You guys playing cards?
October 19, 2022
–Yesterday afternoon, I jotted a note to myself, “long bond trades soft…20y auction Wednesday.” This morning USZ trades 122-25, down 25. As attached chart shows, the contract was at a high of 145-12 at the start of August. Is that what you call a down-trend? 20-yr auction reopening is $12 billion. WI was 4.29% at futures settle, pretty much the highest yield on the treasury curve outside of 2s that ended 4.435%. Yesterday I cited 10/30 spread above zero as indicative of weakness at the long end, especially so in light of high odds of aggressive hikes in Nov and Dec. 10/30 yesterday up nearly 2 bps to 2.2. UK inflation prints 10.1%, a 40 year high.
–Beige Book today. Evans and Bullard speak after the close. Admin looking to further drain the SPR in front of the election. Those empty barrels are really useful for fires on urban street corners when it gets cold.
–Buyer of 20k 0QX2 9525/9500ps vs 2QX2 9587.5/9562.5ps for 3.0. These are SOFR midcurves on SFRZ3 and SFRZ4, expiring on November 11 (24 dte). Synthetic short of SFRZ3/Z4 spread. Settled 5.5 in former ps vs 9549.5 and 3.75 in latter ref 9621.5. So the red midcurve (0QX2 on SFRZ3) is 24.5 out-of-the-money to top strike and green midcurve is 34 otm to top strike. The difference between top strikes is 62.5…the lowest SFRZ3/SFRZ4 has settled is -74.5, and that was on Friday. If the futures spread were to stay around -75 with SFRZ3, for example 9510, then the red midcurve put spread would have 15 intrinsic and the 2QX put spread would have just 2.5 intrinsic.
Invert the front, steepen the back
October 18, 2022
–The 2yr yield fell 5 bps yesterday to 4.45%, completely reversing Friday’s gain. The ten-yr yield rose 0.6 bp to 4.008. Red eurodollars were the leader on the curve, rising 6 bps in price, while golds, the fifth year out, were only +0.75.
–A couple of interesting notes about spreads on either side of the yield curve spectrum: EDM3/EDM4 settled -80.5, a new recent low (9485.5/9566.0). This is the most inverted one-yr calendar on the curve, and it edged to a new recent low, settling -1.5 on the day. The lowest any one-yr calendar has settled in this cycle is -84 in mid-July, which was lower than any 1-yr spread seen in the GFC (low settle was -46.5). So, the market is pricing the Fed pivot from middle of next year. At the other end, 10/30 treasury spread clawed barely above the water line of zero yesterday, with the thirty-yr ending at 4.012% (up 4 bps on the day). Post-FOMC this spread printed -19 bps. After CPI, the market is pricing certainty of 75 in November and high odds of another 75 in December, yet the curve is steepening from 2’s back. Yields at the long end are suspect here, given this price action.
Set up, like a bowlin’ pin
October 17, 2022
–Continued weakness in the short end of the curve Friday. The 2y note rose 5.2 bps to 4.501% while tens were up 5.0 to just over 4%. The 2/10 treasury spread closed at -50, the lowest since April 2000. On the dollar curve, the red pack fell 7.75 bps to a price of 95.47125 or just over 4.5%. All one-year calendars on the euro$ strip are inverted; the red/green pack spread made a new low of -54.75. The lowest contract remains EDH3, which settled 9476 or 5.24%. The most inverted 1-yr calendar is EDM3/M4 at -79.
–EDH3 at-the-money straddle settled Friday at 68 bps (9475^ vs EDH3 9476.0, 148 days til expiry). Nine months ago, on January 13, EDH3 settled 9860.5. At the time, EDH2, the front contract was 9959.0; tightening had not yet started, but the market was expecting hikes: EDH2/EDH3 was positive 98.5. At the time, I would have said the market is expecting FOUR 25 bp hikes. How quaint. On January 13, 2022, EDH3 9862.5^ settled 60.0 with 424 days until expiration. So nine months ago, the atm straddle on the exact same contract was cheaper (in nominal bps) than it is now. Of course, in the intervening period the Fed raised FFs by 300 bps. By the way, in January, the longest dated green straddle was EDZ’24 which settled 113 bps ref 9807.0 (1068 dte). Currently, the last long-dated green straddle is EDU6 which settled 207.5 ref 9611.5. So the straddle is almost twice as high, but the relative price of the last green has not even moved 200 bps. What a long, strange trip it’s been.
Fasten your seatbelts
October 14, 2022
–Staggering moves associated with yesterday’s CPI. ESZ and NQZ had key reversals: new lows early, outside days, huge ranges, closed near the highs of the session; SPX up 2.6%. This price action indicates that selling pressure has come to an end. However, these signals have not been effective recently. I would only conclude that buyers and sellers are likely more balanced going forward.
–The curve flattened hard given 8.2% CPI with 6.6 Core. SFRM3 was the weakest contract on the strip, settling down 22.5 to 9520.5. The red pack in dollars closed -14, as did SOFR reds, but blue packs (4th year forward) were slightly higher on the day. Two year note jumped 16.4 bps to 4.45%, while tens were only up 5.4 to 3.952%. 2/10 spread is inverted by about 1/2%. Long end of the curve having a hard time getting over the 4% hurdle.
–November FF contract, which is the clearest signal for the Nov 2 FOMC, settled 9618.5, down 5 on the day, pricing MORE than a 75 bp hike. On 75 bps, the contract will settle 9622.0 (two days at EFFR 308 and 28 days at 383). The lowest contract on the FF strip is April, which settled 9511.5 (4.885%), down 21.5 on the day. EDH3 and SFRH3 remain the lowest on the strips, at 9487.0 (5.13%) and 9515.5 (4.845%). The timing for the end of the Fed’s tightening hasn’t really changed; it’s still expected to be either December, or at the first meeting of next year on Feb 1. However, the magnitude of upcoming hikes ratcheted up by about 1/4%. A lot of commentators have recently criticized the Fed for the rapidity and size of hikes. For example, el-Erian said the Fed slammed on the brakes and is putting the economy through the windshield. Clearly financial stability issues are growing, but as el-Erain said yesterday, the numbers were hotter than expected…bad news for the Fed. I’ve focused on the SFRZ2/EDZ2 spread which surged to 45.5 yesterday, but came back to settle 40.5. Like the TED spread of old, this spread gives some indication of global banking stress as the ED side settles to libor. JPM, MS, Citi and Wells all report today. Never thought we’d see a 5% (sub-9500) price on near eurodollars again, but here we are!
–Retail Sales today, expected+0.2% on the month.
CPI
October 13, 2022
–CPI today expected 8.1% vs 8.3 last, with Core 6.5 from 6.3. Jobless Claims 225k from 219. Intel cutting 20% of its workforce. 30 year auction today, following less than stellar results in tens, though modest weakness in TYZ quickly reversed.
–FOMC minutes yesterday. Staff saw risks to baseline projections in economic activity. Participants expect below-trend growth for the next couple of years and see upside inflation risks. A couple of clips:
Participants agreed that the uncertainty associated with their economic outlooks was high and that risks to their inflation outlook were weighted to the upside. Some participants noted rising labor tensions, a new round of global energy price increases, further disruptions in supply chains, and a larger-than-expected pass-through of wage increases into price increases as potential shocks that, if they materialized, could compound an already challenging inflation problem. A number of participants commented that a wage–price spiral had not yet developed but cited its possible emergence as a risk.
Many participants emphasized that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action. Several participants underlined the need to maintain a restrictive stance for as long as necessary, with a couple of these participants stressing that historical experience demonstrated the danger of prematurely ending periods of tight monetary policy designed to bring down inflation. Several participants observed that as policy moved into restrictive territory, risks would become more two-sided, reflecting the emergence of the downside risk that the cumulative restraint in aggregate demand would exceed what was required to bring inflation back to 2 percent.
–EDZ2 closed at a new low contract settle 9511.0, having printed 9507.5 post-PPI. SFRZ2/EDZ2 spread settled 41, not quite through the recent high of 42. 3-month libor set just above 4% at 4.01096 yesterday, the first time above 4 since the 2008 GFC credit-induced spike. With just two months until December expiration, EDZ2, which will still settle to 3m libor, is nearing 5%. Treasury Sec’y Yellen is fretting about liquidity in the treasury market, while SFRZ2 settled 9552.0 or 4.48%, which implies negative carry across the entire treasury curve by year-end. Hmmm, ten-year yield 3.90% and repo at 4.48%. We’re confronting some real head-scratchers. Oil and energy are going back up as winter nears, after Biden drained the SPR. And the Treasury is wondering who is going to buy all the treasuries, now that the Fed put their hands in pockets. I guess Treasury will just have to come up with the incentives for domestic banks to absorb debt. NO ONE COULD HAVE SEEN THIS COMING.
–SPX ended Wednesday at its lowest level since November 2020. It’s worse for Nasdaq Comp. low since August 2020.
Everything’s fragile
October 12, 2022
–Today’s news includes PPI expected 8.4% yoy vs 8.7 last, with Core 7.3% vs 7.3. Ten year note auction and FOMC minutes. CPI tomorrow.
–Andrew Bailey warned that the Bank of England would stop gilt purchases at the end of this week, causing an immediate swoon in risk assets. The change from a catastrophic margin call that could buckle the system to an announced end of central bank support seems rather abrupt. US equity futures are currently rebounding with ESZ2 currently up about 26 after making a new low settle yesterday at 3599.25.
–Block of 40k EDZ2 9550/9512.5 put spread sold yesterday (exit) at 26 to 25.5, SFRZ2/EDZ2 spread was pushed down to 36, but popped right back out to 38.5 on Bailey. EDZ2 settled 9514.5.
–October midcurve options expire Friday. With three days left, atm straddles are around 20. For example 0EZ2 9637.5^ settled 20 vs EDZ3 9536.5. Quite high, but the past ten days have had an average range of just under 17 bps, and there are a lot of market events in the next three days.
–A couple of random tweets yesterday: long term gilts have erased an entire decade of gains @LizYoungStrat and Hang Seng closed under 17k for the first time since May 2009; 13 years of gains wiped out @MoneyTalkR3. Wealth evaporation is becoming a hot topic.
–With OPEC’s production cuts, Biden is reevaluating the US relationship with Saudi Arabia, and Sen Dick Durbin says KSA in not an ally of the US. Time to support US production?
Attentive to shocks
October 11, 2022
–ESZ very nearly at new lows this morning 3590. Early story yesterday said ‘Berlin backs joint EU debt for loans to ease energy crisis’. Bunds and tens sold off in response with TYZ 110-22+ low. Then a ‘German Gov’t Source’ disputed the story, and treasuries bounced. Current TYZ 111-00. In a broad sense, policy makers are reeling from high energy prices and inflation and can’t seem to find a coherent response that doesn’t involve borrowing more in less than hospitable debt markets.
–Brainard speech yesterday touched on the possibility that the Fed could overstep the inflation mandate:
The combined effect of concurrent global tightening is larger than the sum of its parts. The Federal Reserve takes into account the spillovers of higher interest rates, a stronger dollar, and weaker demand from foreign economies into the United States, as well as in the reverse direction. We are attentive to the risk of further adverse shocks…. And we are also very aware that the cross-border effects of unexpected movements in interest rates and exchange rates, as well as worsening external imbalances, in some cases could interact with financial vulnerabilities. In this environment, a sharp decrease in risk sentiment or other risk event that may be difficult to anticipate could be amplified, especially given fragile liquidity in core financial markets. In some countries, the realization of these risks could pose challenging tradeoffs for policy.
–That is…we might have to stop…soon. Three year auction today followed by tens and thirties Wednesday and Thursday. Less liquid conditions in US treasuries? We’ll probably find out with the ten year auction, coming just after PPI and before CPI.
Columbus Day, bank holiday
October 10, 2022
–El-Erian yesterday blamed the Fed for “slamming on the brakes this year” after frequently criticizing the Fed for being too soft. “So yes, I fear we risk a very high probability of a damaging recession that was totally avoidable.” Avoidable?
–Rate futures declined Friday, led by the short end. EDZ2 and SFRZ2 made new contract low settles, 9519 and 9554.5. EDH3 was the weakest contract and is lowest on the strip, settling at 9511.5, down 11 on the day. The lowest settle in EDH3 has been 9505 on Sept 23. The 2y note rose 6.1 bps to 4.304% while 5s rose 8.4 to 4.135% and 10s +6.3 to 3.883. Auctions this week of threes, tens and thirties starting tomorrow.
–FFF3/FFF4 calendar settled 4.5, now two days in a row above zero. SFRZ2/Z3 is still inverted at -7.5, but on Sept 26 closed +11. The one-year spreads are oscillating around zero for now, indicating that the terminal rate will be reached this year and iced for next year. Just two and a half weeks until the Nov 2 FOMC. At 9624, FFX2 projects about 70% odds of 75 bps.
–Used car prices seem to be getting some press in the past couple of days. Cox Automotive predicting a 14% decline in Q4 in used car prices.
Too Much Priced?
October 9, 2022 – Weekly Comment
Saturday morning (10/8). Two news items:
Ukraine blew up the Kerch Strait Bridge.
WSJ Nick Timiraos headline: Fed’s Inflation Fight Has Some Economists Fearing an Unnecessarily Deep Downturn. -Rapid rate increases provide less time for central bankers to study their economic effects.
These two taken together tell me that front end ED and SOFR contracts settled too low on Friday. EDH3 and SFRH3 are the lowest contracts on the strip at 9511.5 (4.885%) and 9538.5 (4.615%). Sept contracts are approx 11 bps higher in price and lower in yield, 9523.0 (4.77%) and 9549.0 (4.51%). SOFRRATE is around 3.04%. So the March SOFR contract roughly prices another 150 bps of tightening by Q1.
Let’s first take the Kerch news. That bridge is on the east side of Crimea and is the direct link to Russia. To the north of Crimea is the Dnieper River, which has two bridges near Kherson which have also been heavily damaged. The Dnieper is the fourth longest river in Europe and cuts Ukraine in half. The next closest bridge in in Zaporizhzhia, about 250 kilometers away. Therefore, it appears as if supplies and artillery are being cut off for Russian troops in Crimea – as supplies must cross these waterways- which almost certainly raises the stakes for a nuclear response by Putin. (See presentation by Peter Zeihan, 8 mins in).
https://www.youtube.com/watch?v=UA-jOLF2T4c
The Timiraos article quotes several economists, including Greg Mankiw, former Fed Vice-Chair Donald Kohn and Brian Sack who ran the NY Fed’s market desk from 2009 to 2013. The theme is that the Fed has already moved aggressively, and that more nuanced calibration may be in order. On the other hand, Bloomberg ran at least three stories over the weekend with the theme, “Fed Officials [and other CBs] Won’t Relent…” Larry Summers is still advocating large hikes to crush inflation. No nuance there. I’d lean toward the Wall Street Journal article. The first hike was in March, just over six months ago. In the beginning of March, six-month libor was just under 80 bps. Now it’s 4.4%. I don’t know how many loans adjust, but the process is not instantaneous, and seven months is a short period of time. The main jolt of debt rollover has barely begun in a world where capital is less available.
On Wednesday PPI is released, expected 8.4%. On Thursday we have CPI, with headline expected 8.1% yoy vs 8.3% last, and Core 6.5% vs 6.3% last. The attached chart shows the CPI for urban consumers. The index for June, July and August was pegged, for three months in a row, just above 296.0. Taking the year ago index figures and deriving the yoy percentage, the CPI numbers have declined. If the September index is 296.2 again, then the yoy figure will be 7.6%. In my opinion, the risk is that CPI data may be lower than expected, catching shorts off guard. In the early part of the week, given auctions of 3s, 10s and 30s starting Tuesday, and FOMC minutes Wednesday afternoon, there may be continued selling pressure on rate futures. However, the largest ranges in TY in the past two weeks were 9/28 and 10/3, both up days. I would be inclined to cover shorts by Wednesday, especially inside of ten years.
The same risk is lurking for stock shorts. It’s impossible to find an article that is not bearish with respect to equities, and certainly last week’s price action supports that view, with Tuesday, Wednesday and Thursday upside ranges being thoroughly rejected on Friday. Everything points to new lows, but they rarely make it that easy. Bear market rallies can be vicious.
Crude oil had a powerful move higher last week, with CLZ2 up 12.63 to 91.35. Dec RBOB settled at a low of 220.95 on Sept 26. It closed higher every day last week and on Friday settled 259.10, up 17% from 9/26. Additionally, the bounce in DXY is exacerbating the harsh tightening of financial conditions. The IMF releases its World Economic Outlook on Tuesday, which I am guessing will be a bit gloomy.
| 9/30/2022 | 10/7/2022 | chg | ||
| UST 2Y | 420.2 | 430.4 | 10.2 | |
| UST 5Y | 403.4 | 413.5 | 10.1 | |
| UST 10Y | 379.8 | 388.3 | 8.5 | wI 389.0/388.5 |
| UST 30Y | 375.8 | 384.0 | 8.2 | wi 384.5/384.0 |
| GERM 2Y | 175.9 | 186.6 | 10.7 | |
| GERM 10Y | 210.8 | 219.4 | 8.6 | |
| JPN 30Y | 138.0 | 136.0 | -2.0 | |
| CHINA 10Y | 275.0 | 275.0 | 0.0 | |
| SOFR Z2/Z3 | -6.5 | -7.5 | -1.0 | |
| SOFR Z3/Z4 | -54.5 | -62.5 | -8.0 | |
| SOFR Z4/Z5 | -14.0 | -19.5 | -5.5 | |
| EUR | 98.03 | 97.40 | -0.63 | |
| CRUDE (CLZ2) | 78.72 | 91.35 | 12.63 | |
| SPX | 3585.62 | 3639.66 | 54.04 | 1.5% |
| VIX | 31.62 | 31.36 | -0.26 | |
4.25% by year-end…then crickets?
October 7, 2022
–NFP today expected 250k. CPI is Wednesday. Auctions of 3s, 10s, 30s start Tuesday.
–NY Fed has a relatively new measure of Global Supply Chain pressures which has declined for five consecutive months and is back to more normal levels, unless you’re looking for a good proscuitto sandwich.
https://www.newyorkfed.org/research/policy/gscpi#/interactive
–Nothing from Fed officials to indicate a pivot toward ease. Flatter curve yesterday with 2 and 5 yr notes up 10 bps and tens up only 6.7 (to 3.82%). Some time ago, trade in Friday NFP options would be dominated by TY puts. Yesterday there was a new buyer of 20k FV week-1 (today expiry) 107 puts for 7. Settled 9 ref 107-12+. A bearish number expected to hit the belly hardest. In dollars, reds were the weakest part of the strip, down 11.125, with greens -7.25 and blues -6.5.
–Jan’23 and Jan’24 Fed Fund contracts settled at almost the same price: 9570.5 and 9570.0. In the month of September, the spread ranged between -37 mid-Sept to +22 in the later part of the month. Now settling in around zero? What if that’s correct?…a full year of an idle Fed with funding rates locked in around 4.3%. Of course, prices have been bouncing around somewhat erratically, and there’s probably little to be gleaned from this particular spread; SFRZ2/Z3 settled -9.0 (9562.5/9571.5). The idea is, with the jobs market moderating, and yoy comparisions leading to slowly declining inflation data, would it be bad strategy to just announce a hold on rates and let balance sheet reduction continue? Odds are, it won’t happen, but…red dec ED and SOFR straddles are >135. Could they be more like 125 next Friday?
–Columbus Day Monday. Bank holiday but exchange is open…might take that off.
