Policy Error, 2018

Weekly Comment – December 5, 2021

December euro$ midcurve options expire Friday.  The front EDZ1 contract expires Monday, Dec 13.  The FOMC meeting is December 15.  Quarterly option expiration in equities is December 17.

The first four Fed meetings in the new year are Jan 26, March 16, May 4 and June 15.  EDH2 expires March 14 and EDM2 expires June 13, both two days before the FOMC dates. 

This week’s belatedly hawkish shift by Powell, retiring the word “transitory” and acknowledging a need to DISCUSS a more rapid taper sparked a massive curve move.  On November 29, 2/10 spread was 102.  Late Friday it was 75.  The red/gold Eurodollar pack spread was just above 62 at Monday’s settle, and closed just below 32 on Friday.  There is a tremendous amount of hand-wringing about the inversion in the back end of the Eurodollar curve.  I will just note a few one-year calendars:  EDH2/EDH3 settled 88, projecting 3 to 4 hikes over that year.  EDH3/EDH4 settled 43.  And EDH4/EDH5 at -2.  Inversion at the back end.  All I will say here is that inversion typically signals that the market perceives ‘too tight’ financial conditions which will lead to reduced growth or possible recession.  The Sonia futures curve (UK rates) has led the move.  One-year spreads there are 61, 1.5 and -10 for the three forward March year spreads. 

In Q4 2018, Powell famously stated the Fed was no where near neutral as the Fed was hiking.  The taper at that time had notched up to $50 billion per month.  The Fed’s balance sheet was actually being pared down; it was shrinking as opposed to growing less rapidly, as is the current case.  From the December 19, 2018 FOMC statement: “In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2-1/4 to 2-1/2 percent.”  This was, of course the last hike and peak FF rate.  In late September 2018 SP500 topped around 2914.  By Thanksgiving it had lost nearly 10% to 2635 and bounced a bit, but by Dec 10 it was back at 2637.  From Dec 10 to Dec 24 it dropped another 10%, bringing the total loss to 20% in three months.   Mnuchin held calls on Sunday, Dec 23, 2018 with heads of the top six banks.  Powell was forced into an embarrassing about-face. 

In 2018 the high was ~2915.  In November the high was just above 4700.  After this week’s turmoil SPX is over 50% higher at 4538 than it was at the TOP of 2018, and about 3.4% off the high.  I would say the risk of a further decline in stocks is greater now, given the torrid October/November rally.  The point is that Powell is not going to re-live Q4 of 2018 by speeding up the taper.  At the meeting, he will quell market calls for accelerating the timing of hikes.  The Fed is facing policy errors in both directions.  If he maintains the hawkish tilt, stocks crater and junk bond spreads blow out, which will force a policy reversal.  If he pushes back on the idea of aggressive rate hikes to combat inflation, then price increases may accelerate.  Long end treasury yields are giving him the cover to use option 2, as inflation concerns appear to be abating with a 14 bp plunge in the ten-yr yield on the week to 1.34%.  My guess is that the upcoming week will contain a fair degree of volatility, which will solidify the choice of option 2. 

The policy error that people are worried about has already occurred.  The Fed was too loose for too long and created untenable valuation problems which have allowed the inflation narrative to set in.  On Thursday, Yellen said “What we don’t want to have develop is a wage-price spiral, in which inflation becomes its own self-reinforcing kind of phenomenon that would become chronic in the US economy – something endemic.”  This is what El-Erian, Summers, etc. have been arguing, that inflation is becoming self-reinforcing.  The 5.9% cost-of-living increase to Social Security recipients is an example, but it’s surprising that someone in the Biden administration would openly suggest that workers’ wages might be growing too fast.   

I have a rule (sometimes broken) “when you have a trade problem, do NOT compound it by doing something even more stupid.”  Powell is not going to be pushed into repeating 2018. A firm dollar and declining long end rates buy him time. Slow and steady.

There was a trade Friday, a buy of 10k April ED 9862.5p for 1.5 covered EDM2 9949.  The cover might have been 49.5; it doesn’t matter for this missive.  That’s an astounding price.  Because of the Easter holiday, these options expire on 14-April, Thursday.  There are FOMC meetings Jan 26 and March 16. The May 4 FOMC is three weeks after April expires.  These puts are going to expire worthless.  My personal downside limit for EDM2 is 9930.  OIS to Libor out to 18 bps.  One hike expected in June and a chance of one in July.  9930 is not my target, it’s just that I think every put on EDM2 from the 9925 strike down will expire worthless.  This is NOT A RECOMMENDATION to sell puts, but just for the sake of an example, EDM2 settled 9954.0.  EDM2 9925p settled 6.5 and 9900p settled 3.75.

This week treasury auctions 3, 10 and 30 year paper Tuesday thru Thursday in size of $54b, $35b and $22b.  These amounts are smaller than November by 2 billion in threes and 3 billion in both tens and thirties.  However, in November the auctions raised just $43 billion in new cash as compared to $89 billion expected this week.  (TBAC recommended finance table).  From Tuesday through Friday the Fed will buy $24 billion in securities, though nearly $11 billion of that is in the 0 to 2.25 year maturity range on Wednesday.  It’s hard to imagine that auctions will be well-received given much lower yield levels and the larger amount of new cash being raised, especially in longer maturities. 

On Friday, the new 30-yr bondholders will be faced with CPI, expected 6.7% yoy with Core 4.9%.  Previous levels were 6.2% and 4.6%.  How does anyone justify buying the long-bond at 1.7% with CPI five percentage points higher!?    It’s like the Dave Chappelle skit as the police officer taking a report on Jussie Smollett: “You left the house at 2am, it was minus 16 degrees and you were walking… to Subway.”  Imagine the investor searching for an explanation from the bond buyer:  “You were buying the auction at 1.7%, CPI is 6.2% with higher levels expected, and the Atlanta Fed GDPNow for Q4 is 9.7%.  Oh, you thought that cash migrating from the near 20% drop in bitcoin on Saturday would go straight into long bonds.  I see.”

Obviously there are a lot of geopolitical tensions and other issues that can lead to a risk-off environment which supports treasuries.  But current yields don’t seem to provide adequate compensation given their own risk factors.

	11/26/2021	12/3/2021	chg
UST 2Y	51.6	58.7	7.1
UST 5Y	117.9	112.2	-5.7
UST 10Y	148.3	134.0	-14.3	w/I 135/34.5
UST 30Y	182.9	167.1	-15.8	w/I 168/67
GERM 2Y	-75.6	-74.3	1.3
GERM 10Y	-33.5	-38.3	-4.8
JPN 30Y	67.3	66.3	-1.0
CHINA 10Y	285.8	290.3	4.5
EURO$ H2/H3	81.0	88.0	7.0
EURO$ H3/H4	55.0	43.0	-12.0
EURO$ H4/H5	1.0	-2.0	-3.0
EUR	113.18	113.14	-0.04
CRUDE (active)	68.15	66.26	-1.89
SPX	4592.62	4538.43	-54.19	-1.2%
VIX	28.62	30.67	2.05

https://home.treasury.gov/system/files/221/TBACRecommendedFinancingTableQ42021-11032021.pdf

Front end hammer

December 3, 2021

–The front end of the curve took another beating with the 2-yr note up 5.6 bps to 61.7 bps.  The red euro$ pack (2nd year forward) closed -6 on the day, as several Fed officials supported an accelerated timetable on taper/tightening.  To get the ball rolling, Bostic said it was in the Fed’s interest to wrap up the taper by the end of Q1, then Daly said the Fed may need to taper faster than expected.  Finally Barkin said that inflation readings next year will be messy, and that he supports normalizing policy.  New lows resulted in curve spreads: 2/10 at 83 bps (down 4 on the day), 5/30 closed just below 56 and the red/gold pack spread fell another 3.625 bps to settle 38.25.  To hammer home the flatness, the red ED pack is 9869.5, but the green, blue and gold packs are 9833.125, 9832.25 and 9831.25, all essentially the same price and yield.  

–The chart below shows the 2/5 treasury spread.  After the hawkish June FOMC, all curve measures flattened hard and most never recovered.  However, 2/5 did move back up, as Powell repeatedly said that the bar for lift-off was much higher than the bar for taper, and that the Fed was a LONG way from rate increases.  Therefore, the 2 yr yield was more or less capped.  That was the Fed’s forward guidance which generated complacency if not outright enthusiasm for long curve trades (put me in the latter camp).  But Powell’s hawkish pivot has demolished the idea that rate hikes are far into the distance.  In fact, EDM2 9900 puts traded 4.5 yesterday covered 9949.0 and settled 4.25 vs 9951.0.  With EDZ1 at 9980, EDM2 is already projecting certainty of at least 1 hike, but to reach the 9900 strike suggests a couple more, and the June contract expires 13-June while the FOMC is 15-June.  That’s an AGGRESSIVE price.

–Today brings the payroll data, with NFP expected 530k.  Is every Fed official, including the Chair, making hawkish comments in anticipation of a weak report?  I don’t think so.  Implied vols remain elevated and firmed yesterday with TYH 5.2.  Volatility within other markets portends the possibility of unexpected spillovers.  For example, VIX closed yesterday at 28.29, churning around levels this week which are at the highest since Q1.  Energy markets and spreads have seen wicked moves.    https://www.zerohedge.com/commodities/natgas-widowmaker-spread-collapses-hits-20-month-low                                                                                Though HYG and JNK staged spirited rallies yesterday, it’s still the case that yields are not compensating for risk.

Crushing the curve

December 2, 2021

–Powell’s hawkish shift and widening (gov’t) panic related to omicron conspired to force new lows in the curve with 2/10 down 4 at 87.3, 5/30 down 1 at 62.4 and red/gold euro$ pack spread down 8.25 to just under 42!  On the ED curve whites -1.125, reds -3.375, greens -0.375, blues +3.0 and golds +4.875.  Back end of the dollar curve slightly inverted as EDZ24 settled 9934.5, with EDH25 9835 and the next two blues 9836.  EDH24 settled 9838.5 or 1.615%, and out to EDH27 there’s only 11.5 bps difference, with H27 9827.0.  Open interest declines in longer maturity contracts point to short covering/ hedges being lifted.  TY fell by 12.5k contracts, UXY -27.6k, US -0.9k and WN -6.5k.

–Stocks resumed weakness.  Crude oil was hit further with CLF2 at 65.37 late yesterday, well below the 200 DMA at 67.49.  Russell 2k had been in a long sideways range for nearly all of 2021, clearly defined by IWM (etf) with many lows around 210 and highs just above 230.  In early November it broke out to the upside, but quickly failed at 244 and is now back near the lower end at 213.

–Markets appear to be telegraphing a warning to the Fed over a hawkish mistake, which will stifle both economic activity and inflation.  It’s as if there’s no organic demand within the economy; with stimulus comes inflation and the illusion of strong activity, but the mere hint of withdrawal to restrain the former threatens the latter.  

If taper is faster, hikes comes faster

December 1, 2021

–EDU2 was trading 9944 when Powell suggested tapering could be accelerated, and it immediately traded 9931 before stabilizing and settling 9934.  It currently trades 9927.  The back end of the curve also sold off, but longer maturities then staged a strong rally, flattening some parts of the curve to new lows.  For example USH1 was 162-08 pre-Powell, immediately traded a low of 161-04 and then popped right back to 162-08; the contract settled 162-04.  New low in 2/10 treasury spread at 91 bps.  5/30 closed at just 63.5 and red/gold eurodollar pack spread, which was over 180 bps at the end of March, closed at just 50!  Red/gold is the spread between the second year forward and the fifth. A representative spread would be EDH23 (9887.5) and EDH26 (9830.0) which settled 57.5.  As a comparison, EDU22/EDZ22, a three-month spread in front, settled at 26.5 (9934.0/9907.5).  EDM2/Z2 settled 47.5.  So a near six-month spread has nearly the same amount of ‘tightening’ built in as a forward three-year spread.  All the steepening (and expected tightening) is in the front end of the curve.  The market is currently sending the message that these near-term rate hikes will sap economic activity and stop inflation.  At least that’s the kneejerk. However, all markets are currently rather turbulent. 

–Implied vol firmed.  On Nov 1, 0EH 9887.5^ was 47.5 and 2EH 9837.5^  was 50.0, with 130 days until expiry.  Now the same atm straddles are 43.0 and 47.0, not much of a decline for a month of time.  EDH24 9837.5^ on Nov 1 was 108 vs 9843.0.  With futures nearly the same at 9839.5, this straddle actually appreciated in value and is now 111.  

–I would think Powell has a pretty solid idea of what the payroll report will look like on Friday.  NFP expected 530k.  Today we get ADP, expected 525k.  FT notes US junk bonds hit by sharpest sell-off in a year.  Both HYG and JNK are at new lows for 2021.

Moderna says ‘panic’

November 30, 2021

–Yellen and Powell today at 10:00 EST, but Powell preempted his speech by saying late yesterday that omicron adds to economic risks and inflation uncertainty.  We’re back to Friday’s action: lower oil, lower stocks, higher treasury prices and a tepid rally in gold.  Both Bloomberg and FT lead off with warnings about Omicron….citing Moderna.  Smith and Wesson now contacting both editors with warnings about rising crime spilling over into suburbia.  

–Curve steepened yesterday with 2s down nearly 1 bp to 50.8 and tens up 4.3 to 1.526%.  Implied vol seeped out.  One interesting note in eurodollar options: EDU2 100.125, 100.1875, 100.25 calls all bought for 0.5, in total of about 25k (only the lower strike settled 0.5).  EDU2 settled 9938, so these protection buys are somewhat surprising.  On the other hand, nearly every day there are articles about possible military miscalculations regarding China/Taiwan and Russia/US.  So… get your booster shot.

–Next year’s FOMC calendar shows that the first three quarterly meetings (in March, June, Sept) are two days AFTER the eurodollar contract expiries.  However, the December meeting is 14-December and EDZ2 expires 19-December.  That is, December 22 options capture the actual outcome of the meeting. 

It’s the supply chain, mate. It’s broken.

November 28. 2021 – weekly comment

Supply chain disruptions.  All over the news.  Widespread reports of chip shortages, images of ships stranded outside of ports, trucks idling at pick up points.  The media is now constantly advising to order early, and be prepared to pay much higher prices. 

The analogy I would make in financial markets is a lack of liquidity.  Same thing: I THOUGHT I could buy all the supply I needed, but there is no one there to sell it at the price I need.  Or the next price.  Or the price above that.  

This was on display on Friday.  A crazy market, with pumped vol.  Oil crash (CLF2 down 13%).  Stock decline (SPX, NASDAQ and DJI down 2.2 to 2.5%).  VIX jump, +10 to 28.6.  Dollar pullback. Yield plunge with the ten-year shedding nearly 16 bps to 1.483%.   Star performers on the euro$ curve were June, Sept and Dec 2023 contracts, up 21 on the day.  However, EDZ3 settled at a price of 98.435 or 1.565%, consistent with a FF target of 1.25 to 1.50%.  This rate is still significantly above the Fed’s projections as of September for year-end 2023, which showed a median of 1% (six members’ dots were 1.125%).   

There have already been many articles bemoaning the lack of liquidity in the treasury market.  For example, the FT ran a piece on Nov 9 (linked at bottom) in the wake of the Nov 8 Liquidity Report by the US Treasury, Fed, et al. The FT article noted position unwinds that occurred in early November; clearly the Bank of England and Bank of Canada roiled markets at that time, leading to well-publicized losses for several hedge funds.  The result is wider and smaller markets, especially so now.  Hedge funds have cut activity going into the end of the year.  Again from the FT: “JPM research from Nov 5 showed that market depth [in treasuries], one measure of liquidity, had declined to the lowest levels since summer, when fears about the effect of the Delta variant on the US economy hampered liquidity.”  And now we have Omicron. 

So if I’m a treasury option market-maker being asked for a quote on a 20 delta call on a futures market that is showing 200 a side, I’m going to either quote small size or widen the market, knowing there is a strong possibility of missing the futures hedge.  Obviously implieds should shoot higher, and they did, with treasury vol at the highest level since the late Q1 surge to higher yields.  I marked TYH2 at 5.4 on Friday.  Now, when the client says “MATE, that’s an awful market!” we can respond with, “The supply chain is broken mate.”

There have been comments about the timing of the Omicron leak, on Thursday afternoon when US markets were closed.  However, last Monday there were fairly strong warning signals with Austria reverting to lockdown and Merkel saying “We are in a highly dramatic situation.  What is in place now is not sufficient.”  The Fed has always used Covid as a caveat in terms of policy, and of course this new variant could cause a slight shift.  However, I think taper is still on schedule, given last week’s plunge in Jobless Claims to 199k and Core PCE prices rising 4.1%, the highest since the early 1990’s.  In fact, this is PERFECT for the onset of taper.  The market is demanding the safety of treasuries going into year-end, just as the Fed lessens its bid at the margin.  Net zero.

Of course, in the bigger and longer time-frame picture, things aren’t perfect.  The purpose of QE is to push investors out on the risk spectrum.  It succeeded fabulously, to the point of creating the illusion of no risk at all.  But a day like Friday injects a much needed dose of fear.  If the Fed overtly responds by changing taper plans, then it’s back to moral hazard in an environment where price increases have already taken central bankers by surprise.  We’ll get a hint on policy Tuesday, when both Yellen and Powell are slated to testify about the CARES Act.  Clarida also on tap Tuesday, ironically enough discussing Fed independence.  (Central bank independence in Mexico is under a cloud with Obrador unexpectedly naming Victoria Rodriguez as the head of Bank of Mexico; the peso weakened to 21.92, the lowest of any of the years of Trump’s presidency aside from 2020 covid; the peso is at a new low for 2021).

Here are a couple of prices of things related to the new and improved covid variant.  Peloton (PTON) the ultimate stay-at-home laundry rack gym machine, bucked the trend and rallied on Friday, surging 5.7% to 46.41.  Of course, at the start of the year it was north of 160, so perhaps a new lockdown isn’t being as aggressively priced as it was in the past.  But here’s a price that might have much large ramifications.  March Corn traded down with all the other commodities on Friday, putting in a low of 572.  However, it closed at 591 ¾, just off the day’s high, the highest settle in that particular contract since July. On Tuesday, the NY Fed is presenting a virtual event on food insecurity (Williams is speaking).   From the NY Fed website:

The event is part of the New York Fed focus on three areas affecting community development: household financial well-being, climate-related risks to low- and moderate-income communities [huh?!], and the social determinants of health. One of the key social determinants of health is consistent access to nutritious food.

Now I personally have a soft spot for the last point as my sister developed a grass-roots, nonprofit program to teach kids about gardening and healthy foods: Healthy Foods for Healthy Kids. Donate $20 and get my stuff for FREE!:  https://healthyfoodsforhealthykids.org/

My point is that climate and urban food supplies might not be the main thing the NY Fed should be focused on. On the other hand, global food supplies are critical.  When President Xi instructs energy suppliers in China to acquire sufficient inventory at any price, think about food needs across the planet. I ran across an article on Russia’s possible incursion into eastern Ukraine and though I doubt there would be any impact, Ukraine is a large wheat exporter of about 23 million mt out of 33 million mt produced (about 4% of global supply).  Russia is the largest wheat exporter at 75 mt and is expected to introduce grain export quotas in December.  Food security is critical, and supplies may become much more expensive.

On Wednesday, we have Mfg ISM and the Beige Book for the December 15 FOMC.  Friday brings the Employment Report, with Non-farm payrolls expected 530k. Highlight will likely be Tuesday testimony by Powell and Yellen.

OTHER MARKET THOUGHTS / TRADES    

Obviously, this was a brutal option expiration in December treasuries. On Wednesday, TYZ 129.75 straddle settled 21/64’s vs 129-26+.  On Friday the contract settled 131-05+, the call settled to futures at 1’27.  Option markets were pretty much unavailable on Thursday evening, so there was really no out.

Therefore, markets likely stretched too far on Friday.  Although there is quite a bit of fear-mongering about Omicron, some are dismissing a long-term impact.  In treasuries, there is likely to be a retracement of part of the move, though risk-off seems prudent going into the end of the year.  As of this writing on Sunday morning, bitcoin has not really seen a bounce, though it’s stable at 54295.

A friend in energy markets has mentioned to me that there’s been a consistent seller of CL 65/55 put 1×2’s.  Taking a credit to sell 2x the 55 put vs buy 1x the 65 put.  Protected all the way down to the 45 strike and even lower with the credit.  At least, that’s how it’s SUPPOSED to work.  Until you get a move like Friday’s.  On October 14 as CLZ2 was 72.61, the settles were CLZ2 65p 7.51 and 55p 4.58. a credit of 1.62 on the trade.  On Friday the settles were 12.46 and 7.96. a credit of 3.46 vs 63.98.  Things moved a little faster than indicated by “the model”.

	11/19/2021	11/26/2021	chg
UST 2Y	54.7	51.6	-3.1
UST 5Y	121.7	117.9	-3.8
UST 10Y	153.6	148.3	-5.3
UST 30Y	190.7	182.9	-7.8
GERM 2Y	-77.8	-75.6	2.2
GERM 10Y	-34.2	-33.5	0.7
JPN 30Y	67.9	67.3	-0.6
CHINA 10Y	292.8	285.8	-7.0
EURO$ Z1/Z2	72.0	67.2	-4.8
EURO$ Z2/Z3	65.0	68.0	3.0
EURO$ Z3/Z4	16.0	16.5	0.5
EUR	112.81	113.18	0.37
CRUDE (active)	75.94	68.15	-7.79
SPX	4697.96	4592.62	-105.34	-2.2%
VIX	17.91	28.62	10.71

https://www.ft.com/content/ede12db9-0261-4c7e-8f6f-b61de57b2383

https://www.spglobal.com/platts/en/market-insights/podcasts/crude/111721-skor-biofuels-blending-epa-rfs

Black Friday

November 26, 2021

–The day after Thanksgiving is known as black Friday, when retailers used to turn the corner for the all-important holiday selling season.  Today, it’s about the new covid variant that threatens to ice the economic system (again).  As of this writing, WTI is down 6% (CLF2) and mini-SP is down 2%.  Interest rate futures have exploded higher, exacerbated by today’s December option expiration in treasuries, and thin conditions.  Last night the plain vanilla TYZ 130.25 call was 10/15 ref 130-09 with absolutely no size being quoted.  This morning the contract is trading 130-31, so calls are 46/64’s intrinsic.  Good luck today.

–Wednesday saw renewed flattening with new lows in some of the back spreads.  For example, red/gold pack spread (2nd to 5th year) gave away all of Tuesday’s steepening and closed 56.125, down a whopping 9 bps and a new low.  2/10 closed just below 100 bps, and 5/30 made a new low of 62.6, down 3.6 on the day.  The first curve inversion (on settle) also occurred with these closing levels in blues:  EDZ4 and EDH5 settled 9809.5 and EDM5 and EDU5 settled 9810.0.  This is probably partially technical, with blue Dec midcurves having quite a bit of open interest…but inversion is typically a sign that monetary policy is on the verge of being too tight.  There is nothing normal about this cycle, and thin conditions going into year-end after many liquidity providers have already had their faces ripped off isn’t going to help.  For a dollop of added irony, I’m sure the Biden admin will take credit for the drop in oil prices, related to the tap of the SPR. 

–It’s an early 12:15 CST close in rates and equity futures.

WIN

November 24, 2021

HAPPY THANKSGIVING!

–WIN was a 1974 slogan which stood for Whip Inflation Now.  The current administration is also trying to whip inflation, by announcing yesterday a tap of the Strategic Petroleum Reserve.  The market obliged (having already sold the rumor) and bought the fact.  Yesterday CLF2 settled 78.50, up 1.75 on the day.  Dan Aykroyd parodied Jimmy Carter’s fight against inflation in 1978 in the clip below.  The 1974 slogan to 1978 skit indicates that inflation isn’t always transitory.  Today the Fed’s preferred measure is released, PCE Core Prices, expected +4.1% from 3.6% last. 
  
–The eurodollar curve finally steepened, with reds rebounding by 3 bps and golds declining by 5.125, more than an 8 bp swing in the spread.  In treasuries the five year note rose 1 bp to 1.33% while 30s finally closed above 2%, up 4 bps to 2.02%.  The 3 month libor setting was 17.8 bps yesterday, the highest since May.  In recent weeks it had been anchored at 12.5 to 13 bps. leading to trades like a buy of EDM2 9981.25/9987.5 call 1×2 (a few weeks ago).  At a libor rate of 12.5, this trade nails it, but the current setting pegs the lower strike. 

–On Tuesday, Nov 30, Yellen and Powell will testify before the Senate and again argue that inflation expectations are securely low, centered right around the Fed’s 2% goal.  This afternoon Fed minutes from the last meeting are released.

https://www.nbc.com/saturday-night-live/video/jimmy-carter-on-inflation-cold-open/3007609

Stability at the Fed (but maybe not markets)

November 23, 2021

–New lows in all front euro$ contracts as Powell was reappointed, causing an unwind of bets for a more dovish Chair.  Greens led the carnage, down 14 bps on the day (3rd year out).  All contracts from EDZ2 back were down at least 10.5.  New highs in some of the near calendars: EDM2/U2 rose 2.5 to 25.5, solidifying the perception of one hike over the period, even as financial commentators can’t quite decide whether the Fed will hike by the END of 2022.  The peak one-year calendar is EDM2/EDM3 which settled 95.5, up 8 on the day and essentially forecasting 4 hikes over the year.  Two and five year auctions saw tepid demand (even at higher yields) and on the treasury curve fives were weakest (up 11 bps), with 7s being auctioned today. Markit PMIs today as well. 

–In spite of bearish trade, bonds could not break thru 2% and closed just above 1.98%, up 7.5 on the day.  5/30 treasury spread made a new low of 67 bps.  Tomorrow brings the Fed’s preferred measure of inflation Core PCE prices, expected +4.1% from 3.6% last.

–In terms of Fed policy, the eurodollar curve, even with recent weakness, portrays a very easy Fed.  Forward pack prices (4 contract average prices) are as follow:  Reds (2nd yr) 9865 or 1.35%, Greens 9820.5 or 1.795%, Blues 9812.5 or 1.875% and Golds 9808 or 1.92%.  Bear in mind that in 2018 as Powell was trying to ‘normalize’, the FF target rose to 2.25/2.50%.  Out to five years the FF target isn’t even expected to rise above 1.75% in the current cycle.  The outcome of financial repression is the suppression of risk/reward.  Friend Tony Hamer notes in a Linked post, “The fact Tesla’s market cap increased by $200 billion with the announcement of a purported agreement to sell 100,000 Tesla cars to Hertz is stunning given the deal has a gross margin of about $375 million.”

–Vols took a nice jump on the sell-off.  I marked TYH vol 5.0%, getting closer to the upper end of the recent range.

Flatter

November 22, 2021

–CME Nasdaq 100 futures are at a new all-time high this morning.  I saw somewhere that there have never been as many stocks within the Nasdaq Composite making new lows as the index is making new highs.  The attached chart shows the number of stocks making new lows in blue (about 10% of the components).  Deterioration typically works from the edges toward the center, though big tech seems impervious to any damage given dual attributes of both growth and liquid repositories of flight-to-quality flows.

–Two and five year auctions today, sevens tomorrow.  PCE prices and FOMC minutes on Wednesday.  Possible announcement of Fed Chair, which could add a bit of drama to Friday’s December treasury option expiration.

–Friday featured a flatter curve, with the 2y yield essentially unchanged at 50 and tens down over 5 bps to 1.536%.  5/30 edged to a slight new low at 70 bps, as did red/gold euro$ pack spread at 58.75.  Red/gold is down over 120 bps from the high set early in the year (182) while 5/30 is 93 off the year’s high.  High inflation prints would ordinarily be expected to steepen the curve, and the added tailwind of an accelerated taper should also have an impact, but the market appears to be forecasting a rapid economic slowdown as soon as stimulus wears off.  More immediately, Covid lockdowns are a concern.

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