Whipsaw
November 5, 2021
–Sept ’22 Short sterling leapt 28.5 bps yesterday to 9897.5, as the Bank of England left rates unchanged. The markets had found Carney to be unreliable, and Andrew Bailey is following right along the same path. In the US, it was the forward EDU’23 that was the star performer of the curve, rallying 11.5 to 98.695. The BOE move (or lack thereof) caused second thoughts about the Fed’s prospects of actual rate hikes. For example, FFF’2/FFF’3 calendar (Jan’22 to Jan’23 FF spread) had been around 75 bps, indicating 3 hikes over 2022. Yesterday it fell 6.5 to 67.5. The curve steepened from 5’s out, as the 5y yield fell 8.3 while the thirty-yr yield eased only 2.7. While Powell carefully laid a long-term structural foundation of programs and communication to prevent a taper tantrum, other central banks have contributed to whipsaw moves. It’s worth bearing in mind that we don’t know what the Fed of 2022 is going to look like, as Powell has not yet been re-appointed and political losses by the Dems may spark the Biden administration to employ extra flair in shaping the central bank of the future.
–Unit labor costs in yesterday’s productivity report were +8.3%. The last employment cost index number also raised some eyebrows, yet at Wednesday’s presser Powell said that current inflation is not driven by wage gains. Today features the Employment Report, with NFP expected 450k and yoy Avg Hourly Earnings expected 4.9% from 4.6% last.
–Wow, something new in government: “I went and knocked on doors and I listened to people. They told me what their problems were and told me what their complaints were and I listened,” said [Edward] Durr, first-time office holder who beat NJ State Senate President.
We need more inflation!
Nov 4, 2021
–The Fed began the process of tapering as the Treasury also announced cuts in auction sizes. The taper doesn’t cut the size of the Fed’s balance sheet, it simply reduces the pace of growth. Powell seemed somewhat uneasy in his press conference yesterday, again saying that the case for rate liftoff has not been made according to employment. He also implicitly made the somewhat tenuous case that inflation is not due to wage gains and is therefore transitory. Steve Liesman asked a great question about the risk tradeoff between putting 5 million more people to work at the margin versus accelerating inflation, which hurts ALL Americans. Powell at first attempted to say that we’re not in a Phillip’s Curve situation where there is an actual trade-off, but then noted that there are times of tension between those two goals (of stable inflation and full employment) and it comes down to risk management. That was Liesman’s question in the first place, are the risks of more inflation affecting everyone becoming greater than adding jobs. Powell sidestepped it. I would note that at the onset of the last two tightening cycles in 2004 and 2015 or 2016, the unemployment rate was higher than it is now (4.8%) and trended lower as the hiking progressed. In some ways I think Powell would just like to throw up his hands and say, “Look, the only way out of this mess is to inflate out of it! THAT’S why we can’t raise rates from zero.”
–Yields rose somewhat on the day, with tens +3.3 bps to 1.58% and the 30yr rising a similar amount to just under 2%. Eurodollars were down 3.5 to 5.0 from reds to blues. There was decent put activity in EDM2, most notably a new seller of about 50k 9925p at 5.0. EDM2 settled 9958 or 42 bps, vs the current libor setting around 13-14 bps. The market is currently comfortable with the idea that the first hike will come immediately after taper’s end. The only one-year calendar to post a new high was EDM2/EDM3 which rose 3.5 to 82. Implied vol again eased in treasuries with TY down at 4.3.
Vol implodes in front of today’s FOMC taper announcement
November 3, 2021
–To give an example of vol implosion yesterday, consider EDZ2 9962.5 calls. On Friday they settled 7.25 vs 9913. On Monday 6.5 vs 9910. Yesterday morning they were 5.5/6.5 vs Friday’s same futures ref 9913. And by settlement, as futures had rallied to 9918 they settled 6.0, DOWN 0.5 from Monday with futures UP 8. The fevered pitch to cover premium broke, as news reports named various hedge funds that had ‘grounded’ traders (and likely covered exposures Friday and Monday). There was early (new) selling of 25k 2EZ 9862c from 8.5 to 9.0, settled 9.0 even as futures rallied 6.5 to settle 9854.5 (EDZ3). A red straddle strip, Z2 9900^, H3 9900^, M3 9875^ and U3 9862,5^ settled Monday at 314. That strip was sold in size of at least 3k down to 285 and settled 295.
–One can conclude that today’s taper announcement by the Fed is expected. However, there were still a few large put spreads bought, for example 0EX 9912/9900ps 3 paid 25k and 0EX 9900/9893.75ps 1 paid 50k. These are on EDZ’22 as the underlying, which settled 9918, and expire one week from Friday. Settles were 2.75 and 0.75. The question is how Powell will respond to high inflation and high asset prices which threaten both stability and equality goals.
–Near euro$ calendar spreads receded from recent highs as reds (2nd yr) led the strip higher, closing +8.375. Blues (4th year) were unchanged on the day and golds (5th year) actually closed down 2.25. 5/30 treasury spread was up 3.7 to end at 81. Tens fell 2.8 bps in yield to 1.547%.
–When I was on the CME floor and a big data release came out, sometimes there was a huge price gap of maybe 10-12 bps in a given contract that would almost immediately revert. As a rule, it didn’t take that long to eventually test those extremes again. I.e, if a market gaps to the downside on unexpected news, it’s because it was unbalanced; there weren’t enough shorts with resting bids to help absorb selling on new information. Even though the market would bounce, maybe for a week or two, those extreme levels are revisited, because the same imbalance has only been temporarily alleviated. It was a tough October for longs in the short end of the curve. For example EDZ2 had a high of 9954.5 on Oct 4 and a low Friday of 9906. Longs have had faith in the Fed’s jaw-boning about tapering not being related to rate hikes, and inflation simply being related to covid. We’ll get the same Fed message today, but the market reaction may not be as charitable.
–Is a sign of the possible broad sentiment change in rate markets is also being reflected politically? Youngkin win in VA, Minneapolis rejects ‘defund the police’.
That’s what the world is today
November 2, 2021
–The RBA decided to:
- maintain the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero per cent
- continue to purchase government securities at the rate of $4 billion a week until at least mid February 2022
- discontinue the target of 10 basis points for the April 2024 Australian Government bond.
–Some see the result as less hawkish than expected, but the point is that market forces overwhelmed the target on the Aussie April ’24 note, and related issues are being faced to a greater or lesser degree by many central banks. A couple of interesting notes from eurodollars: Yesterday’s three month libor setting was just over 14 bps, having been anchored for some time at 12 to 13. A week or so ago there was a buyer of 100k EDM2 9981.25/9987.5cs for 1.5. This libor setting chews into the upper strike, threatening the 6.25 max value. Of course, this setting may just be end-of-year pressure which recedes by June, or… it may be an initial fissure regarding credit in general. In any case, EDZ1 9962.5 puts traded at 1.0 yesterday!! Traded small, but they are 15.5 out of the money with just six weeks to go on the front contract. That’s a sign of forced buying. There was also a new buyer of 40k 0EH2 9787.5 puts for 3.5 ref 9890.5 in EDH’23. So these puts are 100 out of the money with the contract already having fallen 40 bps in the month of October. It’s not as if every trade is a reach for premium, but there was also buying in 3EZ 9775p for 1.5 and 9800p for 5-5.5 (settled 1.5 and 4.25) with open interest in all 3EZ puts rising 145k. Buying gamma to protect vega (paraphrasing NovaSatus Trading)
–New highs once again in near euro$ one-yr calendars. EDZ1/EDZ2 up 1.5 to 68, while the peak 1-yr has moved forward to EDH’22/EDH’23 at 82, up 2 on the day. Back spreads continue to make new lows. For example, green to blue pack spread (3rd to 4th year forward) settled at just 11.625. So front spreads are 7x higher than back spreads. In short sterling, we’re nearing a one-year calendar of 100 bps as Dec’21/Dec’22 closed at 97, having launched off a September low of 36. However Dec’23/Dec’24 sterling settled at NEGATIVE 17.
–Virginia governor election today, with possible implications regarding national fiscal stimulus. (Not really…both parties see spending as a great way to buy votes). However, Manchin is still holding out on the Biden agenda. Treasury announced plans yesterday to borrow $1.02 trillion this quarter and $476 billion next quarter. Mind-boggling numbers. What does it all boil down to? Well that’s easy. $8 wheat. (High since December 2012).
“And the band played on.”
Dire Straits
October 31, 2021
Weekly Comment – October 31, 2021
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I think Mark Knopfler was ahead of his time with this one from 1982:
Yeah, now the work force is disgusted, downs tools, walks
Innocence is injured, experience just talks
Everyone seeks damages, everyone agrees that
These are classic symptoms of a monetary squeeze
On ITV and BBC they talk about the curse
Philosophy is useless, theology is worse
History boils over, there’s an economics freeze
Sociologists invent words that mean “industrial disease”
Even the band name is right: Dire Straits. Except now the song might be called Central Bank disease.
Certainly this week’s action had many market participants in dire straits, and there is no question we’re in the midst of a monetary squeeze. Short end rates have exploded higher, belatedly recognizing inflation pressure which is now being acknowledged by central banks. BOE’s Andrew Bailey recently warned the Bank “will have to act” to rein in inflation expectations, which he will have the chance to do at Thursday’s meeting. Last week the Reserve Bank of Australia abandoned Yield Curve Control by failing to defend the 10 bp target. RBA meeting is Nov 2, where it is expected to formally dismiss YCC. The FOMC announcement and press conference is Wednesday.
To give a sense of what many analysts refer to as “carnage” here are changes in two-year sovereign yields from the start of October to Friday: Australia (the undisputed winner) from 5 bps to 77, up 72. Canada, from 50 bps to 109. UK from 40 bps to 70. US from 26.5 bps to 50. Germany from -70.7 to -59.
Curves experienced hard flattening. In 2/10 yield spreads, from October highs to Friday (in bps): Australia 170 to 138. Canada 100 to 62. UK 64 to 34. US 129 to 105. Germany 57 to 47.
For the last two weeks I have started comments by noting changes in Eurodollar calendar spreads, which have aggressively trended in the direction of pushing rate hikes forward. These trends have continued. EDZ’21/EDZ’22 spread rose 4 to a new high this week of 66.5. On Oct 1 it was 29.5 for a one-month gain of 37. EDZ’22/EDZ’23 plunged 8 on the week to 61.0. It started the month at 62, but the mid-month high was 72.5. EDZ’23/EDZ’24 sank 10.5 from 27.5 to 17.0. On October 1 it was 43.5; Friday’s low was easily a new low for the year. Below is a chart of the condor, EDZ’21/Z’22/Z’23/Z’24. In October it exploded from -14.0 to 49.5. This is a monster move. It represents EDZ’21/Z’22 calendar minus EDZ’23/Z’24. It’s amazing this price action could occur without an actual hike, although it’s not as if it’s unprecedented; as the market sniffed out hikes in 2004, the EDM’04/M’05/M’06/M’07 went from 23.5 at the end of March 2004, to 130 in early May. But of course, that’s when the Fed went on to hike at every single meeting for two years. On the Short Sterling curve, the Z’21 thru Z’24 condor has trended from a low of 27 in Sept to 110 on Friday. L Z1/Z2 settled +93.5 and L Z3/Z4 at minus 17 (inverted).
What can we conclude from price action? The market is pushing central banks to hike. However, flattening and inversion (sterling) on the deferred spreads indicates that the global economy won’t be able to handle hikes and growth will suffer. Bill Ackman is vocally calling for taper in the face of high inflation. Goldman has moved their timetable for the first hike up to July 2022. The Fed is expected to announce tapering at Wednesday’s FOMC, which coincides with the Treasury refunding announcement. Actually, Treasury will release financing estimates for the quarter on Monday at 3:00 EST. Auction sizes are expected to be trimmed, specifically in 7’s and 20’s. A Reuters article cites NatWest, which estimates an $800 billion cut in nominal auction sizes in the 2022 fiscal year as compared with 2021. “The majority of those cuts will come in securities with a 7-yr duration or less, with a $2b per month cut in 2,3, and 5 years, and $3b per month in 7, 10, and 20-yr treasuries…” Should make the taper fairly painless, which ironically drives focus to actual rate hikes.
Interesting side note, last week’s Employment Cost Index was deemed “alarmingly big” at 1.5% in Q3 by Ian Shepherdson. (BBG) “If it doesn’t start to abate with larger workforce participation… ‘If that doesn’t happen, and wage growth continues to run at this pace, then Game Over for the transitory inflation argument’, he [Shepherdson] said in a note.
On another side note: China’s PMI was released at 49.2 from 49.6 last, representing contraction. Not too much of a surprise given continuing pressure on China’s huge property sector, thanks to Evergrande.
Coming up
Monday: ISM Mfg and Treasury Announcement
Tuesday: RBA
Wednesday: ADP, ISM Services, FOMC, Auction Refunding Ann
Thursday: BOE
Friday: US Employment Report
(Not an all-inclusive list, but it’s a big week)
OTHER MARKET THOUGHTS / TRADES
I was as wrong as I could be with respect to the idea of selling butterflies last week (see above), but apparently I was in good company as flies continued to stretch higher. EDU’22/EDH’23/EDU’23 which I thought was a decent sale at 2 settled 6.5. On the other hand, I also looked at buying 4EM 9850/9875cs for 5.0, theo settle 7.5 as gold ED contracts levitated.
Implied vol in the short end exploded. 0EZ 9912.5 straddle was 23.5 settle on Friday 10/22 ref EDZ2 9919.0, and settled 26.5 ref 9913.0 on Friday. 0EZ2 9912.5p were 1 bp on October 14 and settled 13.0 on Friday. Take THAT crypto!
Obviously, with rumors swirling about large hedge funds being blown up in the past week, the bid for vol has become a bit panicked. EDJ2 9912.5p settled 5.0 ref EDM’22 9956.0. Tempted to sell prices like these. April serials expire April 14 on EDM’22 underlying.
What is surprising is that VIX remains very low, ending Friday at 16.26, though forward contracts have some juice, for example Dec VIX (UXZ1 index) settled above 21. Also, treasury vol remains subdued relative to Eurodollar price action. FV one month vol is at 3.5 which is at the high end of the year’s range (3.75 in March), but the cash 5-yr yield at 1.19% is 25 bps higher than it was at the March peak. Have to look at being a buyer of TY vol in front of this week’s calendar.
| 10/22/2021 | 10/29/2021 | chg | ||
| UST 2Y | 50.0 | 48.9 | -1.1 | |
| UST 5Y | 122.7 | 118.5 | -4.2 | |
| UST 10Y | 165.5 | 155.2 | -10.3 | |
| UST 30Y | 209.0 | 193.5 | -15.5 | |
| GERM 2Y | -63.7 | -58.4 | 5.3 | |
| GERM 10Y | -10.5 | -10.6 | -0.1 | |
| JPN 30Y | 70.6 | 66.5 | -4.1 | |
| CHINA 10Y | 299.6 | 297.0 | -2.6 | |
| EURO$ Z1/Z2 | 62.0 | 66.5 | 4.5 | |
| EURO$ Z2/Z3 | 69.0 | 61.0 | -8.0 | |
| EURO$ Z3/Z4 | 27.5 | 17.0 | -10.5 | |
| EUR | 116.47 | 115.63 | -0.84 | |
| CRUDE (active) | 83.76 | 83.57 | -0.19 | |
| SPX | 4544.90 | 4605.38 | 60.48 | 1.3% |
| VIX | 15.43 | 16.26 | 0.83 | |
Curve plunge
October 28, 2021
–Bank of Canada ended bond buying and accelerated the timetable for rate hikes, causing a waterfall of selling in the front end. In eurodollars the red/gold pack spread (2nd to 5th year) plunged an astonishing 17.5 bps with reds down 3.25 while golds surged 14.375. The spread made a new low for the year at 71 bps at yesterday’s settle and now prints 64. The high of the year was 182 at the end of March. The high in early June was 163, from there it started to fall going into the hawkish dot surprise at the June FOMC; the low was 94 in mid-July for a total 69 bp drop. By late Sept it had recovered to 122.5. At this morning’s 64 the move is nearing the magnitude of the previous one. The fall in 2/10, while dramatic, has not been quite as large. From June high to July low the move was 48 bps, from 145 to 97. October’s high was 129 and we’re just testing the July low, currently at 99. The low at the very start of the year was 80.
–Near one-year calendars made new highs with EDZ’21/Z’22 up 3.5 to 62.5. The peak has moved forward, with both EDH’22/H’23 and M’22/M’23 at 78.5. After a week like this one on the old floor, a sign of the carnage would be how many seats had been posted for sale.
–While the Fed has taken great pains to set a kinder, gentler path of communication on policy in order to avoid this sort of disruption, the BoC one-upped the Bank of England with a blunt message that overwhelmed the short end. The takeaway of the market is that rate hikes will tamp down inflation and growth, but supply issues will make the Fed’s job much harder. 2013’s taper tantrum saw the 4th ED contract trade to a low of 9932 from above 9960. This morning, EDU2 is in the 4th quarterly slot, and has printed 9930.
–Advanced Q3 GDP today expected 2.7% but the Atlanta Fed GDPNow is just 0.2%. Prices expected +4.2%. Jobless Claims 290k.
Short end weakness weighs on curve
Oct 27, 2021
–Curve flattened yesterday with the 2y yield up just over 1 bp while tens fell 1.6 to 1.617%. Today 5’s are auctioned as the NY Fed desk buys $1.425b 10-22.5 year treasuries, adding to flattener pressure. 2/10 closed 117 bps and 5/30 just under 87, both hovering near recent lows. A spread that made a new HIGH is the attached ten year treasury to inflation-indexed note yield spread, now above 269. While the predictive power of this spread is questionable, it’s worth noting that it is testing the highs of the past 20 years (278). It’s somewhat surprising that the curve shows no signs of life even as this proxy for inflation expectations climbs. Implied vol in treasuries underscores a begrudging bid in long treasuries, with the atm TYZ 130.5 straddle slipping to 1’19 or 4.3, towards the low end of the recent range. On Friday TYZ 130.5 straddle settled 1’30.
–On the dollar curve the first two reds remain the weakest, with both EDZ’22 and EDH’23 down 1.5 on the day. EDM’22/EDU’22 notched a new high at 18, up 1 on the day. The peak 3-month calendar on the strip is EDU’22/EDZ’22 at 23 bps; this is even wider than EDM’23/EDU’23 at 21, which covers the end of libor. EDZ’22 has the most open interest of any futures contract on the strip, just over 1.5 million. At a price of 9921.5 or 0.785% (with Z1/Z2 spread at 59 bps) this contract has at least two 25 bp hikes priced in. It would thus appear to be ‘cheap’. The problem for longs is, shorts are in control and inflation shows no sign of abating. The Fed is giving up on characterizing inflation as transitory and buoyant risk markets are testing the Fed’s soft mandate for financial stability. Slightly aggressive pricing for hikes into next year is weighing on the curve.
Rate hikes questioned
October 26, 2021
–Yields eased yesterday, partially because the prospect of the BOE hiking next week was thrown into question. An BBG story from early yesterday said ‘Tenreyo suggests bank of England can wait to move on rates’. Andrew Bailey, who has recently signaled the BOE would act to contain inflation risks, is not likely to support a rate increase next week, according to HSBC. More immediately, the FT is running this headline before Thursday’s ECB meeting: “Lagarde set to push back on market bets of eurozone rate rise”.
On the eurodollar curve, the rally was led by reds, which closed +4.375. Greens +2.625, Blues +0.875 and Golds +0.125. Chicago Fed Nat’l Activity index also weaker than expected, coming in at -0.13. Today’s news includes New Home Sales and the Conference Board survey data. Consumer Confidence and the Expectations Index both fell in September, with the latter plunging to 86.6, apparently due to the delta variant. A further decline might corroborate weakening signals about Q3 GDP from the Atlanta Fed, though inflation shows no signs of abating. Auction of 2-yr notes today, followed by 5’s and 7’s on Wednesday and Thursday.
One-yr euro$ calendars vs actual hikes
October 24, 2021 -Weekly comment
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“If you stop at general math, you’re only going to make general math money.” – Calvin Cordozar Broadus Jr. aka Snoop Dogg
“The simple mathematics of the yield curve governs the relationship between short- and long-term interest rates. Ten-year yields, for example, can be thought of as an average of ten consecutive one-year forward rates. A rise in the first-year forward rate, which correlates closely with the federal funds rate, would increase the yield on ten-year US Treasury notes even if the more-distant forward rates remain unchanged. Historically, though, even these distant forward rates have tended to rise in association with monetary policy tightening.” -Chairman Greenspan from his Feb 2005 Conundrum speech, aka The Maestro
Here’s how I started last week’s note:
“In my world, here’s what tells the story of the week: EDZ’21/EDZ’22 calendar spread rose 13.5 bps on the week from 38 to 51.5. EDZ’22/EDZ’23 was nearly unchanged, rising just 0.5 from 68.5 to 69.0. EDZ’23/EDZ’24 fell 12.5 bps from 43.5 to 31.0.”
These trends continued last week. EDZ’21/EDZ’22 calendar rose another 10.5 to 62.0. EDZ’22/EDZ’23 was the unchanged pivot, still at 69. EDZ’23/EDZ’24 fell another 3.5 to 27.5. In the space of two weeks, EDZ’21/Z’22 has risen 24 bps, forecasting an additional hike by the end of 2022. Jan’21/Jan’22 Fed Fund spread settled at 55 bps, indicating certainty of two hikes next year. But July’22/July’23 FF calendar settled 74.5, for a total of three hikes over that year.
The Fed’s narrative has changed, and the market is pressing to move the timetable up for hikes. From Powell Friday: “Supply constraints and elevated inflation are likely to last longer than previously expected and well into next year, and the same is true for pressure on wages.” “If we were to see a risk of inflation moving persistently higher, we would certainly use our tools.” The Fed has moved from saying inflation is “transitory” to claiming that “expectations are still anchored”. As SF Fed head Daly said, “raising rates now would not solve the global supply-chain issues but could start to bridle growth next year just as inflation pressures are receding, and cost the economy both output and jobs.” Rate hikes won’t solve port congestion, as the story goes.
All yields rose last week, with fives leading the way up 8.7 bps to 1.21%, but the curve flattened with bonds only up 4.2 to 2.09%. From June 2004 through the middle of 2006 the Fed hiked rates at every FOMC meeting, eight times a year. In February of 2005, Greenspan noted that long term yields had barely budged with the onset of this tightening. “For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum. Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience.”
The Fed’s first hike in 2004 was at the end of June from 1.0 to 1.25%. On June 14, just prior to the Fed’s first hike, the ten year had notched its high for the year at 4.87%. By the beginning of February 2005, the yield was 4.07%, even as the FF target had more than doubled to 2.50%. That was the conundrum. Tens didn’t exceed the 2004 high until early April of 2006, when the yield reached 4.90% as the FF target hit 4.75%. From mid 2004 to mid 2005 CPI bounced between 2.5 and 3.5%. By the end of Q3 ‘05 it had surged to 4.7%, while the ten-yr yield hovered just below that level. By the middle of 2006, as the FF target topped at 5.25%, tens had made an attempt to ‘catch-up’ to funds and CPI, also topping for the cycle at 5.25%.
But it’s not really the action of long rates that I want to focus on, but rather the predictive ability of euro$ one-year calendars to appropriately forecast the amount of Fed hiking. Currently, the peak one-year is EDU’22/EDU’23 at 83 bps, and the next highest is EDM’22/EDM’23 at 79 bps, just prior to the SOFR transition. By no means is it clear that these levels will represent the actual peak, though they are at new yearly highs.
Let’s take a look at the constant maturity 1st to 5th ED contract spread in 2004. Currently, 1st to 5th is EDZ’21/EDZ’22 at 62 bps. At the end of Q1 2004, three months prior to the actual initial hike, ED1 to ED5 was 111 to 137. This spread surged to a high of 215 on June 14; the first actual hike was June 30. The 2nd to 6th picture is much the same; it topped at a high of 191 on May 13. These spreads nailed it at the peak levels: 215 and 191 bps vs an actual 200 bps of hiking in a year. Interestingly, in Q3 2003, the 4th to 8th calendar, currently corresponding to the peak EDU’22/EDU’23 spread, topped at 187 on September 3, 2003. That spread also peaked with a more-or-less accurate forecast of actual hikes.
Above is ED1/ED5 (first to fifth quarterly ED spread) in 2003 to 2005
Where the spreads got it wrong is after the hiking began. By September ‘04, the 1st/5th is back down to 100, even though from September of 2004 to September 2005 there was another 200 bps of actual FF rate increases.
The 2004 to 2006 rate hike cycle lasted two years. The only cycle we’ve had since then is 2015 to 2018. For practical purposes, this was really also only a two-year cycle, as the first 25 bp step was in Dec 2015 and the next in Dec 2016. From Dec 2016 to Dec 2018 the midpoint target moved from 37.5 bps to 237.5, a total of 200 over two years. In this period CPI ranged from around 1.6% to 3%, about 50 bps lower than in mid-2004 to 2005. I would note that both ED1/ED5 and ED2/ED6 topped at about 65 just prior to the Dec 2016 hike. At that time the spreads underestimated the amount of actual annual rate hikes of 100 bps.
The differences now are that inflation is more than twice as high as it was at the start of either previous hike cycle. The initial lift-off rate is lower at 0-0.25. The current conundrum is perhaps to ask why forward Eurodollar contracts are as high as they are or, said another way, why one-year calendars aren’t higher. It’s probably the case that since the first hike isn’t expected until after taper that it’s premature for the forward spreads to be over 100 bps. However, I believe it’s the case that EDU’22/EDU’23 will surpass 100 (up another 17 from here) before it goes to 66.
In the UK the short sterling curve has inverted from 2023 contracts to 2024 as the Nov 4 meeting is in play for a hike and the near Dec’21/Dec’22 sterling spread is the peak at 79.5. In the US the back end of the dollar curve is flattening as well, though nowhere near inverted. I personally continue to look for higher rates, and for back spreads to grind higher with curve roll as time passes.
This week includes auctions of $60b 2’s on Tuesday, $61b 5’s on Wednesday and $62b 7’s on Thursday. Advance Q3 GDP is released Thursday and is expected 2.8%, though the Atlanta Fed’s GDP Now has consistently been revised lower, now standing at just 0.5%.
| 10/15/2021 | 10/22/2021 | chg | ||
| UST 2Y | 39.9 | 46.2 | 6.3 | w/I 50.0 |
| UST 5Y | 112.2 | 120.9 | 8.7 | w/i 122.7 |
| UST 10Y | 157.6 | 165.5 | 7.9 | |
| UST 30Y | 204.8 | 209.0 | 4.2 | |
| GERM 2Y | -67.7 | -63.7 | 4.0 | |
| GERM 10Y | -16.7 | -10.5 | 6.2 | |
| JPN 30Y | 68.7 | 70.6 | 1.9 | |
| CHINA 10Y | 298.9 | 299.6 | 0.7 | |
| EURO$ Z1/Z2 | 51.5 | 62.0 | 10.5 | |
| EURO$ Z2/Z3 | 69.0 | 69.0 | 0.0 | |
| EURO$ Z3/Z4 | 31.0 | 27.5 | -3.5 | |
| EUR | 115.99 | 116.47 | 0.48 | |
| CRUDE (active) | 81.73 | 83.76 | 2.03 | |
| SPX | 4471.37 | 4544.90 | 73.53 | 1.6% |
| VIX | 16.30 | 15.43 | -0.87 | |
https://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm
Three hikes in a year?
October 22, 2021
–Interest rate markets continue to force the issue for hikes, with the red euro$ pack (2nd year) plunging 9.25 bps to an average price of 98.935 or 1.065%. At settlement, EDM’23 was the weakest contract, down 10 on the day to 9884.5. Going into the end of the session it traded as low as -13. This contract has fallen >50 bps since the start of September. Near one-yr euro$ calendar spreads made new highs. The peak is still EDU’22/EDU’23 at 85.5 which rose 3 on the day. The spread before, i.e. EDM’22/EDM’23, was up 5 bps on the day to 80. In Fed Funds, FFN2/N3 (July/July) settled at 74 bps. These year spreads are indicating certainty of 3 hikes starting from the middle of next year. How good are one-year spreads at forecasting actual hikes? I looked back at 2004 to 2006 and even though the Fed hiked at every single meeting for two years (200 bps per year) the ED calendar spreads didn’t fully reflect the consistency of hikes. In my opinion, on the basis of spread levels, one can make a case for buying reds. However, on the basis of actual inflation, buying any interest rate contracts becomes questionable.
–Inflation breakevens are making new highs with the ten yr treasury to tip spread at 2.66%. Powell speaks today; the Fed seems to have toned down the ‘transitory’ argument and now is trying to convince the viewing public that expectations remain solidly anchored at 2%. That is, of course, a fantasy.
–SPX made a new high. The Biden admin is saying tax rates will not be raised. Once again, what we’re seeing in the markets is continued large buys of puts on rate futures. For example, FVZ 121.0p 13 paid for 50k (settled 15 vs FVZ 121-195). Five year treasury made a new high yield on the year, leaping 6.3 bps to 1.21%. In euro$’s 2EZ 9800p were bought in size of 100k for 2.0, ref EDZ’23 9855.5. (settled 2.25 vs 9951.0). There was a large profit-taking sale of 50k EDM2 9962.5/9937.5 put spread at 5.25 (settled 5.5 ref 9964.5). With 3-month libor pegged below 13 bps, and taper expected to end in the middle of next year, EDM’2 at 22 bps above the current libor setting is rather aggressive.
