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.
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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 | |
