Message shift from immediacy to duration
September 8, 2022
–WSJ article by Timiraos suggesting Fed will hike 75 in two weeks had the effect of flattening the curve. FFV2 settled 9697.5 (-1), nearing the 9692 price which would occur on 75 bp move. Greens and blues rallied over 10 bps. The ten year note yield fell 6.7 to 3.263. In an environment of much tighter financial conditions, longer yields give a nod to slower econ conditions.
–Brainard’s speech was somewhat disingenuous, starting out by blaming inflation on supply shocks and then crediting monetary and fiscal policy for ‘growth’. (Take the credit, not the blame). She did mention tighter financial conditions, reduction in the balance sheet, and the risk of over-tightening. In summary, she cited several factors which should continue to moderate price pressures but cautioned against pulling back too soon. The important message from both Brainard and Powell has been duration of tight policy to prevent a backslide, NOT a need to continue near term aggressive hiking. Clearly a hike will occur at the Sept 21 meeting, but there has been little in the way of explanation about effects of the large increase in balance sheet reduction. Brainard simply mentioned it, and Bullard said he “hopes” it results in higher rates, sort of in the same way that I “hope” gold will rebound.
–ECB today, followed by Powell. Jobless Claims expected 235k.
Bailouts for everyone. We’ll just BORROW it
Sept 7, 2022
–Large jump in yields. US tens surge 14 bps to 3.33 while bonds closed at the highest yield level since 2014 at 3.475, up 13.4. Twos gained 9.2 to 3.49%. Tens still haven’t taken out the high from mid-June this year, which was 3.476. After that, it’s back to the 2011 high of 3.74. Curve bear steepened. On the euro$ curve, reds were down 12.875, while golds were -17.5. Negative factors include corporate issuance, inflation concerns, CB actions, QT. However, when protests are breaking out all over the world due to crushing energy costs, and the only solution by gov’ts is handouts, is it a surprise that yields move higher?
–On the SOFR strip, another large buy (10k block) SFRZ4/SFRZ6 at -5.5. On August 31 he paid -15.5 for 10k. New buys. Spread settled -2.5 (9691.0/9693.5).
–After Friday’s payroll data, odds of a 75 bp hike for Sept 21 were trimmed, but yesterday FFV2 settled 9698.5, -4 on the day, again indicating a heavy lean toward 75. SFRU2 settled 9674.5. There’s really no way to justify that price WITHOUT 75 at the Sept meeting. According to my calcs, that price is low even with 75 in Sept and 25 in Nov. $/yen now above 144, highest since 1998.
–Richmond Fed’s Barkin in the FT this morning: “I have a bias in general towards moving more quickly, rather than more slowly, as long as you don’t inadvertently break something along the way.” [ Insert “THIS IS FINE” meme here ]
–Brainard today followed by Beige Book. Powell tomorrow.
Flows
September 5, 2022 – Weekly comment
When I was on the CME trading floor, I recall a particularly busy day. The details are a bit fuzzy, but something like the first two greens in euro$ futures were getting pounded relative to other contracts. What I remember clearly was that I had done some sort of simple spread, let’s say selling the first red to the first green, and had gotten off a price well above previous day’s settle. Again, it’s not the details of the spread that matter, it’s that Denise Miniscalco who had worked her way up to being a pit broker, walked up to me at my desk to deliver the endorsed trading cards, and proceeded to explain to me, in no uncertain terms, as to how we were able to get this price done.
Now, this woman was years younger than me, a petite attractive brunette (is that sexist? Well, sure). She told me who was doing what. “Stumpy and Bono were selling the green pack for Greenwich. Solly was selling first green to first blue.” It was something like that. All concerned with particular flows that were influencing the curve shape. It wasn’t about a piece of fundamental news that was causing anything. Pure flows. She knew exactly what she was talking about. That was the floor local mentality. Who is doing what, and what the big positions are. A lot of locals made a lot of money remembering those details.
Maybe it doesn’t need to be complex.
I saw a chart on twitter which overlaid the 30yr mortgage rate on the Fed’s Balance Sheet holdings of MBS. Unfortunately, I can’t find the chart now; it had various useful notations on it. I recreated the chart above (apologies to original twitter author). The Fed holds $2.7T of MBS and will be shedding $35b per month (along with $60b treasuries), starting now. It’s worth noting, I suppose, that according to the Fed’s Z.1 report, total Household Home Mortgages total $12T in Q1 2022. So I guess the Fed holds 22% of the home mortgage market. (Next Z.1 is released on Friday).
If the Fed isn’t buying, then rates have to go up, right? Unfortunately, it’s not quite that simple. The 30 yr mortgage rate has doubled in a year. But it actually appears on the chart as if rates initially run up when the Fed is paring back the balance sheet, or is EXPECTED to, and then decline as risk assets lose favor and the Fed’s lack of support slows economic growth. The explosion in mortgage rates this year makes the 2013 Taper Tantrum look like just that, a brief tantrum.
Maybe it’s just as simple as Putin’s description from mid-June:
Unable or unwilling to find other solutions, the governments of leading Western economies simply accelerated their money-printing machines and used this ignorant method to cover their unprecedented budget deficits. I have already citied this figure: over the past two years, the money supply in the US has grown by more than 38%. That’s 5.9 trillion dollars. The EU’s money supply has also increased dramatically over this period. It grew by about 20%, or 2.5 trillion euros. Today’s rising prices, accelerating inflation, shortages of food and fuel, and problems in the energy sector are the result of system-wide errors in the economic policies of the current US administration and European bureaucracy.
Of course we know that Putin’s invasion of Ukraine is also a factor, but again, according to the Fed’s report, M2 in the beginning of Feb 2020 was $15.393T, and in Feb of 2022 was 21.571T or a 40% increase. If the currency is depreciating relative to goods due to whirring printers, then of course lenders demand more depreciated dollars in future interest.
Attached is a chart of yoy M2 growth from the St Louis Fed website. The burst of inflation we’re seeing is a direct result of the extraordinary growth in M2 starting in 2020. They say it takes a year for monetary policy to flow through the economy. What’s going to happen now? Interestingly, the M2 chart looks a lot like a chart posted on twitter by CrossBorder Capital on EPS, though the latter has a lag.
In the final analysis, the sharp slowdown in money supply growth coupled with the Fed’s inflation fight will likely affect equity markets more than fixed income. That’s not to say that bonds are set to rally. The Fed’s withdrawal of liquidity will continue to weigh on all financial assets.
OTHER MARKET THOUGHTS / TRADES
Post-employment data, the market lessened chances of a 75 bp hike at the Sept 21 FOMC. For example, SFRU2 rallied 6.5 bps to settle 9682. EDU2 settled 9665.5, +6.25. In terms of the latter, the rate is 3.345% with 3m Libor having set at 3.15814, a basis of 18.7 bps which must converge in two weeks.
October Fed Funds (FFV2) closed +4.5 at 9702.5. The midpoint of 50 or 75 bps is 9704.5. So there is still a slight tilt toward the latter, but it will likely fall to the Sept 13 CPI data to solidify expectations. Of course, the ECB meeting on Thursday also looms. Brainard speaks on the Economic Outlook midday Wednesday, and Powell on Thurs in a moderated discussion on Monetary Policy at the Cato Institute.
With the disappearance of the credit component in short end rates as the transition to SOFR occurs, it’s worth looking at Hi Yield and Investment Grade Corp Bond Index futures listed on the CBOE. Unfortunately, these contracts do not yet have the liquidity to warrant interest, but I suspect that’s likely to change. On BBG, IHBA <index> is investment grade but has only 486 contracts in open interest. (Closely related it LQD etf). IBYA <index> is hi-yld with aggregate OI of 794. (Closed related to HYG). More on these contracts as liquidity improves.
| 8/26/2022 | 9/2/2022 | chg | ||
| UST 2Y | 338.6 | 339.8 | 1.2 | |
| UST 5Y | 319.3 | 329.8 | 10.5 | |
| UST 10Y | 303.3 | 319.1 | 15.8 | |
| UST 30Y | 320.3 | 334.1 | 13.8 | |
| GERM 2Y | 98.7 | 110.2 | 11.5 | |
| GERM 10Y | 139.0 | 152.7 | 13.7 | |
| JPN 30Y | 114.1 | 126.2 | 12.1 | |
| CHINA 10Y | 266.0 | 263.6 | -2.4 | |
| EURO$ U2/U3 | 44.5 | 49.0 | 4.5 | |
| EURO$ U3/U4 | -58.0 | -55.5 | 2.5 | |
| EURO$ U4/U5 | -23.5 | -16.5 | 7.0 | |
| EUR | 99.66 | 99.66 | 0.00 | |
| CRUDE (CLZ2) | 91.55 | 85.90 | -5.65 | |
| SPX | 4057.66 | 3924.26 | -133.40 | -3.3% |
| VIX | 25.56 | 25.47 | -0.09 | |
https://www.federalreserve.gov/newsevents/pressreleases/monetary20220727a1.htm
https://twitter.com/PutinDirect
https://www.cboe.com/tradable_products/corporate_credit/cboe_iboxx_ishares_corporate_bond_index_futures/
Let’s tweak NFP for Labor Day
September 2, 2022
–30y yield ended 3.371, just 5.6 bps away from the year’s high at 3.427. On a continuous US1 futures chart, the low for US on June 14 was 132-09. USZ2 settled yesterday at 133-18. Near ED calendars made new highs, but the lowest one-year spreads remain deeply inverted, EDM3/M4 is -68 and SFRM3/M4 is -67. The market clings to the idea of a Fed pivot even after Powell’s forceful Jackson Hole speech. Lowest SOFR contract is SFRH3 at 9607, and the lowest FF contracts are April and May ’23 at 9604.5. Timing for the terminal rate has been pushed out slightly in time, as witnessed by the widening spreads between Z2 and H3 contracts to new recent highs (14.0s in SOFR). Peak rate is projected at 150 to 175 higher than now, which would put EFFR at 383 to 408. If the Fed were to hike 75 at the Sept 21 meeting, a downshift to increments of 25 to 50 is likely.
–Having said that, there was a new buyer of 30k SFRZ2 9600/9575/9550p fly for 3-3.25 yesterday. Settled 3.0 vs 9621. This trade favors more of the “front-load”.
–Curve bear steepened yesterday. Two-yr yield +7.2 to 3.518%, ten-yr +13.2 to 3.263%.
–NFP today expected 300k. Unemp rate still 3.5%. Avg Hourly Earnings expected 5.3%. I saw a clip on ZH saying that a low NFP would be taken as positive by equities. Maybe initially…but while a low number might spark a pullback in USD and ease some of the pressure on the short end, long bonds probably won’t have a sustained bounce. The long end of the curve is destined to become a much more important factor in terms of tighter (or looser) financial conditions.
Bear Steepener?
September 1, 2022
–Whether related to end of month adjustments or belated realization that increased QT might remove the marginal bid for treasuries, there was a late drop (post-settlement) in long treasuries and stocks. For example, WNZ2 settled 149-16 and was a point lower an hour and a half later at 148-13, and last print this morning is 148-03. This morning’s SOFR curve: SFRU2 -1, U3 -2, U4 -3, U5 -5, U6 -7.5. The market has tended to flatten on moves to higher rates. Just before Jackson Hole a BBG article was highlighting the idea that flattening could continue (and it certainly has in 5/30). The point is simply that IF the curve were to bear steepen, it would likely cause maximum pain.
–Along the same theme, there was a late buyer yesterday of 10k block, green/gold Dec, SFRZ4/SFRZ6 at -15.5. Settled at -15.0 (9704.5/9719.5), but before the end of the screen session it was -11.5. Ten year treasury yield at futures settle was 3.13%, up 2.3 on the day, and the thirty year was 3.25%, up 3 bps on the day. If the Fed were to hike 75 in a couple of weeks, then EFFR will be 308. Though short end curves still forecast Fed eases by next year, the prospect of positive carry is by no means guaranteed. Is it that far-fetched to project 3.75% long bond yield by year end? A point in US is worth about 6 bps. OTM US puts aren’t cheap, but may be worth a look in terms of protection.
–ADP much lower than expected yesterday at 132k. NFP tomorrow expected 298k. Today’s new includes ISM Mfg 51.9 vs 52.8 last. Nonfarm Productivity and Unit Labor Costs as well, 2Q final.
Cracks worsening
August 31, 2022
–New low 5/30 treasury spread -5.5. Fives were +1.2 to 3.275 while thirties were down 2.6 bps to 3.22. Low so far this year -17 and low in 2006 was -8.3. Late price in CLV2 was 91.72, down 4.47 as the demand destruction campaign spills into energy markets. This morning CLV2 is 88.82. Low of the month has been 86.16 (settlement basis).
–A report yesterday that Taiwan fired warning shots at drones, allegedly from China, sent US stocks lower, with a faint end of day bounce. SPX finished -1.1%.
–Eurozone inflation new high at 9.1% in front of next week’s ECB meeting. DXY testing new highs, above 109 this morning with ECU2 printing exactly at parity.
–On the euro$ curve, new highs in EDU2 based spreads, with EDU2/U3 at a new recent high +53, up 6 on the day. EDZ2/EDZ3 was up 3 on the day, but is still -35, while SFRZ2/Z3 settled -25.
–FFV2 continues to tilt toward 75 at the Sept 21 FOMC with a settle at 9698.5, but a lot can happen in three weeks. QT is kicking into high gear in September and markets appear to be in a fragile state. Employment report on Friday.
Here’s an interesting clip from a BBG article yesterday citing Morgan Stanley:
“The canary in today’s credit coal mine could well be leveraged
loans, a less ‘macro’ but equally important part of the credit
market,” says Sankaran. “At $1.4 trillion in outstanding volume,
the loan market has nearly doubled in size since 2015, with a
significant deterioration in quality. Due to the floating-rate
nature of these instruments, underlying borrowers are
particularly vulnerable to the double whammy of weaker earnings
and rising interest rates. A downgrade wave is imminent,
extending through the next few quarters.”
Another piece noted new highs in CCC spreads. Credit quality seeing renewed emphasis.
A lot can change in a couple of years
August 30, 2022
–August 27, 2020…two years ago. The Fed released its new statement on Longer Run Goals:
- On price stability, the FOMC adjusted its strategy for achieving its longer-run inflation goal of 2 percent by noting that it “seeks to achieve inflation that averages 2 percent over time.” To this end, the revised statement states that “following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”
- The updates to the strategy statement explicitly acknowledge the challenges for monetary policy posed by a persistently low interest rate environment. Here in the United States and around the world, monetary policy interest rates are more likely to be constrained by their effective lower-bound than in the past.
–Now it’s all about putting the inflation genie back in the bottle, running from one side of the ship to the other.
–Yields rose yesterday with tens +7.5 to 3.108. New high in EDU2/EDU3 at +47 bps (9659/9591.5). However, FFF3/FFF4 which is a rough proxy for expected Fed action next year is still negative at -21, FFF3 and SFRZ2 both settled at 9628.5, indicating a FF target around 3.75% by year end. FFV2 settled 9698.0, leaning a bit closer to 75 at the Sept 21 FOMC (9717 would be 50, 9692 would be 75). Bloomberg website highlights imminent QT in its lead headline this morning, but the market is ignoring the ramifications for now.
–JOLTS and Consumer Confidence today. NY Fed President Williams to comment in a moderated WSJ panel today.
New high 2y yield 3.46. Bonds also breaking
August 29, 2022
–Bonds breaking even as stocks continue to decline. Powell disabused the market of thoughts that eases will shortly follow front-loaded tightening. As of this writing on Monday morning the red SOFR pack (SFRU3, Z3, H4, M4) is printing down 13.5 bps. Near one-year spreads have rallied; if the Fed isn’t going to pivot then those spreads should be less negative (or maybe even positive). SFRZ2/Z is printing -19, a new recent high, up 7.5 on the day. SFRU2/SFRU3 is positive 48, also a new recent high. The low in mid-July had been negative 31.5.
–Friday brings the employment report. Last time out, NFP was a whopping 528k and is expected at 310k this time, but it’s a lagging indicator. All the start-ups that have been hiring like mad to garner market share while burning cash are facing MUCH tighter financial conditions.
–In Q4 2018, Powell had said the Fed was nowhere near neutral (as the FF target was the same as it is now) and QT kicked up to $50 billion per month. SPX fell 20% by the end of the year, which stopped Fed hiking cold. In September QT will kick up to $95 billion. As of Friday SPX was down 15.4% ytd, 20% would be around 3840. The low so far this year is 3637. High so far this year in the 30y is 3.43%. It is currently 3.25% while the 2yr has made a new high for the year just above 3.46%.
You’ve got one job
August 28, 2022 – Weekly Comment
Powell’s Jackson Hole speech: No mention of “financial conditions”. No mention of the dual mandate with “maximum employment”.* Focus is on bringing down inflation. Like the Bundesbank of old. No talk of soft landings. From the speech, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation.” No mention of the effect of energy prices.
Including the title, ‘Price stability’ is cited ten times in a speech that only has 15 paragraphs. Driving home a point.
The hand-wringing about whether the Fed hikes 50 or 75 at the September meeting is a tree. We’re in the forest. Again from Powell’s speech, “That brings me to the third lesson, which is that we must keep at it until the job is done.” Powell did acknowledge that the pace of hikes would eventually slow. But the idea of a pivot is out Bastiat’s broken window.
Apart from Powell, Bullard said he’s “hopeful we get upward pressure on rates through QT.” About 40 minutes prior to Powell’s speech a Reuters article came out which said “Some ECB policymakers want to discuss a 75 bp interest rate hike at the September policy meeting, even if recession risks loom.” ERZ2 (December Euribor) instantly dropped from 9854 to 9834. From Sunday morning’s FT site: ECB Officials warn of ‘sacrifice’ needed to tame surging inflation. This, as Holger Zschaepitz notes that German forward electricity prices have “skyrocketed to almost €1000 per megawatt hour. The electricity price has risen by 720% ytd.” I’d call that a sacrifice at the energy altar.
Of course. stocks got the message. On Friday, SPX was down 3.4% and Nasdaq down 3.9%. On the week SPX was down 4%. YTD numbers: SPX -15.4%, Nasdaq Comp -23%, DJIA -11.8%. As an indication of real estate woes, Zillow Group stock is down 46% ytd. The takeaway for companies is, ‘we’re going to make it more difficult to raise prices’. Even if energy prices are siphoning away consumer purchasing power, the central bank is NOT going to provide accommodation. Zombies are going to have a much more difficult time with funding.
In other words, ‘There will be pain, but we’re going to stick to it.’ The question in markets is, ‘Can the Fed really take the political pressure associated with much more significant drops in asset prices?’
Short end curves provide some clues, and the short answer is NO, the Fed won’t be able to shoulder the pressure. One-yr forward calendar spreads in Eurodollars are a rough guide for determining whether the market perceives the Fed to be tilted toward easing or hiking. (Same with SOFR of course, but I am using ED because of historical data availability). When the Fed is in a tightening regime, forward spreads are typically positive. That is, longer dated contracts are lower in price and higher in yield than nearer contracts. However, on the current euro$ strip, out to a few years, the only positive spread is EDU2/EDU3, the nearest spread, which settled Friday at positive 44.5 (9662.5/9618.0), a new high since mid-June (the low settle in July was -31). Currently, the lowest, most inverted, spread on the ED curve is EDM3/EDM4 at -66. The low settle in this spread on August 15 was -81.5. The market still perceives that the Fed will be easing sometime by the middle or end of next year. Powell’s speech SHOULD cause these spreads to move more positive, and indeed a few did, but it’s pretty clear that the market does NOT think the Fed is going to be able to hold rates at more restrictive levels as the economy cools, especially if asset prices are crumbling. Below is a long term chart of the 4th to 8th quarterly, currently EDM3/EDM4. While this is currently the lowest spread, when the market is absolutely convinced easing is around the corner, it is the NEAR spreads that become most inverted. In early September 2019, the 1st to 5th had a low of -85 and 2nd to 6th had a low -63.5. Currently 1st to 5th is EDU2/U3 at +44.5 and 2nd to 6th is EDZ2/Z3 at -36.5.
In terms of trades, the higher for longer Fed outlook should mean that something like EDM3/EDM4 is an easy buy. But if the Fed wavers, it’s not clear cut. And, with this particular Fed board, there are likely to be a lot of speeches at odds with Powell’s clear and direct message, especially after the September 21 FOMC. The picture will likely become more muddled. On top of that, midterm elections are just after the Nov 2 FOMC, which might make that meeting more political than usual.
Therefore, the types of trades that make sense are put spreads, and butterflies, and for those who perceive a cap to the terminal rate, put trees, on late 2023 through 2024 contracts. Trades of this type have already occurred. Indeed last week I had suggested that EDZ4 should at least test 9683.5 from 9697, and in fact, EDZ3 settled Friday exactly at that level. On Thursday there was a buyer of over 50k 0QZ2 9650/9600/9550 put fly for 8.5. This is a midcurve based on SFRZ3 expiring Dec 16, 2022. Settled 8.5 on Friday ref SFRZ3 9661.0.
News this week is capped off by the employment report on Friday. ISM Mfg is Thursday. Economic data have been showing weakness, though last NFP was 528k. I anticipate more equity market selling in the early part of the week, which may support fixed income in the short term. CPI is released on Sept 13, and there’s a 30y bond auction also on that day. The long end of the curve continues to trade bearishly; Sept 13 could be a big date.
| 8/19/2022 | 8/26/2022 | chg | ||
| UST 2Y | 326.0 | 338.6 | 12.6 | |
| UST 5Y | 310.9 | 319.3 | 8.4 | |
| UST 10Y | 298.3 | 303.3 | 5.0 | |
| UST 30Y | 322.1 | 320.3 | -1.8 | |
| GERM 2Y | 82.4 | 98.7 | 16.3 | |
| GERM 10Y | 123.0 | 139.0 | 16.0 | |
| JPN 30Y | 107.9 | 114.1 | 6.2 | |
| CHINA 10Y | 263.0 | 266.0 | 3.0 | |
| EURO$ U2/U3 | 33.8 | 44.5 | 10.8 | |
| EURO$ U3/U4 | -56.0 | -58.0 | -2.0 | |
| EURO$ U4/U5 | -28.5 | -23.5 | 5.0 | |
| EUR | 100.40 | 99.66 | -0.74 | |
| CRUDE (active) | 90.44 | 90.44 | 0.00 | |
| SPX | 4228.48 | 4057.66 | -170.82 | -4.0% |
| VIX | 20.60 | 25.56 | 4.96 | |
^ (h/t Doug Noland, Credit Bubble Bulletin
http://creditbubblebulletin.blogspot.com/
https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm
SOFR put fly: higher for longer
August 26, 2022
–It’s all about Powell today. Yesterday, rate futures rallied as those who had needed short hedges were already done by yesterday morning, leaving little remaining upside resistance. Tens fell 8 bps to 3.024%. On the eurodollar curve longer contracts led the way: red pack +2.5, greens +4.125, blues +5.75 and golds +8. There was a large new buyer of about 70k 0QZ2 9650/9600/9550p fly for 8.5 (settled 8.75). This trade is a midcurve which expires December 16 on SFRZ3 underlying (9665.0s).
–The lowest contract on both the ED and SOFR curves is March’23. EDH3 settled 9596 and SFRH3 9623. By Dec’23, the market anticipates easing, as EDZ3 is 9639 (a rate 43 below EDH3) and SFRZ3 is 9665 (42 lower in yield than SFRH3). If the curve stays the same, then the Dec’23 contracts will roll down over time, and the Dec put fly that traded would naturally end up in the money. However, there are only 3 1/2 months until short Dec expiration. In my opinion, the large put fly isn’t so much about the idea of Powell being aggressively hawkish, it’s more that he will try to convince the market of a steadfast stance against inflation, which may mean either that hikes are stretched out over a longer period or that once a terminal objective is achieved, it won’t be coming down any time soon. If that’s the thought process, then it might make sense to do something like buy SFRZ2/SFRZ3 spread. But that’s already had a significant rally to -30 from around -65, so the fly is clearly more limited in risk, and not really dependent on 50 or 75, but on the idea of higher for longer, with a terminal rate around 4%.
–FFV2 settled 9701, still tilted toward 75 in September. FFF3 settled 9636 or 3.64%, currently projecting that the Fed needs to hike by 131 bps in the next three Fed meetings (Sept 21, Nov2, Dec 14).
