Turn those machines back on
March 8, 2022
–The old CME trading floor was rich in hypothetical questions and scenarios. “Would you rather take a bubble bath with x, or have to watch Full Metal Jacket, alone, with y?” (both euro$ option brokers). My memory is a little fuzzy on this next one, I think it was originally just stated as an obvious fact of valuation: “I’d rather have T’s head full of nickels than a million dollars”, instead of “which would you rather have?” In any case, in 2011, Kyle Bass famously bought $1 million worth of nickels, on the premise that the metal in each coin was worth 6.8 cents. It’s worth more now. Unlike Duke & Duke, zerohedge is reporting that a unit of China Construction Bank (CCBI) was given more time to meet a margin call on an, ahem, adverse move in the price of nickel, which more than doubled yesterday. It all comes back to the J Paul Getty quote: “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.” As mentioned yesterday, Zoltan Pozsar posed some hypothetical questions related to exactly this type of financial dislocation in commodity markets a few days ago. Wheat has surged over 60% in two weeks. I guess it’s little wonder that CME stock fell 3.3% yesterday and ICE 2.4%, though surprisingly the former held up better than Nasdaq (-3.6%) and the latter better than SPX (-2.9%).
–Despite wild moves in commodity and equity markets, yields rose yesterday, with tens up 3.3 bps to 1.755%. The two-yr yield was up even more, +5.8 bps, leading to a new low in 2/10 at 20.7. The red/gold euro$ pack spread (2nd to 5th year) fell to a new low NEGATIVE 26.125. Three month eurodollar to SOFR (EDH2 vs SFRH2) ended at a new high above 38 bps. In October of last year, less than 6 months ago, three-month libor was around 13 bps, and 99.875 calls were in play. Without the Fed having overtly moved yet, EDH2 yesterday settled 9916.25 vs a libor setting of 64.286 bps. That’s a difference of over 19 bps with just a week before expiration, when these two rates MUST converge. Obviously, implied vol in rate options has exploded, with treasury vol easily the highest since March 2020 covid. I marked TYM 128.5^ at 3’39 (7.9) vs 128-035 with 74 days until expiry. Just for fun, I looked back around two years ago. On March 18, 2020, TYM’20 134^, then at-the-money vs 134-025, settled at 4’55, 10.8 vol, with 65 days to go.
–Three year auction today, followed by 10s and 30s on Wed and Thurs. The Fed is nearing the end of QT (for now…), with a purchase of $1.825 billion in 22.5 to 30 year bonds. From a ZH article: Kenney (Alberta’s Premier Jason Kenney) noted, “We could discuss how to ship nearly 1 million barrels a day of responsibly produced energy every day from the USA’s closest friend and ally! All it would take is his approval for Keystone XL. Easy.”
Collateral goes bad AND funding is pulled
March 7, 2022
–From Zoltan Pozsar: “Crises happen either because collateral goes bad or funding is pulled away – that’s been the central lesson in every crisis since 1998.”
Pozsar’s latest note concerns the stress being felt in commodity markets, with emphasis on the energy sector. I would just note that not only is oil +6.84 at 122.52 this morning, but May Wheat is just shy of $13. Last summer this contract was $5 to $6. I have attached a May/December wheat spread (from Friday’s close – higher now). That moonshot (from 0 to 2.29) represents a premium > 23% of May over December. Imagine the producer who has sold forward in the May contract but needs to finance the short margin call. As everyone knows from the Duke brothers, the exchange does not finance margin debits. Pozsar’s point is that commodity markets could cause a cascading funding crisis, or at least create significant stress. That angst is apparent in all sorts of futures calendar spreads. For example, last prints this morning: April WTI 122.57 while September is 102.10. And it’s apparent in the behavior of EDH2, which is down another 7.75 bps this morning to 9911.25 while March SOFR is not even down 1 bp at 9953.5. (Treasury collateral doesn’t go bad). On March 1, EDH2 was trading 9937.0. So three-month libor which supposedly prices to the best credits in bank-to-bank lending, has jacked up a quarter percent premium in the past week. Does this cause the Fed to move inflation concerns to the back burner? Of course it does. Do commodity concerns mean inflation will get worse? The answer there is yes as well — as just about every news page I’ve skimmed this morning features a picture of gas station prices.
By the way, EDH2 settles to three-mo libor one week from today. Friday’s setting was just over 61 bps. This morning’s future price is 28 bps higher.
–As mentioned in my weekend note, new historic lows in red/green ED pack spread at -20.125 (down 6.5 on the day) and red/gold at -23.875 (down 7.25). These spreads signal recession ahead.
–Friday’s employment report is now pretty much of an afterthought, with a huge NFP of 678k and rate of 3.8%. Hourly Earnings were much weaker than expected at 5.1% yoy. Treasuries rallied with tens down 12 bps to 1.722% and thirties down 7.8 bps to 2.147% as weekend risks related to financial stability grow. Treasury auctions of 3s, 10s and 30s this week starting tomorrow.
The Equalizer
March 6, 2022 – Weekly comment
My brother was looking to buy an equalizer for his stereo system. I don’t even know what an equalizer is. I saw the set up when I went over to his place. Four foot tall speakers, a rack with a tuner, the equalizer, a turntable, stacks of vinyl. I posted an article some years back about how much modern technology has displaced physical things. It was fascinating, an i-phone that fits in the palm of one’s hand replaced all the stereo stuff, telephones and answering machines, alarm clocks, video players, even desktop computers. Pounds of plastic, metal, glass and wires. But the i-phone is completely dependent on the integrity of the internet. Neil Young not on Spotify? I’ve got the Harvest album right here.
There are just a few themes I am covering this week, mostly through charts. I’m starting with an old one which relates to things you want versus the things you need; a constant thread in my conversations with DK. There are now shrill warnings about upcoming shortages of energy, food, fertilizer, computer chips.
Since the GFC, it’s all been financial engineering of paper assets over physical commodities. Facebook and video games instead of bicycles. If Ukraine has shown us anything, it is how it can all stop on a dime and reverse. This chart shows the resurgence of commodities.
Often we hear people talk about money flowing from one sector to another as if it’s a constant. Sometimes money just disappears. It doesn’t “flow” anywhere. It evaporates. Then those commodities that heat our homes and physically transport us and feed us become quite precious. I heard a comment on a Gavekal interview which I thought was pretty insightful and I am paraphrasing “Almost all economic activity is energy transformation in one way or another.” In this week of the Ukraine conflict CLJ2 (WTI crude) rallied 26% to $115.68/bbl. May Wheat rose 40+ %. According to an article in Wired about half of the world’s supply of neon gas comes from Ukraine.
Among Putin’s first targets was Odesa, a seaside city huddled around the Black Sea, and one of the country’s busiest ports. But it is also home to a little-known company called Cryoin, which plays a big role in the global production of semiconductors.
Cryoin makes neon gas, a substance used to power the lasers that etch patterns into computer chips. It supplies companies in Europe, Japan, Korea, China, and Taiwan, but most of its neon is shipped to the US, the company told WIRED. Now analysts are warning that the ripple effects caused by disruption to Cryoin’s supply could be felt around the world. WIRED Feb 28
The information technology that the world has taken for granted could be vulnerable, not just due to another round of chip shortages but due to cyber attacks.
Another chart below shows the historic inversion of the red pack to green pack on the Eurodollar curve. The reds are the four quarterly contracts one year forward, and the greens are the four quarterly contracts two years forward. On Friday, the red pack, which is just a simple average of the 4 contract prices (EDH3, M3, U3, Z3), settled at 9794.5 or 2.055%. The green pack settled 9815.625 or 1.84375%. The inversion on this part of the ED curve is at a historic low. Typically, an inversion occurs near the end of a tightening cycle (shaded areas), as the chart below shows:
The white line is the red/green pack spread which settled right around -21 bps on Friday. You can see that it has ranged from slightly negative to about 145. Shaded areas are tightening cycles – that’s typically when the red/green pack spread accelerates to the downside. The decline in 2011 was associated with the assault on the euro and widening of peripheral spreads in Europe…tighter financial conditions. It’s also apparent that inversions are related to tops in stocks. The brief tightening cycle in 1999 was a belated response to the dot.com bubble, and red/green bottomed with the end of that cycle (which, by the way, featured FF at 6.5%). The 2004/2006 tightening cycle culminated with the mortgage crisis and GFC. The extended 2015 to 2018 cycle featured the brief 20% drop in SPX in Q4 2018. Now equities are significantly higher, with market cap to GDP starting this year at a historic 200%. The only question is whether the current stock pullback is something brief like 2018 or more protracted like the early 2000’s or 2007 to 2010. I had never thought that monetary policy could “fix” the covid crisis. I was wrong. The Fed certainly ameliorated the pain. I now don’t think that monetary policy can fix a global military conflict. The enormous monetary and fiscal injections into the covid economy have led to inflation. Presently, any monetary policy moves to plug the gap in frozen payment chains will inevitably be viewed through the prism of inflationary impulses.
Lest one thinks this ED curve inversion is simply due to the libor to sofr transition, I would note that the red/green ED pack spread went from +60 last October to -20 now, while the red/green SOFR pack spread went from +63 in November to -7.75 now. It may be slightly accentuated in dollars, but the dynamic is the same.
Not only that but the inversion is moving closer in time. All one-year calendars had been settling in positive territory until December. In the beginning of Dec 2021, as Powell articulated his hawkish shift in late November, EDH4/EDH5, M4/M5 and U4/U5 all went slightly negative, bottoming on Dec 3 with EDU4/EDU5 the lowest at -3.5. So that inversion was 2.5 to 3 years forward. Now the nadir is -26.5 (EDM3/M4 and U3/U4) with the first inversion now EDH3/EDH4 at -6.0, which is only one-year forward. This tells you that the danger of recession is drawing ever closer, like the cartoon damsel strapped to the conveyer moving toward the logging saw before being rescued by Dudley Do Right.
The last two charts are related to credit risks. Is it any wonder that surges in commodities like wheat and oil are leading to a surge in the price of near-term funding? I suppose the surprise might be that the rise in credit spreads is relatively muted, owing of course, to the idea that the Fed will intervene. First chart is Hi Yield CDX five year spread, which has jumped 100 bps since the start of the year.
The second chart is the spread between 3-month EDH2 eurodollar contract to SFRH2 3-month SOFR. This spread has jumped 30 bps since early Feb.
It’s not a huge week for economic reports, though CPI is released on Thursday. The last yoy 7.5% reading left a mark, but it’s expected to be 7.9% this time around, with many looking for an 8 handle. Ouch! The Fed’s Z.1 report which includes all sorts of debt statistics, but is cited by the press for the section on Household Net Worth is also released on Thursday. This latter statistic was $144.7 trillion in Q3 2021, and will probably edge to a new all-time high for Q4 (which will mark the top for some time to come). Auctions of $48b in 3yr on Tues, $34b 10’s on Wednesday and $20b 30’s on Thursday (10 & 30 are re-openings).
OTHER MARKET THOUGHTS/TRADES
Straddles are at extreme levels in Eurodollars. Here are a few examples. Notice the explosion in front straddles relative to backs. Fully one month of time value has passed on the table below.
| EDM2 | strike | straddle | |
| 2/4/2022 | 9895.5 | 9900.0 | 31.00 |
| 3/4/2022 | 9876.5 | 9875.0 | 49.50 |
| EDM3 | |||
| 2/4/2022 | 9802.0 | 9800.0 | 86.50 |
| 3/4/2022 | 9789.0 | 9787.5 | 112.50 |
| 0EM2 | |||
| 2/4/2022 | 9802.0 | 9800.0 | 48.50 |
| 3/4/2022 | 9789.0 | 9787.5 | 64.00 |
| 2EM2 | |||
| 2/4/2022 | 9787.0 | 9787.5 | 48.50 |
| 3/4/2022 | 9815.5 | 9812.5 | 53.50 |
| 3EM2 | |||
| 2/4/2022 | 9784.5 | 9787.5 | 47.50 |
| 3/4/2022 | 9823.0 | 9825.0 | 50.50 |
| TYJ2 | |||
| 2/4/2022 | 126-21 | 126.5 | 1’56 |
| 3/4/2022 | 128-17 | 128.5 | 2’06 |
| 2/25/2022 | 3/4/2022 | chg | ||
| UST 2Y | 158.4 | 149.0 | -9.4 | |
| UST 5Y | 188.3 | 163.2 | -25.1 | |
| UST 10Y | 198.3 | 172.2 | -26.1 | |
| UST 30Y | 229.3 | 214.7 | -14.6 | |
| GERM 2Y | -37.7 | -73.0 | -35.3 | |
| GERM 10Y | 23.1 | -6.9 | -30.0 | |
| JPN 30Y | 92.4 | 84.2 | -8.2 | |
| CHINA 10Y | 278.9 | 282.4 | 3.5 | |
| EURO$ H2/H3 | 146.8 | 117.5 | -29.3 | |
| EURO$ H3/H4 | 14.0 | -6.0 | -20.0 | |
| EURO$ H4/H5 | -13.5 | -14.0 | -0.5 | |
| EUR | 112.73 | 109.35 | -3.38 | |
| CRUDE (active) | 91.59 | 115.68 | 24.09 | |
| SPX | 4384.65 | 4328.87 | -55.78 | -1.3% |
| VIX | 27.59 | 31.98 | 4.39 | |
https://www.wired.com/story/ukraine-chip-shortage-neon/
Stress
March 4, 2022
–This morning May Wheat trades 12.09 as the odds of a nuclear accident rose substantially with a fire at the Zaporizhzhia nuclear generation plant in Ukraine. Reportedly now under control, but that name looks suspiciously like “vaporize”. Has wheat ever traded at a premium to beans? May beans currently 16.57.
–I was once at a bar in London entertaining a group of traders, I believe it was at the Artful Dodger, and I pulled out a stack of pounds to pay for the first round, and one of the guys discreetly pulled back my arm and muttered, “Get your card out mate, this is going to be expensive.” And of course, it was. It turned into many rounds. We’re now in a world where it’s going to be expensive and not as fun.
–Heavy pressure on EDH2 yesterday which settled 9928.0, down 7.5 despite FFJ2 (which prices the odds of a March hike) only down 0.5. This morning EDH2 printed 9922.5 and is currently 9925.5, down 2.5 on the day despite all deferred contracts trading higher. EDH2 to SFRH2 (sofr) is printing 29, up 10 bps in two sessions. That front ED/SOFR spread is now the highest on the curve. That’s the beauty of libor based contracts with the embedded credit component reflecting stress (and that’s exactly what it’s doing now). It’s like the old TED spread, 3m t-bills vs 3m eurodollar, somewhat equivalent to the VIX of today…a fear indicator. Of course, in today’s enlightened world of central banking, where money is conjured up like confetti, monetary stress isn’t as much of an issue… until you pull up to the gas station or grocery store.
–Yesterday the red/gold pack spread settled at a new low of NEGATIVE 16.625. The red pack, 2nd year forward, closed 9786.375 (~2.13%) and golds, the fifth year forward, closed 9803 or 1.97%. This spread is unambiguously forecasting recession ahead. It looks like it printed slightly lower in 1995, but that’s when blue and gold euro$’s were first introduced. In 2000 the low was -7.875. In 2006 the low was +10.25. In December 2018, the low was -5.625. This is a HISTORIC low, and it may not be screaming recession, but it’s certainly muttering. The low in 2006 preceded Bear Stearns’ mortgage fund collapse by a full year. I.e. there’s likely a bit of time to prepare. By the way, the red/green (2nd/3rd years) pack spread is also inverted, settling negative 13.625. This is NOT good.
–Employment report today with NFP expected 420k. As Powell emphasizes, the labor market is awfully strong. But it’s a lagging indicator. On the other hand, the US Army will likely step up hiring. Like Dewey Oxburger said, “I’m gonna walk outta here a lean, mean, fightin’ machine.”
Uncharted waters
March 3, 2022
–Monster reversal of Tuesday’s rally in interest rate futures. The red pack (2nd year forward) fell 27 bps. FFF3 (January FF) fell 30 bps! to 9846.0 or 1.54%, right back to a forecast of 5 or 6 hikes of 25 bps each by year-end, although Powell allowed the possibility of 50 at any given meeting. The rise in oil and other commodities is underscoring inflationary concerns. Late yesterday CLJ2 was 111.31, up $7.90 on the day. This morning it’s 113.20. May Wheat was around $8/bushel in mid-Feb, which was a relatively high price. This morning it is over $11, a rise of 37% in two weeks. Food security will become a hot topic.
–In treasuries, there’s an amazing bid for calls (thanks RK). TYM2 settled 127-09. Equidistant TYJ2 129.25c/127.25p risk rev (combo) settled 9 to the call 24 vs 15. TYJ 129.75c. 2.5 points out of the money settled 20, while 125.5p, 1.75 out of the money, settled 19. Demand continues for the 130c strike, yesterday a new buyer of 50k week-2 130c which settled 11 (paid 15) and expire 11-March. Liquidity across markets is quickly receding.
–FV vol is hugely expensive relative to US vol. For example, FVM settled 118-045. FVJ2 117.5p settled 22, delta -0.33, ~12 bps out of the money. USM2 settled 156-16. USJ 155.5p settled 1’26, delta -0.40, ~5 bps out of the money. Proper ratio is about 3.75 FV to 1 US. THIS IS NOT A RECOMMENDATION, but if you’re looking to put on a synthetic 5/30 steepener, the invitation is dangling in front of you. Caveat of course, is that sometimes the stuff is here for a reason! Typically a 4×1 FV to US put spread will trade fairly close to flat when they are approx equidistant in terms of bps out-of-the-money.
–Attached chart is 10 yr breakeven, which is testing last year’s November high of 277 bps, ending today at 275. Though this particular measure of long-term inflation expectations hasn’t been particularly valuable, it’s another indication that using the phrase “anchored” with respect to expectations should now join our old friend “transitory”.
–EDH2/EDM3 blasted out to 49.5, up 18.25 on the day, as the March FOMC is now cemented at 25 bps, but hikes expected at subsequent May 4 and June 15 meetings. After March, there are 6 more FOMC meetings in 2022. Of note in ED options was a buy of 50k 0EZ 9550/9500ps for 1.5. EDZ3 settled 9785, so this is 235 out of the money, and expires on 16-Dec 2022. Put this in the anything-can-happen bucket.
I can pay the higher gas price if I can keep the Russian tank for free
March 2, 2022
–The wrenching adjustments that have occurred due to the Ukraine conflict are taking a pause, with stocks bouncing, treasuries easing, gold and grains lower (grain article linked below). However, CLJ2 is above 107/bbl this morning, up $4 from yesterday’s close. In my area, a gallon of regular gas was 3.79 last week and 4.09 yesterday afternoon. As can be seen on the attached chart, TY vol has exploded higher, though still well below peak Covid and the GFC. On Friday I marked the atm TYM 126 ^ at 2’49, yesterday the atm 128.5^ settled 3’23. Likely worth looking at buying put 1×2’s here (sell 2 legs) as any retracements in treasury prices will surely coincide with vol declines.
–Biden gave the State of the Union address, followed by Powell’s congressional testimony today. Recently the text of comments has been released prior to his appearance, but I have not seen a link yet on the Fed site. What is clear is that the market has massively scaled back the prospect of near-term rate hikes. The peak performer on the euro$ curve was EDM’23, up 27 bps yesterday to 9818.0. On Friday, that same contract settled 9768.5, so 49.5 bps in two sessions, essentially erasing two hikes. Yesterday EDH’2/EDH’3 settled at a new recent low of 103.25; on Friday it was 146.75. EDH’2/EDM’2 three-mo spread settled at a new recent low of 31.25 vs a high of 58.25 on Valentine’s day. H2/M2 vs U2/Z2 had exploded to as high as 29 last month, but settled 1.25 yesterday. Open interest across the euro$ curve declined by 154k contracts, unsurprisingly indicating short covering. A small part of the OI change is due to migration into SOFR futures, which gained 11k. April Fed Funds settled 9968.0, anchoring the March FOMC at 25 bps. FV open interest plunged 104k as the 5-yr cash yield sank over 15 bps to 1.563%.
–There was continued buying of TYJ 130c yesterday, which added 34k positions, settling at 39/64 (up 25 on the day) vs TYM2 128-23+. These were bought Monday for 9 to 13.
–The IRS in the US could take a page out of the Ukrainian tax collection book. Here’s a new one:
“Have you captured a Russian tank or armored personnel carrier and are worried about how to declare it? Keep calm and continue to defend the Motherland! There is no need to declare the captured Russian tanks and other equipment, because the cost of this … does not exceed 100 living wages (UAH 248,100),” https://en.interfax.com.ua/news/general/804441.html
| No need to declare captured Russian tanks, other equipment of invaders as income – NAPCUkraine’s National Agency for the Protection against Corruption (NAPC) has declared that captured Russian tanks and other equipment are not subject to declaration. “Have you captured a Russian tank or armored personnel carrier and are worried about how to declare it? Keep calm and continue to defend …en.interfax.com.ua |
One hike disappeared from the radar
March 1, 2022
–Conflict in Ukraine caused significant short covering in the front end Monday, which started with a block buy of 50k EDU2 at 9852.5. Other buy blocks included 20k EDM2 9892.0 and 50k EDH2 9933.5. Open interest was down 29k in EDH2, 49k in EDU2, 78k in EDZ2 and 29k in EDH3 (up 15k in EDM2). As shown on the attached chart, the block in EDU2 was instrumental in causing a plunge in EDM2/EDU2 spread which fell 8 bps to 32.0, essentially erasing the jump associated with the 7.5% CPI print on February 10. Odds for a hike of 50 bps have all but evaporated with April FF settling 9965.0. (A hike of 25 should cause the contract to settle 9966 to 67). It’s worth noting that EDU2 was trading 50.5 at the time of the block, but bid/offer sizes have become sparse as liquidity suffers. EDU2 settled 9960.0 (+19.5). Apart from the short end, there was size buying of April TY calls. In the morning +30k TYJ 129c 11-12 (settled 24 with OI +26k) and through the latter part of the session +50k TYJ 130c from 9-13 (settled 14 with OI +32k). The strongest contract on the euro$ strip was EDM3 at 9791.0, up 22.5 on the day. In Fed Funds FFF’23 rose 21 to 9856.0 or 1.44%. In other words, one of the hikes that had been priced for this year has been thrown in the dustbin due to financial instability risks.
–On the inflation front, raw materials are still indicating problems, with oil again nearing $100/bbl this morning (CLJ 98.99) and grains reversing the sell-offs seen at the end of last week. May Corn prints 713. Aluminum continues to surge. Aluminum to zinc (with a little smiley arrow connecting the two). Breakevens are near new highs, with the ten year treasury vs inflation-indexed note closing at 265 bps; the year’s high has been 277. –ISM Mfg expected 58.0 from 57.6 last, with Prices Paid 77.5 vs 76.1. State of the Union speech tonight. Powell testifies tomorrow.
–I personally believe a no-fly zone is about to be announced over Ukraine which will raise the stakes. By a lot. As Winston Churchill once said, “You can always count on the Americans to do the right thing… after they have tried everything else.”
Absorbing the shock
February 28, 2022
Feb 24 highs (Thursday invasion) vs this morning indicate that markets have absorbed the main shock of Putin putting nuclear forces on alert and are adjusting relatively easily.
high on 2/24 high today
CLJ2 100.54 99.10
TYM2 127-115 127-125
EDZ2 98.20 98.215
GCJ2 1976.50 1935.20
ESH2 4101.75 4251.50 (these are relative lows)
EUR 1.1106 1.1122
RUB 89.99 117.93
Interest rate futures made slight new highs. ESH low is significantly higher than last week’s. The high in gold is significantly lower. The primary change is in the Ruble, which has been crushed, leading to capital controls and a punitive increase in rates, but spillover effects appear contained. Russia appears isolated in terms of economic impact for now.
–Tomorrow is the State of the Union. Wednesday begins Powell’s semi-annual testimony. Last print I see on FFJ2 is 9963.5 which indicates 25 bps only at the March 16 FOMC. The curve should steepen as rate hikes are stretched out a bit farther and slower.
The Underdog
February 27, 2022
You got no fear of the underdog
That’s why you will not survive
-Spoon, The Underdog
The fight is here; I need ammunition, not a ride.
On Tuesday, President Biden delivers the State of the Union. He will probably try to reassure the American public that his administration is doing whatever it can to hold down prices. In Ukraine, they’re handing out rifles to ordinary citizens. There are times when we incur costs for supporting what’s right.
On Wednesday, Powell, who has yet to be confirmed by the Senate, begins the Fed’s semi-annual testimony. The Fed’s preferred measure of inflation, Core PCE prices, was released Friday at 6.1%, a new high for the cycle. The conflict in Ukraine likely adds to inflationary pressure, not just because of immediate pressure on natural resources, but because it sharpens the need for the US to become less reliant on global suppliers; to develop more capabilities at home, even at higher prices. The current administration has pursued the opposite path with respect to fossil fuels.
Of course, the Russia/Ukraine conflict raises uncertainty along many contours of the global economy. The March 16 FOMC meeting is now being priced much closer to 25 bps rather than 50. On Feb 11, the low in April FF was 9943.0, pricing near certainty of 50 bps. The high on Thursday was 9965.5, pricing near certainty of just 25 bps. Friday’s settle was 9960.0. The conflict has not taken away the need to price for a hike, but has rather moved the prospect of future hikes a bit further out the curve. For example on Feb 11, EDH2/EDM2 ticked 66 bps (but closed at 58). By Friday that spread had declined to 52.25. However, EDU2/EDZ2 on Feb 11 settled at 28.0. On Friday, this spread had moved to a new high of 35.5, and settled 34.5. Below is a picture of the condor (17.75s). I had never expected it to trade over +2 bps, as I had believed in Powell’s previous guidance of measured tightening. The market is now slightly lessening odds of front-loaded hikes and beginning to spread such actions further back in time.
With Thursday’s Russian invasion, there was some evidence of a flight to quality in treasuries. However, by Friday afternoon the ten year yield was back above 1.98% just 6 bps below the high for the move at 2.045%. The ten-yr yield is holding just above late 2019 (pre-covid) highs. The conflict reduces global trade and increases price pressure at the margin. But it also likely increases the Treasury’s reliance on domestic private sources for funding (rather than the Fed). This was alluded to in the last FOMC minutes. Positive carry is integral to this effort. As mentioned previously, June’23 3m SOFR contract is 9795 or 2.05%, about 7 bps higher than the 10y yield. A slower pace of FF tightening, along with high inflation, should cause an increase in longer maturity yields, which will support demand.
With respect to financial conditions, here’s an interesting clip from Almost Daily Grant’s:
“Meanwhile, a barren primary funding market underscores the chilly conditions in the fixed-rate speculative credit realm. Apart from double-B-plus-rated Twitter, Inc.’s sale of $1 billion in eight-year notes on Wednesday, no other high-yield issuers have managed to come to market during the last two weeks. Yesterday, single-B-rated protein shake maker BellRing Brands offered $840 million in 7% notes due 2032, before pulling back when it was unable to source sufficient demand with a 7.75% yield, Bloomberg reported.
That freeze-out underscores a diametric change in primary market conditions. Domestic junk bond issuance footed to $465 billion last year according to S&P Global, topping the previous record of $435 billion set in 2020. For context, new supply averaged $215 billion over the five years through 2019, while the peak of the prior cycle in 2007 saw $150 billion in issuance. Then, too, first time borrowers accounted for $100 billion of supply last year, a contingent that had never topped $60 billion in sales during any pre-pandemic year.” ADG 2/25/22
If the bell doesn’t ring, can it still signal a top?
***********************************************
On April 26, 1986 the Chernobyl power plant disaster occurred. On April 15, 1986 Dec Wheat was 252. On April 30, it closed at 300. The high settle was 303 on May 8, by July it was back under 250.
On February 18, May Wheat settled 804. If the threat of radioactive contamination to food supplies increases, a percentage move of the same magnitude as Chernobyl 1 would put wheat over 960. Friday’s high happened to be 960 ¾ with a settle of 859 ¾. Exactly 14 years ago on 2/27/08, front wheat hit 1334 ½. This is the same year that WTI reached $145/bbl. It all coincided with the start of the GFC. (Russia and Ukraine combined produce 14% of global wheat and supply 29% of all wheat exports).
OTHER MARKET THOUGHTS/TRADES
There was a notable new seller of about 7k EDH3 9787.5 straddle on Friday, starting at 86. Settled 84 vs 9786. SFRH3 9812.5^ was also sold on a block, 10k at 81.0 (settled 81.5 vs 9809.0). These futures settlements on EDH3 and SFRH3 are with 5 bps of the low settles, which were made this month. EDH2/EDH3 calendar spread settled Friday at 146.75; the highest settle has been 147.25. The straddle sales suggest that downside in reds may be limited from here. Look to buy call spreads on reds.
| 2/18/2022 | 2/25/2022 | chg | ||
| UST 2Y | 150.0 | 158.4 | 8.4 | |
| UST 5Y | 182.5 | 188.3 | 5.8 | |
| UST 10Y | 193.0 | 198.3 | 5.3 | |
| UST 30Y | 224.9 | 229.3 | 4.4 | |
| GERM 2Y | -47.8 | -37.7 | 10.1 | |
| GERM 10Y | 19.2 | 23.1 | 3.9 | |
| JPN 30Y | 93.9 | 92.4 | -1.5 | |
| CHINA 10Y | 281.0 | 278.9 | -2.1 | |
| EURO$ H2/H3 | 137.0 | 146.8 | 9.8 | |
| EURO$ H3/H4 | 17.5 | 14.0 | -3.5 | |
| EURO$ H4/H5 | -11.0 | -13.5 | -2.5 | |
| EUR | 113.22 | 112.73 | -0.49 | |
| CRUDE (active) | 90.21 | 91.59 | 1.38 | |
| SPX | 4348.87 | 4384.65 | 35.78 | 0.8% |
| VIX | 27.75 | 27.59 | -0.16 | |
About face
February 25, 2022
–Reversals yesterday were some of the most astonishing I’ve ever seen. Russia’s full scale invasion of Ukraine elicited panic yesterday morning, but stabilized mid-day. SPX was down 2.6% at the low of the day but then closed up 1.5%. Yields plunged but then came back near unchanged, with tens -1.1 bps at 1.965% at futures settlement. While Fed officials said that hikes are still coming, the March meeting is now priced for 25 bps rather than 50 as April Fed Funds rose 5.5 bps to 9963.0. (50 bps would be 9942 and 25 would be 9967). The two-year note reacted with a plunge of 5.6 bps to 1.542%.
–Whenever I hear something like ‘massive cyber attacks’ (which apparently was one of the options presented to Biden) it makes me think “HOARD”. That means cash and non-perishables. Ukraine has vast natural resources. It’s amazing to me that reversals gathered steam as Biden spoke, but it appears as if markets are gratified that the US is staying out and that any disruptions will only be temporary. Biden spent as much time trying to reassure the US public that costs would not increase as he did outlining plans to end international aggression. Which is more important?
–Ten year treasury to inflation-indexed note spread closed 261 bps, a new recent high. Cycle high has been around 277 from mid-November. There is a lot of attention centered on the inflation report slated for March 10, the week prior to March 16 FOMC, with some concerned it could print 8%. Powell gives semi-annual testimony on March 2 and 3 next week.
