August 8. Hedging costs destroy carry

–Interesting article on Bloomberg today notes that currency hedging costs for overseas investors buying treasuries has increased to such an extent as to eliminate positive carry. “We’re at a point now where investors have to start thinking about this,” said Sachin Gupta, a foreign-bond fund manager at Pimco, which oversees $1.51 trillion. “As the cost of hedging rises to such an extent, there’s no extra carry to be had. That itself will slow down the demand — and, at some point, even reverse the demand — for Treasuries.”

–The immediate reversal of demand for treasuries occurred after Friday’s 255k Payroll report.  The ten year yield jumped nearly 8 bps to 158.2, and the belly was hit even harder, with 5’s up just over 10 bps to 113.  The green (3rd year) eurodollar pack fell nearly 13 bps.  Eurodollar calendar spreads widened, notably Dec’16/Dec’17 which surged 6 bps on heavy volume to 15.5.  However, the Dec’17 contract is not quite through the post-Brexit low of 9889, having settled Friday at 9893.  A close below the late July lows would significantly strengthen the downward trend.

–January Fed Funds settled at 9949, 11.25 bps below the front August contract, approaching 50/50 odds for a hike by the end of the year.  Aug/Oct spread closed 4.25 and Nov/Jan at 7.0, indicating that December is viewed as more likely for a hike.  El-Erian and others are nudging the Fed for a move in September, but speeches by Dudley and Powell urge caution in raising rates too quickly.  Yellen is slated to speak at Jackson Hole on August 26.

–Treasury auctions this week of 3, 10, and 30 year paper starting Tuesday.

Posted on August 8, 2016 at 5:14 am by alexmanzara · Permalink
In: Eurodollar Options

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