Risks from many directions

September 29, 2024 -weekly comment
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Little net change in US markets last week, even as huge events shook various parts of the globe.  The US 10y yield rose just 3 bps to 3.751%.  The 30y was up 3.2 to 4.099%.  SPX +0.6% to 5738.17.

On the financial scoreboard, China’s stimulus package sparked a big rally in stocks and a sizable jump in yields.  CSI 300 index surged 16% on the week!  China’s 10y leapt from new lows approaching 2% to 2.18%. Perhaps I’ve mischaracterized the thrust of policy, but it seems to be targeted domestically rather than towards (deflationary) exports.  Indeed the renminbi powered to the highest level in over a year to 7.011.  In a broader context, DXY has weakened and is testing the bottom of a two year range from 100 to 107.  Last at 100.38, the low in July 2023 was 99.58.

Below is a chart of ShanghaiComp priced in gold (idea from Rob Luxem at TJM who used CSI300) which looks, well…cheap. Not much of a stimulus boost on this chart, so far.

Escalation in Mideast hostilities with the confirmation of Hezbollah leader Nasrallah’s death raises risks of a much wider spillover.  As of Friday, oil hadn’t responded at all as KSA abandoned its $100/bbl target.  By Friday CLX4 was -2.82 on the week at 68.18.  While China’s stimulus gave copper a big boost, oil faltered.  Where’s the bet?  A flood of supply from Saudi Arabia and a weaker US economy?  Or supply disruptions and demand from China?

The natural disaster of Helene has left 3 million without power in the southeast US and has caused massive destruction to property.  Here’s an old storm summary from William Dudley, former NY Fed President, speaking in 2017 regarding Hurricanes Harvey and Irma:

“Those effects tend to be pretty transitory,” Dudley said in a live interview with CNBC. “The long-run effect of these disasters unfortunately is it actually lifts economic activity because you have to rebuild all the things that have been damaged by the storms.”  [what if Dudley’s wrong about ‘transitory’ this time?]

In previous natural disasters, bonds sold off because insurance companies sold bonds to pay claims.  That doesn’t seem to occur anymore.  Much of the burden has fallen to Federal and State governments, which of course, also must sell bonds, but for now, there appears to be adequate demand.  Immediate loss of economic output is another major consideration.   

Notwithstanding the price of oil, everything above would seem to lean towards a boost in inflationary pressures, due to increased demand and possible supply chain issues.  Despite the yoy PCE price measure having only been 2.2% last week, the lowest since the start of the hiking campaign, the best news may be behind us. 

The question of finding a home for new long-bond issuance may become a concern going forward.  Clearly, the Fed is thinking about Treasury market liquidity and functioning as Vice-Chair for Supervision Barr’s speech last week indicated.  Foreign demand for US treasuries is likely to waver, even from Japan, as last week’s election was a factor in the yen’s surge.  My takeaway from Barr’s speech is that US banks will have to absorb more treasury supply, bolstered by the implicit promise of a positive curve even if inflation ticks back up.  2/10 treasury spread may perhaps pause here after a 75 bp run from late June, -50 to +23, but the trend is still strong and supported by fundamentals.  In fact, comparing the price/yield of SFH5 (9661 or 3.39%) to everything on the treasury curve projects positive carry by spring…IF the pricing of the Fed’s aggressive front-loading is correct.  The 5y yield is lowest at 3.558% and the funding level implied by SFRH5 is just 3.39%. 

The week ahead is capped by the employment report, with NFP expected 146k from 142k last.  Rate expected 4.2% from 4.2.  ISM Mfg and JOLTs on Tuesday.  Service ISM on Thursday.

	9/20/2024	9/27/2024	chg
UST 2Y	353.7	356.3	2.6
UST 5Y	348.3	350.7	2.4
UST 10Y	372.2	375.1	2.9
UST 30Y	406.7	409.9	3.2
GERM 2Y	223.0	207.6	-15.4
GERM 10Y	220.8	213.3	-7.5
JPN 20Y	169.2	166.7	-2.5
CHINA 10Y	204.1	218.3	14.2
SOFR Z4/Z5	-107.0	-104.0	3.0
SOFR Z5/Z6	7.5	8.0	0.5
SOFR Z6/Z7	12.0	12.0	0.0
EUR	111.59	111.66	0.07
CRUDE (CLX4)	71.00	68.18	-2.82
SPX	5702.55	5738.17	35.62	0.6%
VIX	16.15	16.96	0.81

Selling pressure on front end

September 27, 2024
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–Main feature yesterday was weakness in front end.  Almost like a delayed reaction to Wednesday’s large block sale of 118k SFRZ4 at 9606.5; on Wed SFRZ4 settled 9606, but yesterday it dropped 5.5 to close at 9600.5.  Vol was bid.  Changes from Wednesday to Thursday:  SFRZ4 9606.25^ 28.75 to 31.25.  SFRZ4 9600^ 28.5 to 30.0.  2yr note rose 6.9 bps to 3.62% while the 10y was up less than 1 bp to 3.789.  In another example of flattening, SFRM5 was the weakest contract on the strip, -9 at 9685.  M6 was -5.5 at 9702.5, M7 -2.0 at 9690.5 and M8 unch’d at 9679.5.  Despite pressure on Z4, Z5 was a bit weaker yet at -7.0 (9703), so Z4/Z5 spread edged to a new high -102.5

–Yesterday I had noted that 2/10 was testing its 50% retracement (~25 bps) from the 2021 high to 2023 low.  Perhaps that was a target area that some used as an exit level; 2/10 fell from 23 to 17 yesterday.  

–Despite front end selling, there is continuous accumulation of SFRV4 9618.75/9625cs for 1, about 65k yesterday.  This trade requires high certainty of a string of 50 bp eases.  Simplistically, EFFR is now 4.83% vs the lower strike 3.8125%; ~100 bp difference.  So even if we know 50 and 50 are coming, that still doesn’t quite get us over the hurdle for the call spread to fill out…need Jan too.  Oct options expire on 11-Oct, capturing the employment report.  Same cs in Nov settled 1.25, but of course November expiration covers another employment report, the election and FOMC on 7-Nov.  So what difference does an election make?  Well, $/yen has dropped about 1% today to 143.29 on Shigeru Ishiba’s victory in Japan.  $/yen is nearing the level it reached on Aug 5, which sent tremors through markets relating to yen-carry unwinds.

–Speech yesterday by Fed Vice Chair for Supervision seemed to have an undertone of bank monetization of US debt.  Perhaps that’s a stretch, but there seems to be emphasis on banks holding treasuries.  From Barr: 

When firms understand that they will not be fully constrained by the capacity of private markets or their individual credit lines to monetize HQLA immediately in stress, they can reduce their demand for reserves in favor of Treasury securities, all else being equal, for their stress planning purposes. This dynamic improves the substitutability of holding reserves and holding Treasury securities either outright or through repo transactions.

–Below I’ve included a chart of BBB/Baa spread to treasuries.  No stress apparent.

–PCE prices expected 0.1 with Core 0.2.  Yoy expected 2.3 from 2.5 last and 2.7 from 2.6 last.

Full Steam Ahead

September 26, 2024
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–There was a BLOCK seller of 118k SFRZ4 at 9606.5 yesterday, but the contract held (had been trading slightly higher at time of block post) and settled 9606.  On huge volume of 650k in Z4, open interest was up 15.6k.  Perhaps the guy was long 60k and doubled up to now get short.  Yields were mostly up 4 to 4.5 across the board.  10y rose 4.5 to 3.781%.  SFRZ4/Z5 made a new high at -104.  Even with the large sale in SFRZ4, it only closed down 1.5 at 9606 while SFRZ5, still the peak contract on the strip, settled -4 at 9710.

–Treasury spreads continued to make new highs, with 2/10 now testing the 50% retrace from 157 high in 2021 to -109 low in 2023.  5/30 made a new high at 62…this is just slightly thru the 50% level (163 to -46).

–There is a Treasury Market Conference at which Powell is making pre-recorded comments at 9:20.  Some additional Fed speakers as well.  Other news includes final Q2 GDP, expecting no change from the second estimate of 3%.  Durable Goods, Jobless Claims expected 223k. 

–SNB delivered a “dovish” 25 bp cut (little reaction in CHF).  Saudi Arabia is considering abandoning its $100 price target in order to reclaim market share (CLX4 down 1.54 at 68.15).  China continues to announce massive stimulus; SHCOMP from 2700 to 3000 in the past week and +3.6% today.  Of course, US equities are in rally mode as well. 

–From Fed Governor Kugler yesterday:

“The labor market remains resilient, but the FOMC now needs to balance its focus so we can continue making progress on disinflation while avoiding unnecessary pain and weakness in the economy as disinflation continues in the right trajectory. I strongly supported last week’s decision and, if progress on inflation continues as I expect, I will support additional cuts in the federal funds rate going forward.”  Nothing in the speech about asset prices except for “…high levels of household wealth relative to income.”  

–Supportive Fed, stimulus from China, lower energy prices.  Firing on all cylinders.  Does inflation follow?  Or is it just financial asset inflation again?  New high Dec Gold $2692, and Dec Silver making a run as well, now printing 32.54.  

–Interesting post below, citing the plunge in the ratio of the Conference Board’s leading to lagging indicators. “We have seen 8 plunges like this since the 1960s and each one flagged a recession.” [thanks TS] 

https://x.com/JeffWeniger/status/1838690956331163975

Curve steepening, but it’s already been a big run

September 25, 2024
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–New high settle 9607.5 in SFRZ4.  Curve trades made new highs, 2/10 up to 19 (3.546, -2.6 bps and 3.736, -0.2 bp).  5/30 up to 61, also a new high.  Slight new high in 10y breakeven at 218 bps.  On the SOFR strip, Z4 +3.0 at 9607.5, Z5 +3.5 at 9714 (peak contract), Z6 +2.5 at 9704 and Z7 +1.0 at 9690.

–Consumer Confidence awful at 98.7 and the Present Situation was at its lowest reading since Covid at 124.3.  In comparison, in 2019 it averaged around 170. 

 

–Today’s news includes New Home Sales expected 700k from 739k last.  5-yr auction.  Powell speaks on Thursday. 

–I’ve included a chart of SFRZ4/M5/Z5 six-month butterfly.  Prices are 9607.5/9697.5/9714.0.  So the near six-month spread settled -90 and M5/Z5 settled -16.5 yielding a fly value of -73.5. Just another visual representation of market expectations of concentrated easing in the first half of next year followed by a soft glide.  Not to overstate it, but if the easing cycle were expected to be in 25 bp increments at every meeting, then the fly would be a lot closer to zero.  

China Stimulus

Sept 24, 2024
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–Curve steepening as the market continues to expect front-loaded easing.  Look at this for example:  Oct/Feb Fed Fund spread, FFV4/G5 captures 3 FOMCs, Nov 7, Dec 18, Jan 29.  It settled yesterday at -110, 9517.5 and 9627.5.  Then look at FFG5 to FFG6… that one-year spread is only -91.  In other words, the market expects more ease over the next four months than it does over the following YEAR (which contains 8 FOMCs).  Pricing remains highly aggressive.  FFV4 9617.5.  FFG5 9627.5.  FFG6 9718.5.

–On the SOFR curve near 1-yr calendars made new recent highs.  SFRZ4/Z5 settled -106 (9604.5/9710.5) +1 on the day. SFRZ4 is the lowest contract at the front end of curve and SFRZ5 is now at the apex.  Ten year yield edged higher, +1.6 bps to 3.738%.

–BBG: China Unleashes Stimulus Package to Revive Economy, Markets.  [rate cuts, measures to boost property]
This morning oil is responding with CLX4 +1.77 at 72.14.  Copper also trading at highest level since mid-July.  US treasuries are softer across the board; US bond contract down nearly a point at 124-07.  US stocks modestly bid.  

–S&P Mfg PMI was dismal at 47.0 vs 48.5 expected.  Services were solid at 55.4 vs 55.2 exp.  Today brings Philly Fed Services, expected -9.3 vs -25.1 last.  Consumer Confidence as well.  Two-yr auction.

–There used to be a guy who compiled an economic Vice Index. He used data on street drug prices, prostitution and alcohol sales (and maybe other data points) as a leading indicator. Well, as we say, history rhymes, and the Star is running this headline: ‘Economics expert, 20, uses her sex-work experience to predict the next recession’. Amelia Lynne calls it the ‘Stripper Index’ and says “Sex work is typically something that’s cut out before everything else; people will stop going to the club and spending cash there.” adding, “It’s been a really slow month in the US.”

A little TOO smart

September 23, 2024
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–Friday featured continued strength in front-end contracts with SFRZ4 at a new high settle 9603.5. (86 bps premium to the new EFFR of 4.83%)  Peak contract on the SOFR curve has moved forward to SFRZ5 at 9710.5; Z4/Z5 spread settled -107.  There was a late block buy of 10k SFRZ4 9600/9575p 1×2 for 7.5 (appears new) which serves to highlight skew.  The put 1×2 settled 12.25 and 2.5 so 7.25 ref 9603.5.  Same otm on the call side?  Z4 9606.25/9631.25 c 1×2 settled 13.0 and 6.25 so just 0.5.  The equally otm 9575p 2.5s and 9631.25c 6.25s.  The call with the same 2.5 settle as the 9575p is way up at 9675!  The risk-aversion with respect to otm call sales is amazing….but not to anyone that got caught in the Q2 2023 regional bank crisis.

–Note that if there were certainty of 50 bp Fed cuts at the 7-Nov, 18-Dec and 29-Jan FOMC meetings, then SFRZ4 should target 9642 to 9644.  (Below is a link on the CME site for SOFR calculations, thanks TD).  

–EuroZone PMI weaker than expected today at 48.9 vs 50.5 estimate.  China continues to take measures to support the economy, yet China’s 10-yr yield is sinking to new lows, currently just above 2%.  

–A couple of interesting snippets this morning.  From WSJ: Electronic Warfare Spooks Airlines, Pilots and Air Safety Officials.  From BBG: The US Commerce Department is planning to reveal proposed rules that would ban Chinese- and Russian-made hardware and software for vehicles as soon as today, according to people familiar with the matter.

After the 9/11 attack, the CME (and other office buildings in major cities) erected concrete and/or steel barriers around building perimeters to deter auto bombs.  It was a somewhat expensive safety measure.  After the hacking of pagers and other technology in Lebanon, it’s not much of a stretch to imagine vulnerabilities in all sorts of new “smart” gadgets.  In a way, there should be acceleration towards ‘on-shoring’ ; new security measures could ultimately be inflationary.  I don’t think it’s hyperbole to think that cyber-security on this scale is comparable to Y2K remediation. 

[We’re bringing back the muscle car.  No computers, just metal and gasoline]

–Headline on ZH:  ‘The biggest wild card in the Presidential Election’ : Just days left until a crippling port strike paralyzes the east coast.
I don’t really perceive this as much of a wild card.  The administration is likely to just pay the demands to put the problem to bed at the last minute.

–Powell speaks on Thursday.  Today we get comments from Bostic, Goolsbee and Kashkari.  S&P PMI numbers this morning.  2, 5 and 7 year auctions begin tomorrow.  

https://www.cmegroup.com/markets/interest-rates/cme-sofrwatch.html?itm_source=cmegroup&itm_medium=hyperlink&itm_campaign=ewo

Heading into (for a) Fall

September 20, 2024
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–Autumn solstice September 22.

–Fed’s SEP on Wednesday had 4.4% as their end-of-year FF projection for 2024.  So someone bought 70k SFRX4 9562.5/9550ps for 0.5, probably in the belief that the Fed’s target has merit.  You know when the Fed is REALLY good with their year-end projection?  At the December FOMC, that’s when.  In any case, it’s not a lot of premium, and if stocks continue their run, maybe Powell will reconsider easing into an asset melt-up.  Even with put buyers, SFRZ4 posted a new high settle at 9601, up 2 on the day and sub-4%.  Contracts from SFRM5 on back settled successively lower on the day,  M5 -0.5 at 9690.5, M6 -0.5 at 9708.5 but M7 -4.0 at 9696.5 and M8 -6.5 at 9684.5.  All sort of clustered around 3%.  

–Nov SOFR options expire 15-Nov, capturing NFP (nov 1), election (nov 5) and FOMC (nov 7).  There is no update to the SEP (projections) at the Nov meeting.

–Steepening was mirrored in the treasury curve with 2s down 1.9 bps to 3.596 and 10s up 3.6 to 3.73 .  That level of 13.4 is a new high in 2/10 spread, and is nearing the 50% retrace level from the 2021 high of +157 to the 2023 low of -108, which is +25. (chart below)  Late in the day there was  a buyer of 30k TYZ4 105p for 2/64s.  On Wednesday same guy paid 2 for 35k of the TYZ 105.5 strike. I’m not sure of the equivalent yield level; right now there’s about 15 bps per point in the TYZ contract which settled 114-235.  This guy is protecting the BIG move, (and taking advantage of lower vols).  Perhaps a modicum of concern is creeping into the market that Treasury won’t have such an easy time selling debt post-election.  However, if SFRZ4 is “right” at 4%, then by year end, there will no longer be negative carry on the long bond (30s are now 4.066%).  I’m taking liberties regarding relative moves, but the point is that a positively sloped curve with lower funding rates will make debt sales a lot easier.  5/30 also closed at a new high of +57 bps (3.496% and 4.066%). Note that 2, 5, 7 year auctions are next week.

–$/yen rebounding as BOJ stands pat on rates, holding at 0.25%.  Current 143.83 having briefly dipped below 140 on Monday.  Equity op-ex today.

Risk Management?

September 19, 2024
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–Regarding my comment yesterday “Post-election comes with heaps of uncertainty and the Fed addresses uncertainty with liquidity” a friend responds with, “I know. I am taking extra time at the gun range.”  INSURANCE.  You buy it before you need it.  Not when the hurricane hits. 

–Powell says the economy is in a good place, but my thought is that he’s worried about the trajectory.  And, I can’t help but feel as if Powell’s 50 bp cut had just a twinge of F-you to Trump.  Of course, there was only one dissenter, Bowman.  The chair also tried to tamp down on the pace of forward easing, saying, “…nothing in the SEP that suggests the committee is in a rush.” By now the dots and projections have pretty much been discredited, on the other hand the Fed’s recent focus on inflation seems to have paid off…for now. 

–On Tuesday, SFRZ4 settled 9596.5 and the 9600^ for Dec was 34 bps.  After yesterday’s FOMC, the futures settle was 9599 and the straddle was just 28.5.  (Probably a bit on the low side given the environment).  The news is known, so the air came out of premium.  I was going to emphasize this point by noting the huge drop in FFV4 open interest as shorts threw in the towel and longs were happy to book an extra 0.5 to 1.0 bp in “premium” as the contract traded 9517.5/18 vs the new target of 4.83.  However, the prelim bulletin shows open interest having INCREASED by 9k.  My comment there is BULLSH-T.  Bad data.  But then I thought, did someone really, really big say, ‘look, the mideast is about to explode, and NATO seems intent on provoking WW3 by using long-range missiles in Russia, and the next attempt on Trump is probably right around the corner, and Diddy is going to commit “suicide” in jail.  Why not squeeze the shorts and pay another bp for the possibility of an emergency ease?’  Just my own musings…probably crazy.  Right?

–But in a related development, late in the day buyers of Oct TY calls that expire tomorrow:  ref 115-025, 116.5 and 116.75 calls expiring Friday were bought for c-7 25k and 15k.  Also a buyer of TYZ4 105.5p 2 paid for 35k.  All of these are new trades.  A few lotto tickets for “Crazy”.

–I marked a few levels just in front of the FOMC, then just after, then settles then late (nr electronic close)
FFV4   9506.5  9518  9517.5s 9517.5
SFRZ4 9591.5  9502 9599.0s 9598.0
SFRH5 9651.5 9666 9659.0s 9657.5
TYZ4  115-025 115-16 115-025s 114-290
ESZ4 5699 5755 5680.0s  5688
GCZ4 was up $32 at one point post-FOMC  but was 2584, down 8.4 late in the day.

–There’s a lot more that could be said, but it probably will take a little more time for volatility to settle down.  Curve steepened with a slight new high in 2/10 to +8 bps.  SFRZ4 is back above 9600 this morning, 40 bps lower in yield than the Fed’s 4.4 yr-end dot projection.  Think about that for a second before selling the straddle at 28.  But then go ahead and sell it anyway.  It’s fun managing short gamma with this backdrop.  

They don’t review it in the booth

Sept 18, 2024
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–It’s 25 or 50.  Just like the election, about half the trading population is going to be very angry.  We’ll get some whiners. FFV4 settled 9508.  If only 25, it still will probably hold 9493-93.5 instead of pegging 9492.  The upside will exactly target 9517, and I wouldn’t be surprised to see 18 print.  It’s like that song about the end of the night at the pub: “Closing time, you don’t have to go home / But you can’t stay here”

At the last June FOMC dot plot, in terms of Fed Fund projections:
2024 was 5.1, up from 4.6 in March.  SFRZ4 is 9596.5 or 4.035%, 100 lower than the Fed’s last projection.
2025 was 4.1, up from 3.9 in March.  SFRZ5 is 9513 or 2.87%, about 1.25% lower than the Fed’s last projection.
2026 was 3.1 from 3.1.  But what does it matter…they were off by a million miles last time with only 6 months until year end.

SFRZ4/Z5 is -116.5 (9596.5/9713), not all that far from the implied spread of -100 on the dot plot, just off by 100 bps in each contract.  By the way, ERZ4/Z5 is -106 and SFIZ4/Z5 is -104.5.  

–There will be typical hand-wringing over the dots.  They don’t matter.  Post-election comes with heaps of uncertainty and the Fed addresses uncertainty with liquidity. 

–Had a client check Wednesday’s (today) TU atm straddle (104.375).  At end of day it was 13 mid-market ref 104-115.  DV01 on contract is about $39.80…straddle is a bit over 10 bps.  Priced about right. 

–Convexity Maven (Harley Bassman) piece out yesterday suggesting the 2-yr yield has way too much ease priced in.  Obviously clear from near SOFR contracts; there’s concern the economic and political wheels could come off.  Hasn’t paid to load up on shorts.  Probably worth selling the pop across the curve and stocks on 50, but don’t overstay the welcome. Longs remain in control, and sell-offs will likely be brief.  

https://www.convexitymaven.com/wp-content/uploads/2024/09/Convexity-Maven-Forests-and-Trees.pdf

One day til FOMC announcement

Sept 17, 2024
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–As Sept SOFR options have expired, I consider SFRZ4 to be ‘front month’.  That is now the lowest quarterly at 9600 or 4%.  The peak contract on the SOFR strip has been moving forward and is now SFRH6 at 9719.5.  It’s now the 6th quarterly contract; it was the 7th quarterly last week.  That spread is -119.5.

–From SFRH6 forward the SOFR calendars are positive, and becoming more so.  Price action is indicative of front-loaded easing.

–The lowest 1-yr calendar is now Z4/Z5 at -118 (9600/9718).  It was +4 on the day.  (U4/U5 is, of course, still listed, and that’s -195, but I don’t consider it to be front any more).  There was a huge block buy of SFRH5/SFRH6 at -55.5 in size of 81.5k. Both contracts gained >60k open interest, so new trade.  That spread settled -52.5 (9667/9719.5).  The difference between Z/Z and H/H is 65.5 which is nearly 1 bp of negative roll (for the buyer) for each trading (not calendar) day.  However, perhaps the spread buy is really focused more on being short the peak contract SFRH6.  In that case I am guessing he’s looking for better than a soft landing, perhaps a new surge of economic activity. 

–The other large trade relating to SFRH5 was a seller of 100k SFRH5 9675/9750/9775/9850 call condor at 12.0 to 12.25,  Said to be a roll-up of 9675/9775cs (20.25s) to 9750/9850cs (7.0s).  Open interest was up >90k in both 9750 and 9850 strikes, but surprisingly was also higher in 9675 and 9775 calls by about 40k. 

–Treasury yields fell by 2 to 4 bps on a slightly flatter curve.  2y -1.9 to 3.555% and 30y -4.1 bps to 3.934%.  Former WSJ Fed whisperer Jon Hilsenrath posted late in the session that he’s now in the 50 bp cut camp.  However, FFV4 settled 9507.5, very close to the dividing line between 25 and 50 which is 9504.5. 

Retail Sales expected -0.2 m/m from +1.0.  Ex-auto expected +0.2 and ex-auto and gas +0.3%
Industrial Production +0.2 and Capacity Utilization 77.9%…post-covid low has been 77.2

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.

  The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.