Four Barrel Carburetor

October 6, 2022

–A lot of crap news out there.  This has nothing to do with markets, but good for these kids and for the guidance of the father…

Group of teen girls transform home garage in Manatee County into an auto shopThe garage of a Lakewood Ranch home has become an auto shop for a group of teenage

–Vol was better bid as yields rose.  Tens jumped 14 bps to 3.753% while twos rose 4.7 to 4.114%.  OPEC cutting output by 2m bpd has the Biden admin creatively responding by threatening to release more oil from the dwindling SPR, and suggests that energy inflation is not going to quickly abate.  I guess the fist-bump didn’t mean as much to MBS as it meant to Joe.  Bostic said the inflation fight is still in the early days, and that fed funds need to go to 4-4.5% by year end.  Current FF target 3.0 to 3.25% with EFFR 308.  Expiring FFV2 is right at the Fed Effective rate (9191.75).  A year out, FFV3 is 126 higher at 9565.5 or 434.5.  March SOFR is more aggressively priced for hikes at 9556 or 444, but a terminal rate of 4.25-4.5% is in the ballpark. SFRH3 (9556) and EDH3 (9528) are the lowest contracts on the strip.

–After a weak day yesterday, the dollar index is rebounding somewhat this morning, weighing on stocks.  Atlanta Fed GDP Now for Q3 jumped to the high of the cycle at 2.7%; the next update is tomorrow after the employment data.  Not much else to say about markets, but just to round out the note and circle back to the top clip, here’s Marissa Tomei at her finest.

Posted on October 6, 2022 at 5:18 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Pressure valve

October 4, 2022

–The ten year yield dropped 14.5 bps to 3.653%.  News swirled about an expedited FRB Board meeting yesterday; it barely matters whether it was previously scheduled or not, the market is attuned to myriad pressures on the Fed to abandon its inflation fight.  For example, the UN called on the Fed to halt rate hikes.  Rumors of problems at Credit Suisse harken back to times when Lehman was in the spotlight, years before the actual failure.  Worth noting is CS market cap of just $10 billion, compared to Citi at $82b (and shrinking) or WFC at $152b.  SNB portfolio is worth $147 billion of which the AAPL stake is approximately equal to the mkt cap of CS.  Hard to imagine the Swiss will let CS fail.

–RBA hiked today, only 25 bps to 2.6% vs an expected 50 bps. In the US, current EFFR is 308 bps, if the Fed hikes 75 on November 2, EFFR will be 383.  Yesterday FFX2 (Nov Fed Funds) settled -1 at 9628.5 or 371.5 bps, so this contract currently tilts slightly toward 75 rather than 50.  FFF3/FFF4 settled back in negative territory at -8, indicating possible ease next year.  Deferred eurodollar contracts soared in price, with reds +13 and greens +15.5.  While the tightening campaign is expected to continue through year-end, it’s clear that the ‘Fed put’ is in play. There are plenty of Fed speakers today that could push back against the relief rally in equities (Williams, Logan, Mester, Jefferson, Daly).  On the other hand, data like ISM Mfg New Orders (chart attached) shows the lowest activity outside of crisis periods. 

–Gary Gensler, the head of the SEC, marshaled the resources at his disposal to get to the bottom of his core mission by fining Kim Kardashian $1 million dollars for her involvement with an artificial currency that is now nearly worthless.  I know I am a LOT more confident about the integrity in markets and financial stability. 

–Bonus ‘Pressure Drop’ youtube by Toots and the Maytals. Because if the markets have you a little confused, a little reggae helps.

Posted on October 4, 2022 at 5:00 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

What’s a Punch Bowl?

October 2, 2022 – Weekly Comment

If we fail to apply the brakes sufficiently and in time, of course, we shall go over the cliff.  If businessmen, bankers, your contemporaries in the business and financial world, stay on the sidelines, concerned only with making profits, letting the government bear all the responsibility and the burden of guidance of the economy, we shall surely fail…. In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects—if it did not it would be ineffective and futile.  Those who have the task of making such policy don’t expect you to applaud.  The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.

Fed Chair William McChesney Martin, Jr, October 19, 1955.  67 years ago.

In the speech he also quoted NY Fed President Allan Sproul (NY Fed Pres 1941 to 1956):

“Those who would seek to promote ‘full employment’ by creeping inflation, induced by credit policy, are trying to correct structural maladjustments, which are inevitable in a highly dynamic economy, by debasing the savings of the people. If their advocacy of this course is motivated by concern for ‘the little fellow’, they should explain to the holders of savings bonds, savings deposits, building and loan shares, life insurance policies and pension rights, just how and why a rise in prices of, say, 3 per cent a year is a small price to pay for achieving ‘full employment’. They should also explain to all of us—little, big, and just plain ordinary Americans—what becomes of our whole system of long term contracts, on which so much of our economic activity depends, if it is to be accepted in advance that repayment of long term debt will surely be in badly depreciated coin.”

From the Fed’s press conference September 22, 2021, just over one year ago:

If sustained higher inflation were to become a serious concern, we would certainly respond and use our tools to assure that inflation runs at levels that are consistent with our goal.

So that suggests that inflation’s going to be higher this year, and a number—I guess the inflation rates for next year and 2023 were also marked up, but just by a couple of tenths. Why—those are very modest overshoots. You’re looking at 2.2 and 2.1, you know, two years and three years out. These are very, very—I don’t think that households are going to, you know, notice a couple of tenths of an overshoot. That just happens to be people’s forecasts.

Everyone, including the Fed, knows that the transitory inflation call was wrong. In part the Fed kept policy too loose with the noble intention of making sure employment opportunities were available to the most marginalized worker, in a misguided effort to smooth the contours of inequality.  It backfired.

It used to be that the Fed was forward-looking in the conduct of monetary policy, with an early articulation coming in the “Punch Bowl” speech   Now it is numbingly reactive.  That’s apparent from Brainard’s speech Friday.  She simply describes possible spillover and cross-border effects of tighter policy, without drawing any conclusions.  Here’s the pith of Brainard’s speech, “…we are committed to avoiding pulling back prematurely.  We also recognize that risks may become more two sided at some point.”  Things are starting to blow up.  Nike, AAPL and Rent-a-Center all are early warning systems with respect to consumer demand.  No vodka.  Just inflation-fighting Kool-Aid.

Despite the UK blow-up, DXY actually closed slightly lower on the week.  Inflation breakevens were crushed.  From a high of 368 bps in late March, the 5yr breakeven is 210 now.  The ten-yr breakeven hit 304 in April and is now at a new low for the year at 215.5.  The US curve steepened. While 2/10 only firmed from -52 to -41 over the week, eurodollar spreads like the red/gold pack spread (2nd to 5th year forward) went from -69.5 to -39.5 a 30 bp jump.  Red/green ED  pack spread (second to third years) went from -52.75 to -38.75, equaling the high since the start of August.  SFRH4/SFRH7 had set a new low of -78 last Friday (Sept 23), but ended the week/month at -47.5.  These spreads are still deeply inverted, however, a less inverted curve is likely a signal that the Fed is getting close to the end of the tightening cycle.

News this week includes:
Monday: ISM Mfg expected 52.1 from 52.8 with prices 52.0 from 52.5.
Thursday: Speeches on the Economic Outlook from Cook, Waller and Mester.

Friday: Employment Report with an unchanged rate of 3.7%, NFP expected 250k.  Average Hourly Earnings expected 5.1% from 5.2% yoy.    

UST 2Y420.5420.2-0.3
UST 5Y397.5403.45.9
UST 10Y369.1379.810.7
UST 30Y361.0375.814.8
GERM 2Y191.8175.9-15.9
GERM 10Y202.4210.88.4
JPN 30Y129.0138.09.0
CHINA 10Y268.0275.07.0
SOFR Z2/Z3-1.5-6.5-5.0
SOFR Z3/Z4-72.5-54.518.0
SOFR Z4/Z5-26.0-14.012.0
CRUDE (CLZ2)78.2578.720.47

Posted on October 3, 2022 at 4:54 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Breakevens at lower end of recent range

September 30, 2022

There’s something happening here
What it is ain’t exactly clear.

Buffalo Springfield-For What It’s Worth

–Those lines capture my sentiments about the market.  Probably a good time to keep risk close to the vest as we enter Q4.

–Ten year and five year inflation breakevens at new lows right around 218 to 219, the high in 2018.  That’s when the FF target had peaked out at 2.25 to 2.5%.

–Bullard, Mester talking tough on the need to tighten further as Yellen prepares to make a graceful exit…or is shoved out.  It doesn’t really matter how she leaves, though perhaps it’s a signal of the last tie to economic knowledge slipping out the administration’s back door. 

–Today’s news includes the Fed’s preferred measure of inflation, PCE deflator expected 6.0% from 6.3 last, with Core expected 4.7 from 4.6 last.  German CPI yesterday was 10%.

–EDZ2/EDZ3 spread settled -23, but SFRZ2/SFRZ3 at -7.  Front Dec euro$ contract reflecting year-end funding stress.  FFF3/FFF4 still above water at +2 (9580.5/9578,5).  Can the Fed hold rates around what is now considered to be the terminal rate of around 4.0-4.25% for an entire year?

Posted on September 30, 2022 at 5:33 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Master of your own domain

September 29, 2022

–Central bankers are in a contest to determine who is the master of their own (inflation) domain.  Yesterday, Andrew Bailey walked in, slapped his money down on the table, and blurted “I’m out!”  Like Kramer.

–Capitulation.  First it was the LME with the margin call on nickel and now it’s the Bank of England, meeting the margin call for gilt longs.  Teetering on the knife’s edge of financial disaster.  Get used to it. 

–Bostic favors another 75 bp hike in November.  Evans was also out yesterday in support of higher US rates into the end of the year.  Yesterday, ten-yr and bond futures made now lows for the move, had outside day ranges on heavy volume and closed near the highs of the day.  Classic reversal formation.  However, this morning much of those gains have been given back.  If lows are breached, it’s going to be a puke.  Going into the last quarter, risk is likely to be pared back and liquidity will suffer.

–Remember the “turn-of-the-year” phenomenon when December eurodollar contracts would invert due to technical demand for funding that covered year-end?  It’s BACK.  Yesterday, EDZ2 was +2.5 to 9533 and EDH3 was +14.5 to 9535.  An inverted spread of -2, new low.  SFRZ2 to EDZ2 closed at a new high of 42 (9575/9533).  Yesterday, there was a buyer of a few thousand EDZ2 9475/9600 strangles for 9.0.  This guy remembers.  Settled 9.25 (4.50 and 4.75).  One last hurrah for the eurodollar contract before it’s completely replaced with gender-neutral SOFR.  SFRU2/EDU2 had compressed all the way to 10 before expiration.  The December spread is a stark reminder that the bank funding window might get sealed shut for winter.  DO NOT BUY EDZ2 contracts.

–Ten year note vs inflation-indexed tip yield ended at 234 bps, around where it was in the beginning of July.  It was over 3% in April. The metaphorical storm surge in markets is like Hurricane Ian, submerging homes, tossing cars around, and I can almost bet we’ll have an academic central banker smugly remark, “Forward inflation expectations are well moored.  It’s apparent in the breakevens.” 

Posted on September 29, 2022 at 5:43 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

7 yr auction today

September 28, 2022

–Bear steepening continues this morning. On Friday, SFRH3 settled 9549, SFRH4 9572.5, SFRH5 9622.5 and SFRH6 9640.5.  This morning (from Friday settle) H3 9556.0 (+7), H4 9584.5 (+12), H5 9620.5 (-2), H6 9626 (-14.5).  The front end of the curve is starting to forecast an end of tightening, the back end is worried about lack of demand.  At yesterday’s future settlement time, the two year was unch’d at 4.308%, while tens were nearly 4%, up 9.8 to 3.968 and thirties were +14 bps to 3.832%.  There are many indications of uncertainty and illiquidity ahead.  For example, I don’t think I have ever seen long-dated red and green euro$ straddles as high as they are now.  My recollection may be suspect, but the 6th quarterly ED straddle used to be high if the nominal level was 120 to 125 bps.  And that was with base rates higher than they are right now.  Yesterday, EDH4 9550 straddle settled 161.5 with EDH4 9550.5.  B/E 9389 to 9711; 538 dte.
–I’m sure I am taking this out of context, but saw this bullet point yesterday
FED’S BULLARD: DANGEROUS TO CHANGE INFLATION TARGET – COULD CAUSE CHAOS.  I guess that would have been prescient if he had said it in the early part of 2020, before the Fed changed its framework to FAIT (flexible average inflation targeting).  In any case, if we had been tiptoeing towards chaos, we’re now in a more purposeful stride.  At this point central bank speakers are not making things better.

–Tens over 4% this morning and mortgage rates around 7%.  Yesterday Case-Shiller reported the “first sequential drop in home prices since March 2012, or ten and a half years.”   

–Some large TYX and FVX put spreads sold early yesterday morning:  FVX 107/106ps sold 20k at 26, appears exit.  In TY looks like rolls out of higher and into lower strikes: -10k TYX 110/109ps 18, -20k TYX 111.5/110.5 ps at 29.  And a late USZ -10k 122/120ps at 38 (roll down).

Posted on September 28, 2022 at 5:56 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

The sea was angry that day

September 27, 2022

–Huge jump in yields yesterday with tens +18 bps to 3.87%.  Implied vol exploded to the highest level since covid as attached chart indicates.  Massive steepening on short end curves.  SFRH3 was the strongest contract on the strip, closing +7 at 9539 (4.61%).  SFRH4 9572.5, -13.0.  SFRH5 9623.5, -20.5.  SFRH6 9639.5, -23.5.  Calendar spreads are still deeply inverted, but less so after yesterday.

–In the near 1-yr calendars, FFF3/FFF4 (a proxy for expected Fed action next year) settled at positive 22, up 9.5 on the day.  SFRZ2/SFRZ3 settled positive 11.5.  Like the FF spread, this SOFR calendar had been inverted for the past three months.  At the start of August it was negative 60, in mid-Sept as low as -40.  The adjustment to positive reflects a change in sentiment which respects the idea that Powell will resist a premature pivot toward ease.  A collapse in asset prices and/or employment may yet overwhelm Powell’s resolve, but for now, FFF3 at a price of 9573 or 4.27% is still nearly 1.25% above the current EFFR.

–News today includes Durables, New Home Sales, Consumer Confidence and comments by Bullard.  Regarding homes, a friend sent these mortgage quotes yesterday: Conforming 30yr fixed with >740 credit score, 6.75% to 6.875% for single family home and 7.0% for condo (thanks RR).  Average home price is $430k.  80% mortgage is $344k.  At 3% (available at start of the year) the monthly pay is $1450.  At 6.75% it’s $2231 or 54% higher.

Posted on September 27, 2022 at 5:27 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

She Can’nae take any more Captain!

Stardate: 47634.44

–Plunge in GBP to 1.0349 overnight though current 1.07.  Dollar/yen over 144.  CNY weakened to new low 7.16 vs 6.75 in early August.  Strength in DXY threatening to bring down the whole house of cards.

–US fixed income under pressure with JPY weak even after last week’s intervention; risk of US treasury sales to shore up the yen.  According to BBG Japan holds $1.156T of long term UST.  Low in 2018 was $960 billion

–This morning Jan’23 FF prints 9568.5 (-2.5) or 4.315%, 123.5 over the new EFFR of 3.08.  FFX2 still indicates a 75 bp hike at the next FOMC.  In spite of increasing global stress the market can’t buy into the thought of a u-turn by the Fed.  Red SOFR contracts down 12.   

–Liquidity likely to be quite poor in this environment.  On Friday I marked TYX at-the-money 112.5^ 2’18 vs 112-20s. Earlier in the week it had been 2’06.  This morning TYX 112^ 2’29/2’30 ref 111-31 or 10.5 vol. This is the highest level since the COVID panic.

Posted on September 26, 2022 at 5:19 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Change in the Landscape

September 25, 2022 – Weekly comment

On August 1, 2021, I wrote a piece titled Keystones, after watching a PBS nature show ‘The Discovery of Keystone Species’.  The premise of the documentary is that a system without keystone species — typically apex predators– gets thrown out of balance. The related concept is ‘The Landscape of Fear’.  If there are no big cats, gazelles are blithely free to overgraze, leading to parched fields.  As scientist John Terborgh succinctly concludes:

“Remove the predator and it leads to the deterioration of the whole system. Loss of predators is almost always a loss of diversity. We coined the word ‘downgrading’ to describe it.”

My analogy was that the Keystone in modern capitalism is the base interest rate.

The Fed, by cutting rates to zero and encouraging investors to pile into the riskiest assets, was instrumental in throwing the health of the economy out of whack.  Zombie corporations that could barely meet interest expenses out of cash flows were allowed to survive and even flourish.

Druckenmiller has often called funding rates an important “hurdle to capitalism”.  Savers provide the capital to productive enterprises and deserve compensation for foregoing consumption.  When the Fed sets the price of risk at zero, capital is misallocated.

We don’t want the economy to be the fat antelope who doesn’t realize the big cats have returned.  We want it to be more like Dewey Oxburger, “a lean mean fightin’ machine.”

The Fed and other Central Banks are now raising rates to rid the economy of the very excesses that previous policies encouraged, which unsurprisingly included runaway inflation as an offshoot.  I’ve included a helpful Far Side image depicting Powell behind one tree, and the retail investing public behind the other.  In his Jackson Hole speech, Powell vowed to keep at it until the job is done and assured us that higher interest rates “…will bring some pain to households and businesses.”  It doesn’t get much clearer than that, and the message was punctuated by the 75bp hike on Wednesday. 

The equity market has put up its tail in notice, and interest rates have started to sprint.  On the week both twos and fives rose over 35 bps, to 4.21% and 3.98%.  SPX is down 23% from the January high.  The Jan’23/Jan’24 Fed Funds futures spread, which can be thought of as a rough proxy for expected Fed action over 2023 was negative 56 on August 1.  On Friday it settled positive 12.5, up from negative 24 just one week ago.  Friday’s settles: FFF3 9571.0 and FFF4 9558.5.  In the new Fed projections for end of year FF rates, the 2022 rate was pegged at 4.4% and end of 2023 at 4.6%.  The rates on the FF contracts are 4.29% and 4.415%, quite close but BELOW the Fed projections.  In June, the Fed estimate for the end of 2022 was 3.4%, while the June 17 settle for FFF3 (the Friday after the FOMC) was 9643.0 or 3.57%.  At least with respect to the end of 2022, the Fed is now “ahead of the curve” as opposed to being behind in June.

It was August 2007 when Cramer unleashed his rant against Fed Chairman Bernanke and St Louis Fed President Poole in the company of the unflappable Erin Burnett.  Cramer: “Bernanke’s being an academic…he has NO IDEA how bad it is out there.  NO IDEA!”

As it turned out, Cramer’s timing pre-dated the market high by two months; SPX made its high for the GFC move on October 11, 2007. 

On Friday, we heard a similar (and more reasoned) ‘NO IDEA’ rant by Wharton Professor Jeremy Siegel, arguing that commodities and housing are now falling in price, and that money supply has emphatically reversed course (see M2 yoy pct change chart below).  “The Fed is too tight!”  Professor Siegel has post-called the SPX high by over nine months. [He’s an academic, after all].

Professor Siegel clearly called out the Fed for ignoring market signals and focusing on lagging indicators.  The charge of the Fed being primarily driven by academics and not market practitioners has been thrown out there numerous times, and the idea that “the market is NOT the economy” seems to be an implicit principle in Powell’s approach.  The contrast between the ‘Fed Listens’ event on Friday and market price action couldn’t have been more telling as several business owners sat around a big conference table sharing the challenges of their particular operations with Fed members who asked a few bland questions in response.


New buyer Friday of 110k SFRZ2 9600/9625cs 2.25 to 2.5.  Settled 2.25 vs 9560.5. 

New Home Sales and Case-Shiller home prices on Tuesday.  PCE Deflator on Friday.

Treasury auctions 2’s, 5’s and 7’s Monday, Tuesday, Wednesday. 

UST 2Y385.4420.835.4 w/I 421.0/19.5
UST 5Y362.4397.735.3 w/I 398.0/97.0
UST 10Y344.7369.124.4
UST 30Y351.6361.09.4
GERM 2Y153.3191.838.5
GERM 10Y175.6202.426.8
JPN 30Y128.7129.00.3
CHINA 10Y268.0268.00.0
SOFR Z2/Z3-31.5-1.530.0
SOFR Z3/Z4-65.0-72.5-7.5
SOFR Z4/Z5-18.0-26.0-8.0
CRUDE (CLZ2)84.0778.25-5.82
Posted on September 25, 2022 at 2:00 pm by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

There IS an alternative

–Meltdown in rate futures suggests possibility of capitulation.  Red, green and blue ED and SFR contracts plunged 18 to 21 bps on settle; new lows.  Two year treasury at a yield of 4.12% (up 13) and tens jumped 18.6 bps to 3.702% in front of today’s October option expiration.  New low in 5/30 treasury spread at -29 bps.  

–If prelim open interest data is correct, net changes are indicative of a puke in the short end, though not in treasuries.  Large OI changes: EDZ2 -35k, EDH3 -23k (all ED combined -28k).  In SOFR: Z3 -36k. U3 -46k, Z3 -38k (all SFR combined -135k).  The theme of the Fed holding rates relatively higher for longer appears to be gaining currency.  For example, since the CPI release in June, FFF3/FFF4 calendar spread (a rough indicator of Fed action over next year) was negative, forecasting eases.  The low in July was -69.5.  Yesterday, this spread settled positive 4.5.   There was buying of SFRZ2/Z3 (same idea) which closed -10.5, up 14.5 on the day.  A couple of early 10k blocks: +SFRU3/SFRU5 at -106 and +SFRZ3/SFRZ5 -91.5 appear to have been closing trades (big declines in OI in U3 and Z3, so someone is taking profit on large shorts).

–Bloomberg has two headlines which capture the mood: ‘Investor Pessimism Hits-2008 Era High in Flight to Cash, BofA Says’ and ‘The Era of Inflation Has Ended – for Asset Prices on Wall St’.  SPX is down just over 20% ytd, and the Fed appears to have become a put BUYER rather than seller.  At down 20% in 2018, Treasury Sec’y Mnuchin was calling together the heads of the big banks to assure market liquidity.  Now, the heads of big banks are in front of the House Financial Services Oversight Committee to be grilled on student loans and green initiatives.  At first blush, one might think the BBG headlines are contrarian.  However, at a 2yr yield above 4% and 5’s nearing 4%, and tips over 1%, large investors finally have an alternative safe port in which it pays to stay docked (with Mary Ann) OR Tina (Tina Louise as Ginger)

Posted on September 23, 2022 at 5:29 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options