Short end yields jump
December 6, 2022
–Large jump in short end rates Monday as ISM Services rose to 56.5 vs expected 53.5. WSJ ran a Timiraos article that suggested the Fed could raise rates above the market’s 5% terminal expectation. March’24 weakest ED and SOFR contracts, down 17 bps (9568.5 and 9594.5) Lowest contract on SOFR strip is M3 at 9502, down 10 on the day. Red/green ED pack spread made another new historic low at -87.75. 2/10 remains anchored to a new cycle low around -80. Ten year yield rose 9.2 bps to 3.596%. Stocks were hit with SPX -1.8% and Nasdaq -1.9%.
–Attached chart shows ISM Services with S&P Service PMI…a bit of a divergence there.
–Jan’23 FF settled at 9564.5, continuing to peg next week’s rate rise to 4.25-4.50% with a new Fed Effective of 433. FFG3, which will capture the Feb 1 FOMC settled 9529.5. Assuming 50 in Dec, another 25 in Feb would lead to a final settle of 9542.9 while another 50 would be 9518.8.
In: Eurodollar Options
Fighting the last war
December 5, 2022
–NFP much stronger than expected 263k. with yoy Avg Hourly Earnings +5.1%. That’s what the Fed is fighting against, so rates jumped, but only short end rates remained higher by the end of the day as higher funding costs will stifle future economic activity. The weakest contract on the SOFR strip was June’23, DOWN 5.5 on the day to 9512.0, consistent with a terminal rate of 4.75-5.0%. However, SFRM4 closed UP 2 at 9654.5 and SFRM5 9718.5 +6.0. The rate on SFRM5 is more than 200 bps LOWER than the rate on SFRM3. Tens ended -2.4 bps at 3.504%, which is more than three-quarter percent below what will be the new repo rate when the Fed hikes 50 next week.
–Some near 1-yr calendars made new lows, the lowest being Sept’23/Sept’24 at -153.5. Red/green ED pack spread made a new historic low at -85.25. While weakness in front-end contracts suggests a stingy Fed, the near spreads between SOFR and ED contracts declined to new recent lows as LIBOR fades into its ultimate demise. For example, a month ago SFRZ2/EDZ2 traded 52.5, but settled Friday at 31.0. SFRH3/EDH3 closed at just 21.0. Libor rates used to signal credit concerns in the banking system, but the vast regulatory framework overseeing the financial architecture has become so robust that it’s hard to even imagine fraud or credit problems going undetected. On the other hand, I’ve heard there are some great values in Bahamas real estate. Speaking of which, here’s the subdial site, which tracks the prices of used watches. Down 5.4% over the past twelve months. Because, of course, you can now just look at your phone.
https://beta.subdial.co/market
In: Eurodollar Options
SFRZ4
December 4, 2022 – Weekly Comment
The chart is SFRZ’24, the three-month future, two years forward. On November 4, the settle was 9602.5. On Friday, December 2, the settle was exactly 100 bps higher, 9702.5, a rate below 3% (2.975). When looking at the low to high prints, the range is wider: 9587.5 on Nov 4 to 9706 on Friday, 118.5 bps.
In terms of a technical set up, there was a double bottom, low of 9590.5 on Oct 20, followed by a bounce to 9640.5, then the Nov 4 low at 9587.5. Upside objective is double the range, 9590 to 9640 is 50 bps, so 9690. The breakout above 9640 came on Nov 10, when CPI printed 7.7 vs 7.9 expected, with Core 6.3. On that day the contract traded up to 9654.5. It then tested the breakout above 9640.5 three times, low of 9645.5 on Nov 14, low of 9647 on Nov 21 and 9647.5 on Nov 22. On Wednesday, Powell spoke and indicated a shift to smaller hikes, and said the Fed didn’t want to over-tighten. Those comments sparked a 35 bp range: 9659 to 9694.5. While Friday’s stronger than expected payroll and wage number had analysts penciling in a higher terminal rate, SFRZ4 closed at a new high. The next big resistance level comes in at 9712, which coincides with the 61.8 retrace and the 200 day moving average.
Why focus on this chart? Several reasons: 1) it’s the nearest contract to settle below 3%. The lowest contract settle is SFRH’23 at 9511.5 or 4.885%. There is nearly 200 bps of ‘ease’ priced over the time frame from March of next year to Dec 2024. 2) the technical set-up is instructive 3) there have been a lot of SOFR call spreads purchased in November, targeting 3% or lower forward rates, the 9700 call strike 4) this chart looks a lot like other macro charts; everything is sort of trading together.
For example, DXY was testing the 200 DMA, and convincingly broke through on Thursday, after Powell’s comments. SPX broke through the 200 DMA on Wednesday. Below is a chart showing EUR, SPX and SFRZ4.
Larry Summers is quoted in a Bloomberg article from an interview Friday. In a way, his comments capture the market action. He thinks the Fed is going to tighten more than currently priced.
“Six is certainly a scenario we can write,” Summers said with regard to the peak percentage rate for the Fed’s benchmark. “And that tells me that five is not a good best-guess.”
The market has been centered around 5% as a best guess, so Summers is going out on a limb here. Of course, he doesn’t face the same criticism as Powell when things go badly. In any case, he unintentionally (I think) makes the case for much lower rates in the future. Summers adds this:
“There are all these mechanisms that kick in,” he said. “At a certain point, consumers run out of their savings and then you have a Wile E. Coyote kind of moment,” he said in reference to the cartoon character that falls off a cliff.
In the housing market, there tends to be a sudden rush of sellers putting their properties on the market when prices start to drop, he said. And “at a certain point, you see credit drying up,” forcing repayment problems, he added.
“Once you get into a negative situation, there’s an avalanche aspect — and I think we have a real risk that that’s going to happen at some point” for the US economy, Summers said. “I don’t know when it’s going to come,” he said of a downturn. “But when it kicks in, I suspect it’ll be fairly forceful.”
If it wasn’t Larry Summers, one might be forgiven for thinking the speaker is an idiot. One of Powell’s objectives is to attempt a relatively soft landing. That is, he wants to avoid the Wile E Coyote moment that Summers so blithely refers to. Powell, and the market, apparently think that if short rates go too high, it hastens the moment of negative inflection.
And when does the market think that moment arrives? Just looking at six month calendar spreads gives a clue. SFR Sept’23/March’24 is -80.5. Dec’23/June’24 is -89.5 and March’24/Sept’24 is -73. Prices: U3 9531.0, Z3 9565.0, H4 9611.5, M4 9654.5 and U4 9684.5. So Wile is sprinting to the edge of the cliff by September.
News items like Blackstone limiting withdrawals from its non-traded REIT (BREIT) are an indication of concern. So is the most recent reading of Chicago PMI to a recessionary level of 37.2.
“The move comes as real estate investors express concern about how rising interest rates and an economic slowdown would affect the commercial property market.” (costar.com) “Our business is built on performance, not fund flows, and performance is rock solid,” according to a Blacktstone statement emailed to CoStar.
Both quotes may be true, but the withdrawal of liquidity in a leveraged situation will always trump performance.
******************************************************************************
Friday’s NFP was stronger than expected 263k, with higher than expected yoy wage growth at 5.1%. The market knows employment is a lagging indicator. But the Fed has been clear that the labor market needs to come into balance, and that means a goal of higher unemployment. Therefore. near contracts ended lower on Friday, but deferred contracts and bonds traded higher.
OTHER MARKET THOUGHTS/ TRADES
January’23 FF contract, which captures the outcome of the Dec 14 FOMC, settled 9565.0 or 435 bps. The Fed Effective rate EFFR has been 383 since the last hike. On a hike of 50 next week, EFFR should go to 433. This outcome (a half-percent hike) has been pegged for a month; since 11/10 FFF3 has settled between 9561.5 and 9565.5. The low contracts on the FF curve are May and June 2023 at 9508.5 or 491.5, but by Jan’24 the level is very close to Jan’23, at 9556.0 (444). So hike, then ease. At 433, the Fed Effective will be above every treasury yield from the two-year out. The spread of EFFR to CPI is NOT saying ‘restrictive’ but the spread of EFFR to treasuries is.
Red/green euro$ pack spread on a constant maturity basis settled Friday at a new historic low -85.25. On October 2021 it was +60.
Should be a fairly quiet week. ISM Services on Monday, expected 53.3 from 54.4. PPI is released Friday, expected 7.2% from 8.0 with Core 5.9% from 6.7. CPI is on the 13th, the FOMC is the 14t.
| 11/25/2022 | 12/2/2022 | chg | ||
| UST 2Y | 447.3 | 427.8 | -19.5 | |
| UST 5Y | 388.4 | 366.6 | -21.8 | |
| UST 10Y | 369.8 | 350.4 | -19.4 | |
| UST 30Y | 375.0 | 356.0 | -19.0 | |
| GERM 2Y | 220.5 | 211.0 | -9.5 | |
| GERM 10Y | 197.9 | 185.6 | -12.3 | |
| JPN 30Y | 147.8 | 148.7 | 0.9 | |
| CHINA 10Y | 284.0 | 291.1 | 7.1 | |
| SOFR Z2/Z3 | -0.8 | -22.3 | -21.5 | |
| SOFR Z3/Z4 | -124.5 | -137.5 | -13.0 | |
| SOFR Z4/Z5 | -23.5 | -21.5 | 2.0 | |
| EUR | 104.00 | 105.38 | 1.38 | |
| CRUDE (CLf3) | 76.28 | 79.98 | 3.70 | |
| SPX | 4026.12 | 4071.70 | 45.58 | 1.1% |
| VIX | 20.50 | 19.06 | -1.44 | |
In: Eurodollar Options
Conditions are easing
December 2, 2022
–Yields continued to plummet in front of today’s payroll data. NFP expected 200k from 261k last, with a rate of 3.7%. YOY Avg Hourly Earnings expected 4.6% from 4.7% last. 10y yield -17 bps to 3.528% while green and blue ED/SFR were +16.375.
–PCE inflation numbers yesterday were about as expected, headline 6.0% and Core 5.0%. ISM Mfg came in at 49.0, with the Prices Paid component 43.0 from 46.6, hasn’t been lower since Covid in May 2020.
–The 2y yield plunged 12.6 bps to 4.252%. The Fed is expected to raise the FF target to 4.25-4.5% at the Dec 14 FOMC, so twos will likely be under FF by the end of the year. New lows in several of the near one-year calendars on ED and SOFR curves. The lowest remains Sept’23/Sept’24 at negative 146, down 6 on the day (SOFR 9535.5/9681.5). Dec’23 SOFR settled 9568.0 or 432 bps; the new EFFR after the FOMC will be 433 bps. Dec’24 SOFR settled 9699.0 (+16 on the day) or 301 bps.
–Powell’s message of holding rates at a restrictive level has been met with a disdainful shrug. Sure, FFF3/FFF4 is holding positive at +4.5 bps (9564.5/9560), but SFRZ2/Z2 is -20.0 (9548/9568) and SFRU3/SFRH4 six-month spread is -76.5 (9535.5/9612). Maybe things will hold together for the first half, but 2H looks dicey.
–Financial conditions are easing significantly. SPX is back above the 200 DMA and DXY closed below the 200 DMA.
In: Eurodollar Options
Softened tone
December 1, 2022
–Powell emphasized that rate hikes would slow, but did NOT stress that the Fed would be keeping rates high for a long time. The market seems to have concluded that the commitment to “keep at it until the job is done” was watered down. Huge rally ensued with reds (2nd year) up 15.375 bps. Grns +13, blues +8.25, golds +5.375. New low in the lowest one-year calendar, SFRU3/U4 settled -140, down 4.5 on the day. SFRH3/H4 had an outside day range of -75 to -92.5 and settled -91.5 (9508.5/9600.0). The expectation of ease late next year into 2024 has strengthened. Data like the plunge in Chgo PMI to 37.2, lowest save the GFC and Covid, support the idea of forced easing ahead. SPX +3.1% and Nasdaq +4.4% as Powell’s softened tone, combined with relaxation of China’s covid policies, sparked panic buying on the month’s last day.
–At futures settle, 2y -9.3 bps to 4.378, 5y -8.8 to 3.832, 10y -4.7 to 3.699 and 30y +1.8 to 3.818.
–A lot of news today: yoy PCE prices expected 6.0 from 6.2 with Core 5.0 from 5.1. ISM Mfg expected 49.7; it hasn’t been sub-50 since May 2020. Job Claims expected 235k. In two weeks the FF target will move to 4.25-4.5%. Possible the Core PCE prices drop below 5% today? Powell said he wanted to see positive real rates across the curve. Getting close.
In: Eurodollar Options
High for longer
November 30, 2022
–Today’s news includes ADP expected 200k. GDP 2.8% from 2.6%. JOLTS and Beige Book. MAIN EVENT: Powell speaks 1:30 EST. Jackson Hole was just three months ago. Since then there has been 150 bps of hiking with another 50 priced for December. Core message likely to be that rates will stay relatively high until the Fed is certain inflation is receding.
–Conforming mortgage loan limits are increasing in 2023 to $726,200, up from $647,200. Some high-priced areas will have a conforming limit of over $1m. Here’s a map (and a mission statement with almost all of the popular buzzwords) :
https://www.fhfa.gov/DataTools/Tools/Pages/Conforming-Loan-Limit-Map.aspx
| Conforming Loan Limit Map | Federal Housing Finance AgencyFairness We value varied perspectives and thoughts and treat others with impartiality. Accountability We are responsible for carrying out our work with transparency and professional excellence. Integrity We are committed to the highest ethical and professional standards to inspire trust and confidence in our work. Respect We treat others with dignity, share information and resources, and …www.fhfa.gov |
With 20% down, that’s a mortgage of $580960, a monthly payment of $3672 at 6.5%. From the FHFA website, “According to the nominal, seasonally adjusted data…house prices increased 12.1% on average, between the 3rd quarters of 2021 and 2022.” It’s hard for Powell to break the government’s own inflation bias.
–AAPL shellacked yesterday, -2.1% while SPX was -0.16% and Nasdaq Comp -0.6%. This is where it gets tricky, the cutting-edge corporate facade, which I’m sure embraces the same cookie-cutter mission statement as FHFA: Fairness, Accountability and Integrity, meets the reality of Chinese factories and policies.
–Curve slightly steepened. Twos nearly unch while 10s +4.8 to 3.746% and thirties +5.6 to 3.80%. 2/10 ended -72.5. Low in this cycle over the past week has been -81/-80.
In: Eurodollar Options
4.5 to 4.75%
November 29, 2022
–Large buyer >60k EDZ2 9512.5/9531.25 cs 2.5 up to 3.0. Settled 3.0 (3.5/0.5) ref 9506.25. SFRZ2/EDZ2 has collapsed since the start of the month, from 52.5 down to 36.5 at Monday settle. So turn-of-year pressure has been alleviated (extra liquidity reaching the markets?). Three month libor currently 4.73486 (9526.5) with 16 days until FOMC, when EFFR will shift to 433 bps on a 50 bp hike. FFF3 settled 9562.0 or 438. FFG3 will capture the Feb 1 FOMC result and is 9524.0, a spread of 38 over January. If yoy Core PCE prices print a 4 handle (Thursday) and NFP is weak (Friday), could the Feb FOMC gravitate to hike of just 25? (which would cause FFG3 to trade over 9540). If so, inversion from 2’s back would likely lessen.
–Both Williams and Bullard yesterday indicated more hiking to come, with Bullard saying the markets could be underpricing risks of more aggressive Fed tightening. Powell speaks tomorrow. Does EFFR have to be greater than Core PCE prices to fit the definition of “restrictive”? It’s possible that EFFR could be 458 by February (50 in Dec, 25 in Feb) and Core PCE around 4.5 – 4.7. Williams expects the jobless rate to climb to 4.5 to 5.0% by late 2023. Perhaps Core PCE, FF target and Unemployment will all be 4.5-4.75 by 2H 2023.
In: Eurodollar Options
China is a wildcard
November 28, 2022
–Protests in China are a wildcard, with risks to both supply chains and global growth (the latter indicated by CLF3, below $74/bbl this morning, -2.32).
The NY Fed puts out a supply chain pressure index; pressures have been easing.
https://www.newyorkfed.org/research/policy/gscpi#/interactive
From the last report, “…pressures increased moderately in October after five consecutive months of easing. …The October increase was driven by upward pressures from Taiwan delivery times, Taiwan purchases, Asia outbound air freight, and UK backlogs.”
–Obviously the Fed doesn’t change policy based on China/Taiwan, but possible impact creates a new range of scenarios, and likely tilts trades toward safe havens, especially going into year-end.
–Friday featured new lows in 2/10 treasury spread at -77.5, the twelfth lower day in a row. Red/green euro$ pack spread new historic low at -80 bps. For a while, June’23/June’24 was the lowest 1-year calendar. It has moved forward now to Sept’23/Sept’24 at -136 (in both ED and SOFR) which reflects a ‘higher for longer’ view of the Fed.
–Williams speaks today. Powell on Wednesday.
In: Eurodollar Options
Inversion accentuated
November 27, 2022- weekly comment
Last week I highlighted two market themes. First, was buying of otm call spreads in SFRU3, namely the 9700/9800 call spread for 4.25 to 4.5. This week that ripple turned into a small wave with significant buying of Z3 and H4 call spreads in SOFR.
The other feature I noted was a new high in SFRZ2/Z3/Z4 butterfly which had settled at a new recent high level of +108. Last week (11/18) SFRZ2 settled 9545 which was -4.0. SFRZ3 9544.5 -22.5 and SFRZ4 9652.0 -4.5. Dec’22 and Dec’24 were down a bit, but Z’23 was hammered on a relative basis.
On Friday 11/25, the SFRZ2/Z3/Z4 fly settled at a new high of 124.25. However, net changes on the week reflect a different story. SFRZ2 settled 9543.25 down just 1.75 on the week. SFRZ3 9544.0, down 0.5. SFRZ4 was the driver at 9558.5, UP 16.5.
First, I will briefly cover the call spreads.
SFRU3 9700/9800cs traded a bit more, settled 4.25 ref 9514.5. OI in both strikes >65k
SFRZ3 9625/9725cs settled 17.75 ref 9544, OI in both strikes +20k on the week
SFRZ3 9700/9800cs settled 8.25 ref 9544, OI in both strikes +40k
SFRH4 9700/9800cs settled 16.0 ref 9584.5, buying on the week >50k 14.5 to 15.5.
The theme is for a much lower FF target in 1 to 1.5 years.
Of greater significance is the message from the one-year butterfly.
On the week ending Nov 18, SFRZ’23 was hit (-22.5) because the Fed is clearly saying a pause is NOT in the cards. The minutes released this week indicate a slowing in the pace of hikes, but perhaps a higher peak. The lowest contract on the SOFR curve is June’23 at 9500, exactly at 5%. The low in that contract is 9475.5, made in the beginning of November (11/4). The market is comfortable with a peak rate projection of 5% or perhaps slightly more. Downside in front contracts seems limited from here.
What changed this week to push the fly higher? The change is in the back end of the curve. SFRZ’24 was UP 16.5 on the week, while Z’22 and Z’23 were essentially unch’d. The market is projecting 5% as an approximate terminal rate, but the concern is that funding at that level will become stifling. SFRZ3/Z4 was -20.5 at the start of June. On Friday it settled -124.5, over 100 bps further inversion in less than six months.
Indeed many curve trades are at historic inversions. For example, 2/10 closed Friday -77.5. According to my (2:00 pm CST) marks, that is the twelfth day in row at a lower level. Have to go back to 1981 to see a more negative print. The red/green pack spread in ED settled just below -80 (same in SOFR). That too, is a historic low.
Does it make sense for SFRZ’24 to be at a rate of 3.315%? The five-yr treasury ended at 3.884, down 11.2 bps on the week, while tens ended 3.698, down 11.8. The market continues to price longer term inflation at lower levels and is signaling a large deceleration in growth. It doesn’t pay to fight the trend. The question is whether the inversion accelerates going into the Dec 14 FOMC. CPI will be released the day before, on December 13.
This week the major economic data are released Thursday and Friday. However, NY Fed’s Williams speaks at the Economic Club of NY on Monday, and Powell discusses the economic outlook midday Wednesday. On Thursday, the Fed’s preferred measure of inflation, CORE PCE prices are expected 5.0 from 5.1%, with headline yoy expected 6.0 from 6.2. ISM Mfg is also on Thursday, expected 49.8 from 50.2. It hasn’t printed sub-50 since May 2020 during COVID. Friday features the employment report with NFP expected 200k from 261k.
My guess is that peak pressure on the curve will occur prior to Powell’s speech on Wednesday. I would look to cover shorts or take a shot at buying red/green spreads before the data at end of week, which I suspect will show cracks.
OTHER MARKET THOUGHTS/ TRADES
There is some talk of loosening financial conditions which the Fed might want to lean against. Dudley, the previous NY Fed chief, had five inputs: short and long term interest rates, the value of the dollar, equities and credit spreads. Goldman’s index GSUSFI has eased since early October. The Chicago Fed puts out a weekly chart on financial conditions, also easing, here’s a link:
https://www.chicagofed.org/publications/nfci/index
Clearly equities have firmed, long rates have declined slightly, the dollar index has fallen and is at an interesting level. I don’t know if VIX is incorporated into the Chgo Fed index, but at 20.5 it’s near the low of the year (16.60 in January) having recently peaked at 33.6 on Oct 12. VIX is not my focus, but I am highly tempted to buy UXZ2 vs sell UXF3 spread which is at a recent extreme of 2.52, having been 1.00 a month ago. SPX is testing the 200 DMA at 4057, and has failed that MA in April and August. SPX has not been above the 200 DMA since early April. Likewise DXY is testing the 200 DMA at 105.33 (close Friday 105.96). DXY has not been below the 200 DMA since June 2021. The 38.2 retrace from June’21 low to Sept’22 high is 105.15. The 50% retrace from this year’s low in Jan to the high is Sept is 104.70. I believe the value of USD is a big determinant of financial conditions, and though it has recently weakened, it’s near major support.
| 11/18/2022 | 11/25/2022 | chg | ||
| UST 2Y | 451.0 | 447.3 | -3.7 | |
| UST 5Y | 399.6 | 388.4 | -11.2 | |
| UST 10Y | 381.6 | 369.8 | -11.8 | |
| UST 30Y | 392.7 | 375.0 | -17.7 | |
| GERM 2Y | 210.5 | 220.5 | 10.0 | |
| GERM 10Y | 201.4 | 197.9 | -3.5 | |
| JPN 30Y | 140.2 | 147.8 | 7.6 | |
| CHINA 10Y | 283.0 | 284.0 | 1.0 | |
| SOFR Z2/Z3 | 0.5 | -0.8 | -1.3 | |
| SOFR Z3/Z4 | -107.5 | -124.5 | -17.0 | |
| SOFR Z4/Z5 | -28.5 | -23.5 | 5.0 | |
| EUR | 103.26 | 104.00 | 0.74 | |
| CRUDE (CLf3) | 80.11 | 76.28 | -3.83 | |
| SPX | 3965.34 | 4026.12 | 60.78 | 1.5% |
| VIX | 23.12 | 20.50 | -2.62 | |
In: Eurodollar Options
Vol bid in treasuries, lower VIX, as curve inverts to new lows
November 26, 2022
–Wednesday was the tenth day in a row that 2/10 ended lower. It closed just under 77 having printed as low as -80. On Nov 9, I marked 2/10 at -47.7 while BBG has -49.3. In any case it’s a drop of around 30 bps in two weeks. Dec 14 FOMC is two and a half weeks away. [My marks are at 2:00 CST, futures settle]
–Headlines out of Fed minutes: ‘most Fed officials favor slower tightening pace soon and various Fed officials see higher peak rates’. Result…more inverted curve with the inflection point moved slightly further forward.
–Red/green (2nd to 3rd year) euro$ pack spread settled at a new historic low of -78. Red/gold pack (2nd to 5th year) spread closed just under -83.0. The most inverted 1-yr calendar on the SOFR (and ED curve) is now Sept’23/Sept’24 at -138. The lowest CONTRACT on the SOFR curve is SFRM3 at 9498.5 or 5.015%. Current Fed Effective rate is 383. So the difference between current EFFR and June SOFR (7 months forward) is 118.5. In the following year, with M3/M4 -126.5, that tightening is expected to be reversed…and then some. When viewed in the context of these inverted spreads, the creative finance packages being offered by mortgage lenders make a lot of sense (“We’ll pay 1% of your mortgage rate for a year”). If dollar curves (and forward yields) are correct, then it’s likely rates will fall by over a percent, which provides a refi opportunity.
–Vol bid in rates. On Monday TYH 112.5^ settled 3’35. On Wedneday atm 113^ settled 3’44 (ref 113-08).
In: Eurodollar Options
