Too Much Priced?
October 9, 2022 – Weekly Comment
Saturday morning (10/8). Two news items:
Ukraine blew up the Kerch Strait Bridge.
WSJ Nick Timiraos headline: Fed’s Inflation Fight Has Some Economists Fearing an Unnecessarily Deep Downturn. -Rapid rate increases provide less time for central bankers to study their economic effects.
These two taken together tell me that front end ED and SOFR contracts settled too low on Friday. EDH3 and SFRH3 are the lowest contracts on the strip at 9511.5 (4.885%) and 9538.5 (4.615%). Sept contracts are approx 11 bps higher in price and lower in yield, 9523.0 (4.77%) and 9549.0 (4.51%). SOFRRATE is around 3.04%. So the March SOFR contract roughly prices another 150 bps of tightening by Q1.
Let’s first take the Kerch news. That bridge is on the east side of Crimea and is the direct link to Russia. To the north of Crimea is the Dnieper River, which has two bridges near Kherson which have also been heavily damaged. The Dnieper is the fourth longest river in Europe and cuts Ukraine in half. The next closest bridge in in Zaporizhzhia, about 250 kilometers away. Therefore, it appears as if supplies and artillery are being cut off for Russian troops in Crimea – as supplies must cross these waterways- which almost certainly raises the stakes for a nuclear response by Putin. (See presentation by Peter Zeihan, 8 mins in).
https://www.youtube.com/watch?v=UA-jOLF2T4c
The Timiraos article quotes several economists, including Greg Mankiw, former Fed Vice-Chair Donald Kohn and Brian Sack who ran the NY Fed’s market desk from 2009 to 2013. The theme is that the Fed has already moved aggressively, and that more nuanced calibration may be in order. On the other hand, Bloomberg ran at least three stories over the weekend with the theme, “Fed Officials [and other CBs] Won’t Relent…” Larry Summers is still advocating large hikes to crush inflation. No nuance there. I’d lean toward the Wall Street Journal article. The first hike was in March, just over six months ago. In the beginning of March, six-month libor was just under 80 bps. Now it’s 4.4%. I don’t know how many loans adjust, but the process is not instantaneous, and seven months is a short period of time. The main jolt of debt rollover has barely begun in a world where capital is less available.
On Wednesday PPI is released, expected 8.4%. On Thursday we have CPI, with headline expected 8.1% yoy vs 8.3% last, and Core 6.5% vs 6.3% last. The attached chart shows the CPI for urban consumers. The index for June, July and August was pegged, for three months in a row, just above 296.0. Taking the year ago index figures and deriving the yoy percentage, the CPI numbers have declined. If the September index is 296.2 again, then the yoy figure will be 7.6%. In my opinion, the risk is that CPI data may be lower than expected, catching shorts off guard. In the early part of the week, given auctions of 3s, 10s and 30s starting Tuesday, and FOMC minutes Wednesday afternoon, there may be continued selling pressure on rate futures. However, the largest ranges in TY in the past two weeks were 9/28 and 10/3, both up days. I would be inclined to cover shorts by Wednesday, especially inside of ten years.
The same risk is lurking for stock shorts. It’s impossible to find an article that is not bearish with respect to equities, and certainly last week’s price action supports that view, with Tuesday, Wednesday and Thursday upside ranges being thoroughly rejected on Friday. Everything points to new lows, but they rarely make it that easy. Bear market rallies can be vicious.
Crude oil had a powerful move higher last week, with CLZ2 up 12.63 to 91.35. Dec RBOB settled at a low of 220.95 on Sept 26. It closed higher every day last week and on Friday settled 259.10, up 17% from 9/26. Additionally, the bounce in DXY is exacerbating the harsh tightening of financial conditions. The IMF releases its World Economic Outlook on Tuesday, which I am guessing will be a bit gloomy.
| 9/30/2022 | 10/7/2022 | chg | ||
| UST 2Y | 420.2 | 430.4 | 10.2 | |
| UST 5Y | 403.4 | 413.5 | 10.1 | |
| UST 10Y | 379.8 | 388.3 | 8.5 | wI 389.0/388.5 |
| UST 30Y | 375.8 | 384.0 | 8.2 | wi 384.5/384.0 |
| GERM 2Y | 175.9 | 186.6 | 10.7 | |
| GERM 10Y | 210.8 | 219.4 | 8.6 | |
| JPN 30Y | 138.0 | 136.0 | -2.0 | |
| CHINA 10Y | 275.0 | 275.0 | 0.0 | |
| SOFR Z2/Z3 | -6.5 | -7.5 | -1.0 | |
| SOFR Z3/Z4 | -54.5 | -62.5 | -8.0 | |
| SOFR Z4/Z5 | -14.0 | -19.5 | -5.5 | |
| EUR | 98.03 | 97.40 | -0.63 | |
| CRUDE (CLZ2) | 78.72 | 91.35 | 12.63 | |
| SPX | 3585.62 | 3639.66 | 54.04 | 1.5% |
| VIX | 31.62 | 31.36 | -0.26 | |
