Fed postmortem
May 7, 2023
On a week when the Fed raised the Fed Fund target 25 bps to 5.0-5.25%, the strongest SOFR contract on the week was SFRH4 which ROSE 24.5 bps to 9629.5. Therefore, a hike of 25 was met with a drop of 25 bps less than one year forward. The yield on SFRH4 is 3.705%, which is 1.335% lower than that of front June SFRM3 (9496.0).
On the treasury curve, the 2yr yield fell 13.8 bps on the week to 3.922%, but at the opposite end the 30yr rose 8.2 bps to 3.755%.
The takeaways, after some rather volatile trading during the week, are 1) that this is expected to be the last hike out of the Fed 2) therefore, short curve trades which were predicated on consistently higher short term rates are being exited.
In the new Fed statement, the following line from February 1 was omitted: “The Committee anticipates that ongoing increases in the target range will be appropriate…” During the press conference, Powell said the removal of that language was “meaningful.” He also specifically referred to Monday’s release of the SLOOS, or Sr Loan Officer Survey, when asked about the impact of tightening credit conditions related to last month’s revelations that many banks are insolvent mismatched regarding maturities.
I am including the link to the January 2023 SLOOS below (quarterly release). However, this was before the banking discomfort that was experienced in March. It was issued February 6, 2023. Here is the key line:
The January SLOOS survey also included a set of special questions inquiring about banks’ expectations for changes in lending standards, borrower demand, and loan performance over 2023. Banks, on balance, reported expecting lending standards to tighten, demand to weaken, and loan quality to deteriorate across all loan types.
https://www.federalreserve.gov/data/sloos/sloos-202301.htm
What are the bankers likely to say this time? That the better than expected NFP (253k) and historically low unemployment rate of 3.4% has changed minds and now loan quality is improving? Hardly. The key question is how much a credit slowdown will affect growth in the near term. When asked in the press conference to equate credit issues with rate hikes, Powell said the Fed will just have to watch.
In terms of the curve. 5/30 ended the week at +34 bps (3.415% vs 3.755%), having posted a high of 40 on Thursday. These are the highs since early March 2022, just prior to the Fed’s first hike. Below I have added a chart of 5/30 (blue) vs the 2nd red to 2nd blue SOFR, currently SFRU4 vs SFRU6 (white). SFRU4/U6 settled -14.5, also the high since before hikes began. [NOTE: BBG inexplicably uses March’24 as the first red; should be June’24].
These spreads track fairly closely, and it’s worth noting that on Thursday, two 15k blocks of SFRM4/SFRM6 were bought at -38 and -29.5. These trades appear new as open interest in SFRM6 rose to a fresh high of 124k (+16k on the week). The M4/M6 spread settled -45.5, significantly lower than the above cited trades. In Q1 2021, the 5/30 spread was as high as 163. The demise of SVB (and oozing contagion) appears to have marked the end of curve flattening in the US.
DXY closed near the low of the year at 101.21. The high in Sept of last year was 114.11; the low in 2021 was 89.68. Weakness in USD is another hint that the Fed is done. Next target in DXY should be around 99. Perhaps it’s worth mention that some commodities notched end-of-week bounces off depressed levels; it’s a bit early to call a commodity bottom, but bears watching.
Another sidenote concerns China’s 10y yield which ended at a new low for the year at 2.74%. At the beginning of March it was 2.93%. I would consider the ten-year yield to be a red flag to those that think China’s re-open will lead to a burst of sustained growth.
After SLOOS on Monday, the Treasury kicks off auctions of 3s, 10s and 30s starting Tuesday. CPI is Wednesday, followed by PPI Thursday. CPI yoy expected 5.0%, same as last month. Core yoy expected 5.5% from 5.6% last. The Fed Effective rate was 5.08% on Thursday post-Fed, so that rate is now likely to exceed headline CPI for the first time since 2019. Recall the last Fed hike cycle ended in December 2018 at 2.25-2.50%. CPI high in mid-2018 was 3% but had retreated to 1.9% by year-end. The first ease was in July 2019, seven months after the last hike.
OTHER THOUGHTS
Last week pre-Fed I suggested sell FFM3/FFQ3 calendar -2.5. Settled -9.0 as FFM3 closed Friday at 9493.0, essentially equal to the new EFFR of 5.08% while FFQ3 settled 9502. I also suggested buying SFRZ3 9525/9475 p 1×2 for 4.0; settled 8.0 with SFRZ3 up 21.5 to 9576.5, it currently has zero delta. Somewhat interesting to note that the December 50bp put 1×2 that is 50 bps out-of-the-money is +8 (26.0/9.0) while the 9625/9675 call 1×2, approximately equally out-of-the-money, is -18.25 (40.25/29.25) with delta -0.14.
A couple of option trades worth note. New buyer Friday 2QH4 9500/9475ps for 1.5. Settled 1.25 ref 9720 in the underlying SFRH6 contract. Expires 15-March 2024. This put spread is 220 out of the money. Green midcurves in SOFR don’t have a ton of open interest. This trade would benefit from a monster steepener with much higher long rates.
Buyer 40k SFRM3 9493.75/9506.25/9518.75c fly 1.0. Settled 1 ref 9496.0. Currently the lower strike is 2.25 in the money. This trade could hit the sweet spot middle strike if the Fed holds in June, but the market expects an initial ease at the July 26 FOMC.
New buyer on Thursday of 100k SFRN3 9575/9587.5cs vs selling SFRN3 9487.5/9475.0 ps for 1 (call spread over). Settled on Thursday at 1.75 in favor of the call spread, but with Friday’s fall in SFRU3 to 9531.0 (-16.5 on the day), the call spread settled 2.50 and the put spread at 2.25.
| 4/28/2023 | 5/5/2023 | chg | ||
| UST 2Y | 406.0 | 392.2 | -13.8 | |
| UST 5Y | 353.3 | 341.6 | -11.7 | |
| UST 10Y | 344.8 | 344.1 | -0.7 | wi 343.5/43.0 |
| UST 30Y | 367.3 | 375.5 | 8.2 | wi 375.5/75.0 |
| GERM 2Y | 269.1 | 257.2 | -11.9 | |
| GERM 10Y | 231.3 | 229.0 | -2.3 | |
| JPN 30Y | 122.2 | 126.4 | 4.2 | |
| CHINA 10Y | 278.0 | 273.6 | -4.4 | |
| SOFR M3/M4 | -158.0 | -176.0 | -18.0 | |
| SOFR M4/M5 | -62.5 | -50.5 | 12.0 | |
| SOFR M5/M6 | 0.5 | 5.0 | 4.5 | |
| EUR | 110.17 | 111.46 | 1.29 | |
| CRUDE (CLM3) | 76.78 | 71.34 | -5.44 | |
| SPX | 4169.48 | 4136.25 | -33.23 | -0.8% |
| VIX | 15.78 | 17.19 | 1.41 | |
SLOOS
