5) at 3.11% and the gold pack at 3.2175%.  It almost appears as if the financial markets are smugly certain of how things will play out, but I’ll guarantee that some of those levels are ultimately going to be very wrong.  Note that the EDU4 9687.5^ is 184 bps.

–So, which ones are wrong?  I don’t know.  If I knew I wouldn’t be writing this

Euro$ curve may signal end of Fed cycle

June 26, 2022 – Weekly comment

Once again Bullard referred back to 1994 as a parallel to tightening in this cycle.  Below is a chart of the red/green Eurodollar pack spread which overlays the tightening schedule in 1994 (chart starts in late November 1993, amber) to the current time (chart starts late Jan 2021 in white).

I’m not sure how much can be gleaned here, but what is somewhat interesting is that this tightening cycle is much more aggressive than 1994 (see chart comment).  Second, it’s either the Fed’s forward guidance or the fact that the market could clearly see inflation increasing that caused the red/green spread to flatten hard before the Fed ever even actually started to hike.  In 1994 it was only after the November 75 bp hike that the red/green spread inverted.  Before that, the Fed had already moved 175 bps in increments of 25 and 50. In the current case, this spread inverted in February, before the Fed ever moved. 

After the November 75 bp hike in 1994, the Fed hiked one more time in a 50 bp clip in February 1995, bringing the terminal FF target to 6%.  In February ’95 CPI was 2.9%, but it actually increased over the next couple of months to 3.2%. In any case the real FF rate was highly restrictive at about 3%.  The point is that the curve had bottomed well before the final hike.  By point of comparison, the red/gold pack spread made its 1994 low at the very end of the year at -27, and had rallied over 100 bps by June of 1995. 

The forward looking nature of the markets makes it likely that these yield curve spreads bottom prior, but close to, the end of the Fed hiking cycle.  In the present case, the red/green pack spread made a new low at -40 on June 13, just prior to the FOMC, but rallied afterward to -24.  The red/gold pack spread hit a low of -87 on April 1, then rallied to -9 by early May.  Just before the last FOMC, red/gold reached -60 on June 13, but has since snapped back to -11.5.  So, while red/green made a new low in connection with the last FOMC, red/gold did NOT.  These spreads appear to be telegraphing the strong possibility that the Fed is closer to the end of the hiking cycle than most analysts are forecasting.

The next FOMC is one month away, on July 27.  Near contracts continue to lean heavily toward the idea of another 75 bp hike.  For example, FFQ2 settled 9772.5 or 2.275%.  Current Fed Effective (EFFR) is 158 bps, so another 75 bp hike would bring EFFR to 233 bps, or a price of 9767.  Even the SF Fed’s Mary Daly is saying that she can support another 75 bp hike in July.  At this point, it’s worth noting that as of November of last year in an interview with Reuters’ Brian Cheung, Daly was considering one 25 bp hike by the end of 2022 as appropriate.  She was more or less in the mainstream, as the December SEP projection for the end of 2022 was 0.9%.  The only point in singling out Daly is that Fed officials (and private professional economists) are often wrong in their forecasts, and today’s set of circumstances is particularly challenging.

My bias from this note, and in consideration of other market signals, is that buying red Eurodollar contracts and selling more deferred is the proper position, entering on pullbacks.  This goes for treasury spreads as well, for example 5/10.  The five-yr, ten-yr treasury spread made its low for the move on April 1 at -17, rallied by early May to +8.5, down to -12 by June 13 and ended the week at -6. 

This week we’ll get to see how the market reacts to the release of the Fed’s preferred measure of inflation, Core PCE prices.  This report is released on Thursdau June 30, and is expected yoy 4.8% vs last at 4.9%.  The peak has been 5.3% at the end of February.  A lower than expected number should put the odds for a Fed hike in July closer to 50 bps than 75.  That is, FFQ2, on a number lower than 4.8 should end up closer to 9792 than 9767.  (Friday settle 9772.5).  Last Friday’s revision of UofM long-term inflation expectations from 3.3% to 3.1% already caused some analysts to pare back forward hike projections; keep an eye on the reds to forward contracts, a move to more positive levels would indicate that the Fed is nearing the end of the cycle.  

Auctions this week: 2ss and 5s on Monday, 7s on Tuesday.
   

OTHER MARKET THOUGHTS/ TRADES

FFV/FFX settled 34 from 39.5 on the previous Friday.  FOMC meeting on November 2.  This spread now leans a bit closer to 25 bps than 50 for that meeting.  There is likely to be intense political pressure on the Fed going into election day on November 8.

	6/17/2022	6/24/2022	chg
UST 2Y	316.2	305.5	-10.7
UST 5Y	333.8	317.5	-16.3
UST 10Y	323.7	312.4	-11.3
UST 30Y	329.1	325.8	-3.3
GERM 2Y	109.4	81.3	-28.1
GERM 10Y	166.1	144.2	-21.9
JPN 30Y	116.8	123.0	6.2
CHINA 10Y	281.4	284.9	3.5
EURO$ U2/U3	43.5	24.5	-19.0
EURO$ U3/U4	-38.5	-36.5	2.0
EURO$ U4/U5	-17.0	-5.0	12.0
EUR	104.99	105.58	0.59
CRUDE (active)	107.99	107.62	-0.37
SPX	3674.84	3911.74	236.90	6.4%
VIX	31.13	27.23	-3.90

Below are closes from Friday. For those who aren’t familiar with euro$ futures jargon, the contracts are 3 month consecutive periods. For example, EDU’22 will set to the three-month libor setting on 9/19/22 and that interest rate covers the three months from 9/21 until 12/21. The first four quarterly contracts cover one year, and are referred to as ‘fronts’ or whites. The second year forward, currently representing EDU’23, EDZ’23, EDH’24 and EDM’24 are the reds. The third year is greens, fourth is blues, fifth is golds. A pack is simply the four contracts averaged in price. Example, reds are EDU3 9650.5, EDZ3 9662.5, EDH4 9672.5 and EDM4 9681.5. The pack price is 9666.75. Therefore, a ROUGH approximation of yield for the second year forward is 3.3325%.

Sudden re-pricing

June 24, 2022

 –Repricing since the FOMC meeting has been extraordinary.  On June 15, the day of the meeting, EDU2/EDU3 settled 54.5.  Yesterday it traded as low as 5 before coming back to settle 15.5.  EDZ2/EDZ3 was -28.5 but settled -44 yesterday.  EDZ2/EDH3 was 11, traded as low as -7.5 before settling -4.5 yesterday.  The new pricing indicates that hikes end this year, followed by a strong bias towards easing next year (despite the Fed’s dot plot which forecasts continued modest hikes in 2023).  

–Yields plunged yesterday morning, partially as PMI weaker than expected.  EDU3 traded as high as 9672 before coming back to settle 9653.5.  At the high the contract was nearly 100 higher than the low set just before the FOMC on June 13, which was 9580.5.  At futures settle, the ten year yield was down nearly 10 bps to 3.065%. Exaggerated moves reflect both uncertainty and illiquidity.  

–The price of copper and other base metals continues to plunge.  HGN2 this morning is 3.72; it started the month around 4.50.  The prices of economically sensitive inputs have dropped as calls for a slowdown have captured the narrative…having been telegraphed by the eurodollar curve months ago.  Ten year treasury to inflation-indexed yield made a new low of 250 bps. Mexico hiked 75 bps to 7.75%.  Inflation for Q3 is expected 8.1%, so that’s a rather restrictive policy rate, compared to the Fed’s dots which project year-end inflation at 5.2% with FF at 3.4%.  In any case, higher market rates of interest have had an impact, likely to be reflected by today’s New Home Sales (for May) expected at a rate of 590k as compared to the start of the year around 840k.

End of hikes, end of growth

June 23, 2022

–The message from the interest rate market is becoming more shrill: a recession is coming fast. This conclusion probably isn’t good for stocks but hold the thought. 

–For a while the lowest contract on the euro$ strip was EDM3. The idea was that Fed tightening would be over by the middle of next year. Then, on June 13, EDH3/EDM3 inverted at settlement…and hasn’t looked back (-9.5 settle).  So, EDH3 became the cheapest contract on the strip.  But yesterday EDZ2/EDH3 inverted…and was trading negative 2 late (-0.5 settle).  The market has moved the end of hikes up to the end of the year. The lowest (most inverted) spread is EDH3/EDH4 at -47.5.

–Consider EDU2/EDU3.  On June 10 it was 87.  Yesterday’s settle was 26.5, and shortly after settle it was 23.  It’s almost astonishing that a 1-yr spread like EDU2/EDU3 could be below 1/4% while a 1-month spread like Oct/Nov FF could be 36.5.  (FFF3/FFF4 settled -23.5!) Spreads from 2023 to 2024 are telegraphing an unmistakably bearish economic signal, although further back the curve is actually steepening.  Yesterday reds settled +20.25 while golds were only up 12.25.

–Now, what does that mean for stocks?  The economy is expected to grind to a halt. Look at the bbg base metals chart.  It had a half-hearted bounce at the 38 pct retracement and is now looking at 50%.  The 50% for SPX is ~3500.  Do earnings really hold up where the administration is jawboning constantly against profits?  My answer is no….we’re not in the Kansas of an accommodative Fed and a capitalistic govt any more.  From Chevron CEO’s Mike Wirth letter to the President: “…your administration has largely sought to criticize, and at times vilify, our industry.  These actions are not beneficial to meeting the challenges we face…”

Dr Copper, in the study, bludgeoned by a gold candlestick

June 22, 2022

–The front EDU2/EDU3 one-year calendar made a new low yesterday of 39 bps, down 4.5 on the day, as the market anticipates that Powell’s semi-annual testimony today will emphasize the Fed’s fight against inflation.  In fact, EDU2/EDU3, the front one-year spread, is the ONLY positive one on the ED strip until EDM5/EDM6 which settled +0.5.  The most negative one-year is EDH3/EDH4 at -45.5.  Once again, the message from the market is that front-loaded hikes will work — by slowing the economy to a dead halt.  Note that EDH3 remains the lowest contract on the strip at 9599.5 or 4.005%, consistent with a peak FF rate of 3.5-3.75%.  EDH3/EDM3 settled at a new low -9.5 (9599.5/9609.0) ; the market has an easing bias early next year. 

–BBG leads with a piece saying Citi economists see chance of global recession nearing 50%.  Can’t help it, but all my mind can see is a few guys standing around the office with crumpled Taco Bell wrappers on their desks saying “let’s run it through the model” as one reaches in his pocket to flip a coin.   One suggests using the word ‘nearing’ in the report, otherwise senior management might catch on.

–Looking at this morning’s price action: ESU -45, TYU +12 at 116-055 almost makes it seem as if someone knows what Powell is going to say.   Of course, the Monetary Policy Report was already published on the Fed web site for those in Congress to read, all 77 pages, and you can tell they’ve done so by the fabulous questions we’ll be treated to…link here
https://www.federalreserve.gov/monetarypolicy/files/20220617_mprfullreport.pdf

–The curve was somewhat odd at Tuesday’s settle, with whites -1.75, reds +1.875, greens -0.75, blues -5.375 and golds -8.825.  Fairly large steepening from reds to golds as reds (the second year forward) were the only contracts to settle positive on the day.  Contracts past the reds are more correlated to longer maturity treasuries, and indeed the curve steepened there as well, with fives +4.1 bps, tens +6.8 to 3.305% and thirties +9.6 to 3.387%.  

–With respect to longer maturities, I have attached the ‘Gundlach’ indicator of the copper/gold ratio to the ten year treasury yield.  The former is falling as copper (HGN2, seen as an important economic input correlated with growth) has made a new low for the year.  The copper/gold ratio has broken down to levels not seen since early 2021.  However, treasuries have more or less ignored this signal as tens exceeded the 2018 yield peak just last week.  This sort of looks like the 2018 divergence, which resolved with lower bond yields.   

Summer Solstice

June 21, 2022

–On Friday EDU2/EDU3 made a new low settle of 43.5 from 87 the previous Friday; down 2 on the day.  The euro$ curve continues to flatten in the face of the Fed’s inflation fighting resolve. EDZ2/EDZ3 settled -28.5, indicating that by next year, the Fed will be back to an easing bias.  

–Bitcoin traded sub-18k over the weekend, but is now back around 21k as the crypto army regroups.  The problem now is that companies like MSTR issued bonds to buy bitcoin.  Whenever leverage is involved, there is more of a chance for forced sales that spiral, and the low rate environment encouraged borrowing.  Higher rates create a hurdle, especially when the collateral is volatile.

–Crude oil is rebounding this morning, with CLQ2 up 2.50 over 110.50/bbl.  Biden is floating the idea of a gas tax holiday which Yellen inexplicably endorsed; the Federal gas tax is 18.4 cents a gallon.

–News today includes Existing Home Sales and a Barkin speech.  Existing Home Sales expected at 5.4 million rate from 5.6 last.  The high in 2020 was over 6.5m; the range from 2016 to 2020 was mostly 5.2 to 5.5, so today should put us squarely back into that range.  Powell begins semi-annual testimony tomorrow.  

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