Sept 28. I’d rather talk about HH (Hugh Hefner) than FF (Fed Funds), but….
–Yields jumped Wednesday morning on tax cut proposals with tens up 8 bps to 230.9. While it feels like the start of a new move to higher rates, there are a few caveats. First, as indicated by the chart below, the current 10y yield is fully 30 bps lower than it was at the Dec and March hikes, and only about 18 bps higher than the yield at the June hike. (I suppose one could interpret that in a couple of ways: either there’s plenty of room for yields to run to the upside given the cutback of Fed’s reinvestment, or that FF hikes are likely to choke future growth).
–I would also note that rather than vol jumping up due to panicked buys of puts, the early trade was comprised of 50k 0EZ 9800p sold at 3.0 and 60k TYX 124.5p sold at 5 down to 4 ref 125-115 up to 125-145. The point: very little evidence of fear in terms of reaching for puts. Early 50k buy 2EZ 9800/9787/9775/9762p condor for 4.0. Both the 0EZ put sale and 2EZ condor were new open interest…taken together suggest modest downside in the context of a slightly steeper dollar curve. TYX puts new as well.
–On the long end there was a notable steepener trade, block of 52449 TYZ7 125-16+ vs 14244 WNZ7 165-11. This trade is a bit over $4m per bp.
–As a small exercise I marked ED contracts vs FF contracts as a proxy for lib-ois. EDZ7 to FFF8 is 16.5 mid mkt. EDH8 to FFJ8 is 19.5 mid and EDM8/FFN8 is 21.0. Current Fed effective is 1.16. On one hike, it goes to 1.41 (or 98.59) and then to 1.66 (or 98.34) and on a third hike to 1.91 (or 98.09). If we use a rough proxy of 16 to 21 bps for lib-ois then ED contracts would price to 9838 to 9843 (for December) then 9813 to 9818 on hike #2, then to 9788 to 9793 on hike #3. How might one target a 2nd hike by March? Buy EDH8 9825/9812p 1×2 and sell Jan 9825p for 0.25 (traded about 30k yesterday). And a third hike in June? Buy EDM8 9800/9787ps (traded just below 1.5 20k yesterday).
–What is notably absent is the idea of an overshoot. Yes…once upon a time it used to happen, but now it’s gone away like Hugh Hefner.
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Fed hike 14-Dec 2016, Ten year high yield 2.60% the next day.
Fed hike 15-March 2017, Ten year high yield 2.63 on 13-March.
Fed hike 14-June 2017, Ten year yield 2.13%
Current 2.31%…need to go up 30 bps just to get to the level from 3 hikes ago. Chart below is ten year treasury yield and recent Fed hike history.
