Let the long end do the tightening work
August 12, 2022
–Bloomberg reports that Mary Daly favors a 50 bp hike in September. I might be incorrect, but I think she directly channels Powell’s sentiments.
–Large steepening trade over the past two sessions, even as inflation data were lower than expected. Yesterday PPI was 9.8% yoy vs 10.4 expected, with Core 7.6 vs 7.7. Changes from Tuesday (at futures settle) to yesterday: 2yr 3.28 to 3.225. 30y 3.00 to 3.16. A move of over 21 bps in two days as the bond contract has seen nothing but offers. The market trades as if the Fed is planning to slow the pace of hikes due to mark-downs in growth estimates, while inflation remains stubborn with a slightly decreasing bias.
–New recent high in EDU2/EDU3 calendar at positive 19 (9663.5/9644.5). Previous 20-session range -27.5 to +13. All one year calendars behind are negative. EDZ2/EDZ2 is negative 56.5 (9609.0/9664.5). It’s a stark difference between expectations for the end of this year, where EDU2/EDZ2 is 54.5 as the Fed continues its hiking campaign, while EDU3/EDZ3 is negative 20, when the weight of this year’s front-loaded tightening will buckle the knees of economic prospects.
–News today includes U of Mich Inflation expectations, expected 5.1% for 1-year and 2.8% for 5-10yr. The ten year treasury to tip breakeven has comfortably settled in around 2.5% over the past month.
Defining near-term parameters
August 11, 2022
–Rate futures were strongly geared toward a high CPI number; EDZ2 traded 9600 or 4% just prior to the data, testing the NFP low from Friday which was 9599.5. The actual month/month print of zero caused a panic short squeeze, taking EDZ2 to a high of 9626.5. Similarly, EDU3 had a range of 9643 to 9668 or 25 bps, putting in the entire day’s range within a couple of minutes post-data. EDU3 came back to settle at 9650.5, nearer to the low of the day as Evans and Kashkari suggested little change in the Fed’s rate path (3.5 to 4% by year-end). A piece by WSJ’s Nick Timiraos made the same point. With two days until expiration 0EQ 9650^ settled 12.0. Never thought we’d see a relief rally with Core yoy CPI 5.9%.
–FFV2 contract traded to a high of 9712 but fell back to settle at 9706 or 294, almost the exact midpoint between a hike of 50 (which would take EFFR to 283) and 75 (which would take EFFR to 308). Prior to CPI the market was heavily leaning for a 75 bp hike at the Sept 21 FOMC; the low on NFP was 9696 or 304. Yesterday’s high of 9712 is just 5 away from 50. Perhaps the tone of the entire short end can be defined by FFV2: the parameters have been clearly set for the Sept FOMC. Going further, FFV/FFX spread settled 36 almost the exact midpoint between 25 and 50 for the November 2 meeting. Unsurprisingly implied vol declined somewhat. Likely to be a slow two weeks going into Jackson Hole symposium, which starts August 25.
–The long end is a different story, with bonds closing lower on the day. The 30yr yield ended +3 bps at futures settle to 303.4 in front of today’s auction. If Fed is going to be hiking less aggressively then naturally the curve should steepen a bit, especially from very depressed levels. 2/10 ended at -43, up 5.7 from yesterday. 5/30 jumped 8.8 to 11.4.
–PPI today expected 10.4 from 11.3, with Core 7.6 from 8.2. Jobless Claims expected 260k.
New curve lows in front of CPI
August 10, 2022
–CPI this morning expected 8.7% from 9.1% with Core 6.1% from 5.9%. Yields rose, with tens up 4 bps in front of today’s auction, to 2.796%. On the eurodollar curve, reds and greens were weakest, both packs settled -9.875. New low in 2/10 at -48.6. New low in red/gold euro$ pack spread at -61. FFF3 settled 9641, or 359 bps, 126 over the current EFFR of 233, with three meetings to go.
–New high in EDU2/Z2 at 53.5, but U2/Z2 in SOFR is 41.5. Trade action was biased to the downside. Example, +30k SFRM3 9600/9550/9500p fly 4.75 to 5 (9651s) and +24k EDZ3 SFRZ3 9600/9550/9500p fly 4 to 4.5 (9691.5s).
Expecting (near) hikes, but every contract from EDZ2 to EDU5 is at a successively lower yield
August 9, 2022
–An early stock rally to new highs fizzled. The US curve continued to flatten to new lows, with 2/10 spread down to -46, just 10 away from the 2000 low of -56. The most negative one-year calendar on the ED curve is EDH3/EDH4 at -82.5. The most positive one-year calendar is EDU2/EDU3 which settled 0. Every other 1-yr calendar is inverted out to EDU5/EDU6. Settles: whites +1.5. reds +8.25, greens +9.875, blues +9.875 and golds +9.25. The red gold pack spread fell to a new low -53.625.
–Large buyer (adding) of SFRH3 9625/9600ps for 10, about 20k on the day. Settled 9.75 ref 9641.0
–Implied vol in rates was slightly softer on the day.
–News today includes NFIB Small Business Optimism expected 88 from 89.5. The June report featured this headline: Small Business Expectations for Future Conditions Hits All-Time Low. Hard to sugar coat that. Unit Labor Costs and NonFarm Productivity for Q2 expected -5%.
–3 yr auction today. CPI on Wednesday.
https://www.nfib.com/surveys/small-business-economic-trends/
Blowout NFP causes further inversion
August 9, 2022
–Blowout NFP 528k with 3.5% rate and yoy AHE 5.2% vs expected 4.9%. June Consumer Credit was released at the end of the day at a whopping $40.15b. EDM3 was the weakest contract, closing down 24.5 at a price of 9627.0. On the euro$ strip, EDZ2 is the lowest contract at 9603, close to 4%, and on the SOFR strip, H3 is the lowest at 9639. FFV2, which captures the Sept FOMC, settled 9698.5 or 301.5. If the Fed hikes 75 in Sept, the new EFFR will be 308. Getting close.
–There was chatter of an emergency Fed hike which caused FFQ2 to trade 9764, 3 bps above the current 233 EFFR. Settled 9765.75.
–Red euro$ pack (2nd year forward) settled 9676.75, down 22.625 on the day. New lows in all spreads from reds back: red/green (2nd to 3rd yr) settled -44.25, and red/gold (2nd to 5th) settled -50.625. 2/10 treasury spread closed at a new low of -41. The more aggressive that hikes are perceived going into year-end, the more the curve inverts. Curve inversion is indicative of what used to be called a recession. Although Mary Daly last week said the market was getting ahead of itself in terms of pricing future easing from the Fed, FFF3/FFF4 settled -45.5, a transparent marker of how much easing is priced for next year. (9643.5/9689.0). FFF3 settled 9643.5 or 356.5, about 1.25% higher than current EFFR. Jan’23 encompasses the next three FOMC meetings: Sept 21, Nov 2 and Dec 14. So if they’re putting in 75 for Sept, it doesn’t leave much for the other two.
–CPI Wednesday.
It’s a Bob Ross market
August 7, 2022 – weekly comment
The following tweet is by @_elvishpresley_
[every time I watch the joy of painting]
*5 minutes in*
yellow ochre?? for a snow-covered mountain?! alright bob ross this time you’ve really lost it
*15 minutes in*
bob ross you son of a bitch
The Joy of Painting ran on tv from January 1983 to May 1994. The format of the program started with a blank canvas on an easel. Bob Ross would hold his palette and had a bunch of brushes to demonstrate various techniques, and by the end of the half hour he would produce a landscape painting.
I had seen some of the early shows but was drawn further into the Bob Ross orbit during covid when we were stuck inside. The show is strangely mesmerizing, and I don’t know if Covid is the reason, but Bob Ross has surged in popularity even with a younger cohort, perhaps partially due to the wine and painting workshops that are now popular for a night out.
The tweet is funny because it’s accurate. He starts with a mountain and progressively works to the foreground, adding boulders and rivulets, saplings and wildflowers; it’s amazing. All the while he’s saying in a smoothing voice, “Maybe we’d like a happy little tree here.” And “maybe that tree needs a friend.” All of a sudden a grove of pine trees appears.
As relates to the market:
[Last Friday SFRZ2 settles 9674.5]
*tuesday*
SFRZ2 9600 puts?? buying a 4% strike? everyone knows the Fed’s about to pivot. this time you’ve gone too far!
*friday NFP*
SFRZ2 9642.5. son of a bitch
Maybe we should print a happy little Service ISM number of 59.9. Now pull out your big brush and imagine 598k NFP with an unemployment rate of just 3.5%. “It’s unbelievable that you can have that much power. But on this canvas, you do.” And there’s your final portrait. Recession-proof.
After the payroll number, one bank suggested the possibility of an intermeeting hike, taking FFQ2 down to a low of 9764.0 or 236 bps (settled 9765.75). The next FOMC is Sept 21 and the Fed Effective rate since the July FOMC has been 233 bps (with one day at 232). Printing 3 bps above the current EFFR with effectively 1/3rd of the month already pegged is astonishing. There are those that say the Fed has damaged its credibility, and certainly the economic projections support that view, but no one is doubting the possibility of large hikes to quell inflation. October Fed Funds (FFV2) which captures the Sept 21 FOMC (along with any unscheduled hikes) settled 9698.5 or 301.5. With current EFFR 233, a 50 bp hike would result in 283 or 9717 while 75 would be 308. Obviously, the market has tilted heavily toward the latter.
The internals of the employment report weren’t as strong as the headline suggested. For example. The household survey has been diverging significantly from the headline establishment data. However, it barely matters going into Tuesday’s CPI number (expected yoy 8.7 with Core 6.1). Either the Fed tries to thread the needle to achieve a soft landing or it crushes inflation expectations. That’s the choice after CPI. The easier goal to accomplish is the latter.
On June 10 CPI printed 8.6 with Core 6.0, the highest numbers up to that time. On June 14, rates topped, with the ten year yield 3.47%, and on June 16 SPX bottomed at 3667. Just a week before, WTI had topped at 117.15 on June 8. On July 13, CPI was 9.1 with core 5.9%. CL was at 93.83. The ten year yield went from 293.5 on July 13 to just 3.027 one week later (a rather modest move). SPX made its most recent bottom on July 14 at 3790, just after CPI. The price of oil seems to have been the dominant factor.
Now, after Friday’s NFP the ten year yield jumped to 283 from 264 the previous week. SPX rallied slightly on the week to 4145. CLU2 is 89.01. There’s a bit of divergence here. The administration wants the oil price down. The Fed wants the ten year yield to be more restrictive. Tens tend to follow the price of oil, but the administration is just about out of bullets in terms of draining the SPR.
With a head and shoulders top formation in the ten-year yield, I had thought a target of 2.40% was attainable. That’s still plausible but the yield has to stay below the recent 303 high.
Besides inflation data (CPI Tuesday and PPI Wednesday) the treasury auctions 3s, 10s and 30s Tuesday, Wednesday, Thursday. The 2/10 treasury spread made a new low of -41 this week. The ten year yield is 283, 50 above the current EFFR and 54 above the SOFR rate. If the Fed hikes 50 in September then positive carry likely vanishes. The banking model of lend long, borrow short is facing increasing headwinds.
OTHER MARKET THOUGHTS/ TRADES
The 2-yr treasury yield surged 34 bps this week to 3.24%. The 6/14 high was 3.43% and the subsequent 7/19 high was 3.24%. The trend for the short end is toward higher yields. SFRM3 (the biggest mover) was 9703.5 on 7/29, but settled 9657 Friday, for a total 46.5 bps as the market pivoted away from the Fed pivot. SFRH3 which is the lowest contract on the strip at 9639 or 3.61%, was down 44 bps.
While the 2 yr yield is just 19 bps away from the June high, SFRH3 is still 40 away from the low settle on 6/14 of 9599, which, by the way, is the lowest any near SOFR contract has settled on the move. SFRU3 at 9677 is fully 38 above the SFRH3 price. Said another way, there is a strong gravitational pull lower on SFRU3, which argues for the idea of being long Sept midcurve put flies on SFRU3, with a target around 25 lower than here, depending on your view of actual Fed hikes.
| 7/29/2022 | 8/5/2022 | chg | ||
| UST 2Y | 289.7 | 324.4 | 34.7 | |
| UST 5Y | 269.3 | 297.4 | 28.1 | |
| UST 10Y | 264.3 | 283.6 | 19.3 | wi 2.830/825 |
| UST 30Y | 297.7 | 306.5 | 8.8 | wi 3.045/040 |
| GERM 2Y | 28.1 | 47.8 | 19.7 | |
| GERM 10Y | 81.7 | 95.5 | 13.8 | |
| JPN 30Y | 119.5 | 115.3 | -4.2 | |
| CHINA 10Y | 276.5 | 274.6 | -1.9 | |
| EURO$ U2/U3 | -25.0 | 2.5 | 27.5 | |
| EURO$ U3/U4 | -50.5 | -59.5 | -9.0 | |
| EURO$ U4/U5 | -13.5 | -22.0 | -8.5 | |
| EUR | 102.27 | 101.84 | -0.43 | |
| CRUDE (active) | 98.62 | 89.01 | -9.61 | |
| SPX | 4130.29 | 4145.19 | 14.90 | 0.4% |
| VIX | 21.33 | 21.15 | -0.18 | |
https://en.wikipedia.org/wiki/Bob_Ross
Employment day
August 5, 2022
–Yields slipped in front of today’s Employment report. The ten year fell 7.7 bps to 2.668%. On the eurodollar curve, greens (3rd year out) have been the most volatile, and rallied 13 bps today. NFP is expected 250k, though stronger numbers would fit the administration’s and Fed’s narrative a bit better. Wages yoy expected 4.9% from 5.1.
–Large exit of the SFRZ2/SFRZ3 spread on a block: 57k were sold at -54.0, an exit from the July 26 buy of 67k at -63. SFRZ2/SFRZ3 settled -55.5. By comparison, EDZ2/EDZ3 settled -69.0. The libor transition occurs at the end of June 2023, so SPRZ3/EDZ3 is pegged at 26. The relative weakness of EDZ2 is attributable to turn-of-year pressure which seems to be worth about 9 bps and credit concerns, about 4-5 bps.
–Implied vol is fading in the short end as the market has determined that Fed chatter of 75 at the September meeting is likely empty talk, and if it DID occur it would probably shave future hikes. Job cut announcements are becoming more prevalent, and though gasoline has come down, a higher cost of living has become accepted if not acceptable. New low in red/green euro$ pack spread at -42.625. As previously mentioned, this spread is at a new historical low at least since 1998…low in 2000 was -9.375, barely inverted in 2006 and 2007, and low in 2019 was -9.625. Perhaps Mary Daly can keep an eye on that with respect to how the market perceives forward Fed policy, because this spread is blithely ignoring her protestations that the Fed won’t ease in 2024. Below is a chart from a couple of days ago.
Flight to safety fizzles
August 3, 2022
–Large jump in yields as reaction to Pelosi’s Taiwan trip fizzled and both Evans and Mester indicated support for 50 to 75 at the September meeting. Current Fed Effective has printed both 232 and 233. another 50 would be 283 or 9717. FFV2 settled 9706.5…pretty close to the midpoint between 50 and 75 in terms of pricing for the Sept 21 FOMC.
–Green pack (3rd year out) was the leader in terms of yield increase, with the price down 25 bps to just under 9732. That price is still 109 higher than EDZ2 at 9623, the lowest contract on the strip. EDZ2 is consistent with FF of about 3.5% by year end. Jan’23 FF contract settled 9661, down 10 on the day) or 3.39%. Instead of the green pack, let’s consider the average price of the four 2024 contracts: EDH4 thru EDZ4 averages 9716 or 2.84%, consistent with a FF target of 2.5 to 2.75%. That’s how we get to a soft landing: Higher rates to slow things down and then lower rates to cushion the blow. It’s all in the handbook: Fed Presidents for Dummies.
–After making new highs for the move, tens and bonds had large outside ranges and closed near the lows. Bearish signal on long rates in front of next week’s auctions of 3s, 10s, 30s. 2/10 spread made a new low of -33 bps. Twos closed 3.077% while 5s, 10s and 30s are all under 3%. Strong temptation to buy the steepener if the market gets a bit closer to pricing 75.
–News today includes ISM Services expected 63.5 from 55.3. Factory Orders as well.
Piling on uncertainty
August 2, 2022
–Yields continue to decline with tens down nearly 4 bps at futures settle to 2.605%. With 20 minutes left in the day session the yield had eased to 2.59%. Volume was fairly light. Early large buyer of 10k TYX2 125.5c for 29/64’s. Expires 21-Oct and settled 29 vs 121-125 in TYZ2. Perhaps it was Nancy’s husband, as it’s reported she WILL visit Taiwan; TYU2 currently 121-25. (“Honey, I’m very worried about you making this trip.” *Dials cell phone. “Morty, buy me up to $5 million in treasury calls. Try not to be obvious.” DOD spokesman John Kirby tried to make a visit sound like a routine affair at yesterday’s press conference, while China has left no doubt there will be a response.
–New historic low in red/green euro$ spread which settled -41.25. 2/5 treasury spread is also at a new low (as mentioned over the weekend). It fell 1.2 bps today to -24. If snarled supply chains are partially due to chip shortages, and if uncertain supplies lead to inflation, and if Taiwan is a major supplier of chips, and if the Fed is determined to stop inflation at all costs, then this spread might have more to go.
Nearer flatter, farther steeper
July 31, 2022 – Weekly comment
The big events of last week were the Fed’s (expected) 75 bp hike in the FF target to 2.25/2.50% equaling the high from 2018, and the Advance Q2 GDP print of -0.9%, signaling a recession that we’re going to pretend is not occurring.
In the wake of the FOMC meeting, the 2/5 treasury spread closed Friday at -21, at the lowest level since 2000. The red/green Eurodollar pack spread settled Friday -37.125. This is lower than all levels starting from 1999. Lows of approximately -10 in red/grn occurred in the year 2000 and in 2019. In June the record low since the turn of the century was posted at -39.75.
These spreads unambiguously reflect tight monetary policy. That policy was designed to restrain economic activity in order to squelch inflation, and the preliminary evidence is that demand is indeed being destroyed. On the inflation front, yoy PCE prices were +6.8% as expected, with Core a bit firmer than the survey at +4.8%. In terms of inflation expectations, the 5y breakeven hit a high of 368 in March, but the tightening campaign caused a favorable compression down to 229 by early July. In the past week the 5y b/e bounced from 234 to 279 as Powell toned down the tightening rhetoric. The October Fed Fund contract, (FFV2) which prices odds for the September 21 FOMC, had been halfway between 50 and 75 bps, but ended the week closer to 50 at a price of 9710 or 2.90%; 57 bps above the new Fed Effective rate of 2.33%.
While 2/5 spread is mired at new lows, the 5/30 treasury spread closed at its highest level since mid-March at 33 bps. On a technical basis there’s a double bottom at -17 which projects to around 70, which also happens to be the approximate halfway back point from the high in Feb of 2021 at 163 to the June 14 low of -17.
I would summarize price action as acknowledging very tight Fed policy, with hints of less hawkishness in the future, which encourages profit taking on short curve and long USD. Straddle prices in long dated red Eurodollar options offer further evidence that the market perceives somewhat less aggressive Fed action. For example, EDU3 9687.5 straddle settled on July 22 at 138 bps vs 9689.5. On Friday, the contract settled 9695.0 (+7.5 on the week) and the 9687.5^ settled 125.25 (-12.75 on the week). The 9700 straddle settled 124.5. All red straddles were down 13 to 17 bps; a significant mark-down of panic premium.
A large trade worth mention was Tuesday’s 67k block buy of the Dec’22/Dec’23 SOFR spread at -63 bps. The spread rallied to a high print of -46.5 by Wednesday afternoon, but gave back nearly all of that on Thursday and Friday, ending the week at -61.5. My interpretation is that the buyer expected a stronger signal of a near-term policy pivot. However, SFRZ2 settled at 9674.5 up only 6 bps on the week. The rate on SFRZ2 is 3.255%. In other words, the market’s forecast of a final year-end FF target around 3.25% didn’t much change. SFRZ2 settled 9674.5 and SFRZ3 settled 9736.0. The spread DOES indicate a pivot to easing next year. As always, timing is key.
Both the administration and the Fed have cited the strong labor market as one of the main reasons that the economy is NOT in recession. The employment report is Friday, with NFP expected 250k from 372k. The unemployment rate is expected unchanged at 3.6%. Jobless Claims have been slowly trending up since the historic low of 166k in mid-March to 256k last week.
| 7/22/2022 | 7/29/2022 | chg | ||
| UST 2Y | 299.1 | 289.7 | -9.4 | |
| UST 5Y | 287.5 | 269.3 | -18.2 | |
| UST 10Y | 278.7 | 264.3 | -14.4 | |
| UST 30Y | 300.3 | 297.7 | -2.6 | |
| GERM 2Y | 45.2 | 28.1 | -17.1 | |
| GERM 10Y | 103.1 | 81.7 | -21.4 | |
| JPN 30Y | 122.5 | 119.5 | -3.0 | |
| CHINA 10Y | 278.6 | 276.5 | -2.1 | |
| EURO$ U2/U3 | -27.5 | -25.0 | 2.5 | |
| EURO$ U3/U4 | -43.5 | -50.5 | -7.0 | |
| EURO$ U4/U5 | -5.5 | -13.5 | -8.0 | |
| EUR | 102.16 | 102.27 | 0.11 | |
| CRUDE (active) | 94.70 | 98.62 | 3.92 | |
| SPX | 3961.63 | 4130.29 | 168.66 | 4.3% |
| VIX | 23.03 | 21.33 | -1.70 | |
