Front end hammer

December 3, 2021

–The front end of the curve took another beating with the 2-yr note up 5.6 bps to 61.7 bps.  The red euro$ pack (2nd year forward) closed -6 on the day, as several Fed officials supported an accelerated timetable on taper/tightening.  To get the ball rolling, Bostic said it was in the Fed’s interest to wrap up the taper by the end of Q1, then Daly said the Fed may need to taper faster than expected.  Finally Barkin said that inflation readings next year will be messy, and that he supports normalizing policy.  New lows resulted in curve spreads: 2/10 at 83 bps (down 4 on the day), 5/30 closed just below 56 and the red/gold pack spread fell another 3.625 bps to settle 38.25.  To hammer home the flatness, the red ED pack is 9869.5, but the green, blue and gold packs are 9833.125, 9832.25 and 9831.25, all essentially the same price and yield.  

–The chart below shows the 2/5 treasury spread.  After the hawkish June FOMC, all curve measures flattened hard and most never recovered.  However, 2/5 did move back up, as Powell repeatedly said that the bar for lift-off was much higher than the bar for taper, and that the Fed was a LONG way from rate increases.  Therefore, the 2 yr yield was more or less capped.  That was the Fed’s forward guidance which generated complacency if not outright enthusiasm for long curve trades (put me in the latter camp).  But Powell’s hawkish pivot has demolished the idea that rate hikes are far into the distance.  In fact, EDM2 9900 puts traded 4.5 yesterday covered 9949.0 and settled 4.25 vs 9951.0.  With EDZ1 at 9980, EDM2 is already projecting certainty of at least 1 hike, but to reach the 9900 strike suggests a couple more, and the June contract expires 13-June while the FOMC is 15-June.  That’s an AGGRESSIVE price.

–Today brings the payroll data, with NFP expected 530k.  Is every Fed official, including the Chair, making hawkish comments in anticipation of a weak report?  I don’t think so.  Implied vols remain elevated and firmed yesterday with TYH 5.2.  Volatility within other markets portends the possibility of unexpected spillovers.  For example, VIX closed yesterday at 28.29, churning around levels this week which are at the highest since Q1.  Energy markets and spreads have seen wicked moves.                                                                                Though HYG and JNK staged spirited rallies yesterday, it’s still the case that yields are not compensating for risk.

Posted on December 3, 2021 at 5:30 am by alexmanzara · Permalink
In: Eurodollar Options

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