February 14, 2021 – Weekly comment

“There is a sharp, and artificial decline in rent inflation that is tied to eviction moratoria.  When moratoriums end, shelter inflation will rebound and add roughly 0.9% to core inflation in a short period of time.” -Enduring Intellectual Properties, Feb 13 Inflation Report    Info@EnduringIP.com

“Inflation that runs below its desired level can lead to an unwelcome fall in loner-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectation.”  Chairman Powell

Powell has emphasized inflation expectations repeatedly in his comments, mostly in the context of downward risk.  The new risk is a psychological shift to the upside.  University of Michigan’s 1-year inflation expectation survey was released last week at 3.3%, the highest level since 2013.  The 5-10 year number was 2.7%, matching the highs of last year (this series has been between 2.3 and 2.7 since 2016).  The ten-year inflation breakeven (10y treasury – inflation indexed note) hit a new high of 222.5.

Nearly everyone agrees that rapid money supply growth and fiscal stimulus has led to stock market buoyancy and pockets of distortion throughout the economy.  This has fed into changes in forward interest rates.  This note outlines some of these changes.  Last week ended with new highs in most curve measures as noted below:

2/10 109 bps      high since April 2017.  High in past 5 years 135.5 Dec 2016.  Near term objective 125-27
2/30 189.5           high since Dec 2016.  High past 5 years 203.5 Dec 2016.  Near term obj 198, then 220-25
5/30 152               high since 2015.  There are a few highs in 2015 155-157. Resist 162 then 190 – 195

Since short end yields are pretty much locked up, the thirty year bond yield on its own defines some of the curve levels.  This area, 201 to 203 bps should be initial resistance, with 240 to 256 a more important objective.  Friday’s futures close in cash was 200.4.

Red/gold ED pack spread 113.375. (years 2022 to 2025)
This is at its highest since 2015 and at the 38% retrace from the 2013 high of 306 to the 2018 low of -6.

Green/blue ED pack spread 46.0 (years 2023 to 2024)
This is at the highest since 2015, testing those highs.  It’s through the 38% retrace from the 2013 high of 117 to 2018 low of -3.  This is the “meatiest” part of the ED curve, as it encompasses the libor cessation and is three years forward, when the Fed is expected to have resumed ‘normalization’.      

The peak one-year Eurodollar calendar is EDM’23/EDM’24 at 50.5 bps (new high).  Therefore, it makes some sense to look at EDM4 on its own, the second blue.  On Friday it made a low of 9907.5 and settled 9909, the low in this contract since March 2020.  Not surprisingly, there has been constant put buying on this contract through midcurves (3EM1).  For example, early last week a new buyer of >100k 3EM 9875p for 3.5, settled 3.5 ref 9909.  I’ll note a couple of other large ED put plays below.  First, here’s futures pricing:

EDH’23                  9968.0
EDM’23                9959.5
EDU’23                 9941.0

EDZ’23                  9930.0

EDH’24                 9920.5

EDM’24                9909.0

EDU’24                 9898.0

EDZ’24                  9887.0

Buyer of over 40k 2EM 9937.5/9912.5ps up to 2.0.  Settled 1.5 vs EDM3 9959.5.  Buyer of 60k 3EU 9862.5p vs 9937.5c for 2.25 to 2.5.  The put settled 7.0 vs EDU4 9898.0.  The salient points are that the market is becoming comfortable with deferred futures levels above 1% yields (below 9900) and continues to accumulate puts on those contracts.  Total blue March midcurve put open interest is 1.283 million while blue June is gaining traction at 842k.  By comparison EDH4 futures have 436k positions, and EDM4 289k.  Three-month futures calendars in blues are around 11 bps which adds a roll-up aspect to the decay of long puts.  Compare that to the EDZ’21/EDZ’22 one-year calendar at only 9.0 bps.  If the Fed were to change or be forced into a hiking cycle, outright FF target changes will more than compensate for decay at these low vols. We’re still barely flirting with 1% forward levels.  


This is sort of a repeat from last week, but EDZ2 at a price of 9970.0, just 10 bps above the current 3-month libor setting and still embedded with a credit aspect, is a sale, plain and simple.  The high settle of this contract was 9981 on August 3 of last year.  There are 673 days until expiration.  It took 392 days from Powell’s “we’re a long way from neutral” comment on Oct 3, 2018, when the FF target was 2-2.25% to 50 bps lower at 1.50-1.75% by October 30, 2019.  Of course it’s easier for the Fed to ease than hike, but we may not be that far away from the market taking a preemptive step.  On Jan 27, Powell said in the FOMC press conference, we’re “a long way from our employment and inflation goals.”  I’ll go out on  limb and say the first Fed hike will be March 16, 2022, 413 days from the Jan 2020 FOMC, which will be right after the end of Powell’s term as Fed chair in February 2022.

UST 2Y10.510.90.4
UST 5Y46.648.51.9
UST 10Y118.5120.01.5
UST 30Y197.0200.43.4
GERM 2Y-71.1-70.80.3
GERM 10Y-44.8-42.82.0
JPN 30Y65.366.31.0
CHINA 10Y322.1324.32.2
EURO$ H1/H22.02.00.0
EURO$ H2/H312.513.51.0
EURO$ H3/H445.047.52.5
CRUDE (active)56.7059.382.68
Posted on February 14, 2021 at 8:16 am by alexmanzara · Permalink
In: Eurodollar Options

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