Maybe it’s just about supply
September 10, 2023
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On the week, the 2yr yield rose 11.6 to 4.98%, 5y up 11 to 4.394%, 10y +8.7 to 4.254% and 30y up 4.7 bps to 4.33%. Almost an exact reversal of the previous week. Yields remain close to highs of the year.
ISM Service data was a major catalyst at 54.5 vs 52.7 last. Employment, Prices and New Orders all higher. Powell’s emphasis on non-housing services accentuated reaction to the data, as these prices have been stickiest and are relatively labor intensive. SFRU4 and SFRZ4 notched new low settlements for the entire move in the wake of this report, at 9525.5 and 9559.0.
However, it’s not just the data that is weighing on treasuries. More analysts are pointing to supply (both from the Treasury and Corporates) as a major factor for price action. This week brings auctions of 3s, 10s and 30s starting Monday. Amounts are $44b, $35b and $20b. The narrative has shifted away from the stimulative effects of gov’t spending to an uneasy concern about the sustainability of deficit spending at high financing rates. I had seen a clip that the US is now spending $2 billion per DAY on interest payments. Of course, some of that money flows to (and supports) the household sector, accentuated by the move out of bank deposits into higher yielding t-bills and money markets. On the other hand, student loan obligations are re-starting. BBG’s Valerie Tytel notes that student loan repayments since August 1 have totaled $9.2 billion. Consumer finance rates for cars, goods and homes are now restrictive.
While treasuries are weighed by heavy supply, it’s the opposite case in energy, where the near CL contract has made new highs for the year. CLV3 settled 87.51, as the Saudis and Russia maintain cuts, and I don’t think Biden’s warm handshake with MBS at the G20 meeting is likely to move the needle. Additionally, as the chart shows, selling oil out of the SPR to suppress energy prices is played out as a strategy.
This week brings CPI, expected 3.6% from 3.2% last, with yoy Core expected 4.3% from 4.7%. Retail Sales on Thursday, along with PPI and Jobless Claims. Industrial Production on Friday.
As Dallas Fed President Lorie Logan noted, a skip is in store for next week’s FOMC, but November remains in play. FFV3 settled 9465.0 or 5.35%, close to the current 5.33% Fed Effective Rate. FFX3 settled 9455.0 or 5.45%, more like a coin flip for the Nov 1 FOMC.
The spread SFRZ3/SFRZ4 settled -108 on Friday (9455.5/9563.5). As noted above, SFRZ4 made a new contract low this week at 9559.0. This price still indicates significant easing by the Fed next year, which is also reflected in the SEP. In June, the Fed’s end of 2023 projection for Fed Funds was 5.6% (which pencils in one more hike prior to year end). FFX3 is only 5 bps away from that level. The end-of-2024 FF projection was 4.6%, which implies 100 bps of easing. SFRZ3/Z4 almost syncs up perfectly with the SEP. The market appears to have accepted the idea that squeezing out the ‘last mile’ of inflation will necessitate higher rates for longer and a relatively stingy schedule for eases when they do actually start.
| 9/1/2023 | 9/8/2023 | chg | ||
| UST 2Y | 486.4 | 498.0 | 11.6 | |
| UST 5Y | 428.5 | 439.4 | 10.9 | |
| UST 10Y | 416.7 | 425.4 | 8.7 | wi 426.0/425.5 |
| UST 30Y | 428.2 | 432.9 | 4.7 | wi 433.5/433.0 |
| GERM 2Y | 299.0 | 308.1 | 9.1 | |
| GERM 10Y | 254.9 | 261.0 | 6.1 | |
| JPN 20Y | 134.2 | 139.7 | 5.5 | |
| CHINA 10Y | 262.3 | 266.7 | 4.4 | |
| SOFR Z3/Z4 | -121.0 | -108.0 | 13.0 | |
| SOFR Z4/Z5 | -54.5 | -59.0 | -4.5 | |
| SOFR Z5/Z6 | -4.0 | -6.0 | -2.0 | |
| EUR | 107.77 | 107.03 | -0.74 | |
| CRUDE (CLV3) | 85.55 | 87.51 | 1.96 | |
| SPX | 4515.77 | 4457.49 | -58.28 | -1.3% |
| VIX | 13.09 | 13.84 | 0.75 | |
In: Eurodollar Options
Asset Values Can be Fickle
September 8, 2023
–Much of Wednesday’s sell off in rate futures was reversed yesterday and yields are slightly lower this morning. Two year yield down 7 bps yesterday to 4.95% and tens fell 3.2 bps to 4.256. Having made a new recent high Wednesday of -104.5, SFRZ3/Z4 fell 9.5 yesterday to settle -114 (9455.5/9569.5).
–Dallas Fed President Lorie Logan gave a speech yesterday which supported a skip at the Sept 20 FOMC, but her comments were more or less balanced on risks:
“But skipping does not imply stopping. In coming months, further evaluation of the data and outlook could confirm that we need to do more to extinguish inflation.”
–Fed releases its quarterly Z.1 report today at noon. Headlines mostly cover Household Net Worth, but there are a lot of stats in the report. Summary picture of net worth below. Assets likely boosted by inflated values, while liabilities barely move. Large rally in SPX during Q2 will potentially trumpet new highs in Net Worth.
–Now here’s where you grab your tin foil hat. These are very rough approximations for illustrative purposes. NVDA is worth about 1.1T, or at least that’s current market cap (price 462 vs recent high 502). From end of March to end of June the stock went from 240ish to 420 a jump of 75%. There are a lot of twitter articles about possible improprieties regarding NVDA’s orders in the last quarterly report, some of which revolve around a company called Core Weave. I have no idea how to ascertain these allegations. However, I did see this August 3 article on Reuters:
Aug 3 (Reuters) – Specialized cloud provider CoreWeave has raised $2.3 billion in a debt facility led by Magnetar Capital and Blackstone (BX.N) and collateralized by Nvidia chips, with the funds to be used to expand to meet rising AI workload, the company said on Thursday.
So CoreWeave buys NVDA chips and then is able to collateralize them to raise money? Over my head. However, if the smoke from these embers turns into a fire [sale], then Nasdaq as a whole would likely take a tumble, which could reverberate into other assets. This is all rampant speculation on my part; I just feel it ties in to PERCEPTIONS of net worth, so it’s “worth” a mention as Z.1 is released.
ISM Services spark tighter conditions
Sept 7, 2023
–Much stronger than expected Service ISM sent short-dated contracts lower, accentuating curve inversion. SFRU4 and Z4 settled at new lows for the move, 9525.5 (-7.5) and 9559 (-8.5). Weakness in reds caused near one-year calendars to settle at new recent highs, -67.5 in SFRU3/U4 (9458/9525.5) and -104.5 in Z3/Z4 (9454.5/9559). Data like yesterday’s reinforces the idea that “the last mile” in getting inflation to target is likely to be a long slog which will forestall the easing schedule.
Data: ISM Service 54.5 vs 52.7 last. Employment and New Orders higher. Prices 58.9 vs 56.8 last.
–2-yr note ended above 5% at 5.022% and the ten-year inflation-indexed note is now essentially at 2%, a level not seen since early 2009. At the same time, the dollar continues to strengthen, for example USDCNY at new high today 7.3284. Financial conditions are again tightening. 5/30 which had been hanging around zero closed at -7.8 bps, and 2/10 eased 3.4 bps to -73.4.
–News today includes Productivity and Unit Labor Costs, the latter expected 1.9%. Jobless Claims 234k. Fed speakers in the afternoon, Williams, Bostic (economic outlook), Bowman (Future of Money and Consumer Protection conference). Harker early at 9:00.
Below: 10-yr inflation-indexed note yield
Beige Book likely to cite moderating growth
September 6, 2023
–Waller comments yesterday suggested balanced risks as the economy slows, with the possibility of just one more hike. He said the Fed can now wait and see how data evolves. However, rates jumped with red sofr contracts leading the way. SFRU4 was the weakest contract on the board settling 9533 or 4.67%. The low in this contract has been 9522 on Aug 28; the low settle on that date is 9528. SFRU3/SFRU4 one-year calendar settled exactly at -75 bps, suggesting three eases over the coming year. The most inverted one-year spread is SFRH4/H5 at -125.5 (9470/9595.5).
–The ten year yield rose nearly 10 bps to 4.264%, while the thirty year rose 9.2 bps to 4.374%. Treasury auctions of 3s, 10s, and 30s next week, and heavy corporate supply is also pressuring the rate complex. A surge in energy prices as the Saudis extended production cuts could have negative inflation implications. After spending May through early July in a range of 68 to 72/bbl, CLV3 settled yesterday at 86.69, +1.14.
–News today includes Balance of Trade, and ISM Service PMI, expected to be down slightly from 52.7 last. Given that Powell has cited Core Services as a sticking point on inflation, this report could carry a bit of extra weight, especially if the employment component were to print sub-50; it was 50.7 last. The Service Price index was 56.8 last, expected to be somewhat lower. Beige Book in the afternoon.
USD strength
September 5, 2023
–Brief rally in interest rate contracts post-NFP quickly fizzled, with TYZ posting an outside day and closing near the low. No relief during yesterday’s holiday session and futures are lower yet this morning. TYZ settled 110-185 on Friday, down 14.5/32 and currently print 110-085.
–It’s a light news week in the US, with Factory Orders today, Service ISM and Beige Book Wednesday. Not likely to be much drama associated with the Sept 20 FOMC as the market indicates small odds of a hike. FFV3 settled 9465.5 or 5.345% against a current Fed Effective rate of 5.33.
–China’s fits and starts to stabilize continued deterioration in the property sector seem to be resolving in a weaker currency, with $/cny now above 7.30, nearing last year’s high (weakest level in the yuan). $/yen also at this year’s high, over 147. US stock index futures responding with marginal weakness.
–Front end of the US curve was well supported on Friday even as longer maturities sold off. Two-yr yield up just half a bp to 4.864%. SFRZ3 settled 9460.5, +0.5 and SFRH4 9479.5, -0.5. Heavy buying of call spreads on the latter. SFRH4 9500/9525cs 5 paid for 15k. 9550/9600/9650c fly 1.5 to 1.75 paid for 15k.
Labor Day comes with more balance in jobs market
Sept 3, 2023 – Weekly comment
**********************************
On the week, the 2y yield fell about 15 bps, the 5y 13 bps, 10y 7 bps and 30y 1 bp. As mentioned in last week’s note, Powell, in his Jackson Hole comments, focused on non-housing services, which account for over half the core PCE index. He noted, “Production of these services is relatively labor intensive, and the labor market remains tight. Given the size of this sector, some further progress here will be essential to restoring price stability.”
This week there were signs of further progress, which trimmed odds of another hike this year. JOLTs came in at 8.827m vs expected 9.5m. At the end of last year the number was 11.234m. While NFP was 187k, the unemployment rate jumped to 3.8% from 3.5% and the participation rate ticked up to 62.8% from 62.6% However, ISM Mfg Employment component increased to 48.5 from 44.4. ISM Service data comes out next week on Wed; the last Service Index was 52.7 and the Employment piece was 50.7. I would further note that ISM Service Emp bounced around either side of 55 from 2017 through mid-19. Since 2021 it has bounced around 51. The GDP Price Index for Q2 was 2%, exactly at the Fed’s target.
Friend Joseph Hogg, proprietor of Inflexion Financial, posted this comment and chart on Linked-In. “This jump in 55+ Participation is another indication that the pandemic savings buffer that has been supporting consumer spending – is probably gone.”
So yields fell, but the drop was tempered by this:
September 1 – Bloomberg (Alyce Andres): “Preparations for an onslaught of corporate supply next week have weighed in Treasuries today… Banks that underwrite the bonds expect about $120 billion to be issued [this] month, much more than the $78 billion sold in September 2022… Expectations are for that number to get revised higher as the market is ripe for debt issuance. That’s because investment-grade credit default swaps fell to an 18-month low this week.”
The above chart is from a BBG article:
‘S&P 500 Bulls Get Back to Believing Everything Is Just Perfect’
(interest rate expense is still low as a percentage of earnings)
Another Saturday morning BBG article had this (cheerleading) title
‘Sputtering Europe and Jittery China Add Bull Case for US Stocks’
…because TINA, There Is No Alternative.
The problem isn’t what interest rate costs are right now, it’s what they are GOING TO BE as billions in corporate debt need to be rolled at higher rates, just as earnings are crimped by a stretched consumer. Can’t vouch for the accuracy of this tweet by Jack Farley, but the Commercial Real Estate market is a case in point. Farley says, “I have it on good authority that 84% of office CMBS were not paid off in August. 16% pay-off rate; 84% were either modified/extended or entered maturity default.”
Of course, those in the higher inflation camp are still prevalent, as evidenced by this clip from Doug Noland’s Credit Bubble Bulletin:
Recent tempering of wage gains doesn’t negate the strongest compensation momentum in decades. Importantly, labor markets remain sufficiently tight to further embolden unions and workers alike. And especially with the U.S. economy having evolved over recent decades to be services dominant, wage growth today plays a pivotal inflationary role.(CBB)
The market has remained priced for easing over the coming year, and last week’s data bolstered that view. For example, SFRZ3/SFRZ4 calendar settled -121 (9460.5/9581.5) on Friday, from -113.5 the previous week.
I thought I would take a cursory look at some open interest levels:
Open interest in SFRZ3 is 1.262m.
Open interest in SFRH4 is 976k
Open interest in Z3 options excluding serials is just over 11 million, nearly 10x futures. Of course, with the tremendous changes in short term rates, OI is spread across many strikes. In calls, from the atm 9462.5c (47d) to 9550c (11d) OI is 1.807m. On the put side, atm 9462p (-53d) to 9425p (-11d) OI is 1.517m. That’s either a lot of pressure to monetize on small moves, or a lot of gamma if an outside catalyst intervenes. Note, I’m not trying to draw conclusions about direction, only looking at values.
However, there was a reasonable amount of upside bought in SFRH4 last week (SFRH4 settle 9479.5, +15 on the week). Examples: SFRH4 9500/9525cs 5 paid 15k. SFRH4 9500/9512.5cs 3 paid covered 84.5, 14k. SFRH4 9550/9600/9650 paid 1.5 to 1.75, 10k. SFRH4 9500/9600c 1×2, 1.0 paid Wed and 2.0 Thursday. There’s only 190k open in SFRH4 9500c +35k Friday, so it’s not overwhelming.
But let’s take a look at skew:
SFRH4 9500c settle 22.0 with 40d. 20.5 otm ref 9479.5. SFRH4 9462.5p settled 18.0 with 39 delta, closer to the money and cheaper. SFRH4 9437.5p, which would be the midpoint strike if the Fed hiked to 5.5/5.75% is 8.5 with 24d. It’s 42 bps otm. To find an equal premium call one has to go all the way to the 9618.25 strike which settled 8.5. It’s 138.75 otm!
As has been the case for a while, the market is expecting, hoping, clamoring for an ease. It’s clear from calendar spreads and option pricing. Only the degree has changed.
Now consider the longer end of the yield spectrum. USZ3 settled 120-11. 1.342m in open int. 127c settled 44 with 18d. 114p settled 53 with -19d and 113p settled 43 with -16d. Much more balanced. Of course, here too, the yield on the 30y treasury is 4.28%, much lower than fed funds. However, USZ3 has a DV01 of $136.02 per 100k, which is closer to the 20y cash bond, which has DV01 $129.70. The 20y yields 4.48%
Long treasuries decisively rejected Friday’s post-data rally. TYZ had an outside day and closed 110-185, down 14.5/32 on the day. US and WN weren’t able to exceed Thursday’s highs and settled in the bottom quarter of the day’s ranges. The long end continues to be in a bear market.
It’s a light news week with ISM Services and Beige Book on Wednesday
| 8/25/2023 | 9/1/2023 | chg | ||
| UST 2Y | 501.7 | 486.4 | -15.3 | |
| UST 5Y | 441.7 | 428.5 | -13.2 | |
| UST 10Y | 423.9 | 416.7 | -7.2 | |
| UST 30Y | 429.3 | 428.2 | -1.1 | |
| GERM 2Y | 303.5 | 299.0 | -4.5 | |
| GERM 10Y | 258.7 | 254.9 | -3.8 | |
| JPN 20Y | 139.0 | 134.2 | -4.8 | |
| CHINA 10Y | 256.7 | 262.3 | 5.6 | |
| SOFR Z3/Z4 | -113.5 | -121.0 | -7.5 | |
| SOFR Z4/Z5 | -55.0 | -54.5 | 0.5 | |
| SOFR Z5/Z6 | -6.0 | -4.0 | 2.0 | |
| EUR | 107.96 | 107.77 | -0.19 | |
| CRUDE (CLV3) | 79.83 | 85.55 | 5.72 | |
| SPX | 4405.71 | 4515.77 | 110.06 | 2.5% |
| VIX | 15.68 | 13.09 | -2.59 | |
https://blinks.bloomberg.com/news/stories/S09Q15DWRGG0
https://blinks.bloomberg.com/news/stories/S075TFDWLU68
In: Eurodollar Options
Payrolls and Paydays
Sept 1, 2023
–PCE Price data exactly as expected Thursday, PCE Prices yoy 3.3% and Core 4.2%. Employment report today with NFP expected 170k, UE rate 3.5% and Avg Hourly Earnings 4.4%. Speaking of wages, in a NomNomNomics effort to fight inflation, Biden is proposing a pay raise of 4.7% for federal employees. Actually, it’s 4.7% base pay raise plus 0.5% avg locality pay adjustment, totaling 5.2%.
“A 5.2% raise would be the biggest pay boost for feds since the Carter admin offered up 9.1% in 1980. Fed employees received a 4.6% raise at the start of 2023, and 2.7% in 2022.” This, while Social Security recipients are expected to get a boost of about 3% in ’24. Still want to buy those tens at 4.25%? Because the Federal Gov’t is BORROWING to give pay raises. Yes, it IS like your brother-in-law asking you to lend him some money for a vacation.
–Decent amount of upside continues to go through. Seller of 40k SFRM4 9500/9475ps (exit) vs buying SFRM5 9675/9725cs (new) paying 4.25. While the SFRM5 call spread is only 50 out of the money at present, it’s still 200 bps below the current FF rate. June’24 put spread settled 12.25 ref 9511.5, and there is still significant open interest in those strikes. June’25 cs settled 16.25 ref 9627.5.
SFRH4 9500/9600cs continues to trade as well. Paid 1 on Wednesday and 2 Thursday, settled 2.25 vs 9480.
–A couple of spreads to note: FFF4 settled 9458 and FFX4 settled 9558, exactly 100 higher. There are nearly 7 meetings over this period, the first is Jan 31, 2024, but the Nov meeting chews into FFX4 as it’s Nov 7 (just after the election). The only real takeaway here is that easing is expected in 2024, but it’s not being quite as aggressively priced as it was a few months ago.
–China continues to trickle out stimulus measures, which seems to have the odd outcome of boosting US equities.
10yr treasury / tip spread notched a recent low of 225 bps, down from >240 early in the month. Bulk of the year has been between 218 and 231. One might even be able to get away with calling this measure of inflation expectations “anchored” with a straight face.
–There was a buyer yesterday of 125k Dec Vix 25/32 call spreads somewhere around 45 to 50 cents. Dec VIX closed yesterday at 17.55. Nov closed 17.22 and Oct at 16.37, so the roll down isn’t extreme over the next month or so.
Fed recommends boarding up windows and doors in case another hurricane hits
August 31, 2023
–ADP added a buying catalyst for the short end on Wednesday following weaker than expected JOLTs on Tuesday.
ADP lower than expected at 177k vs 195k expected and Q2 GDP revision was also lower at 2.1%. GDP Price Index was 2.0% vs 2.2 last, exactly at the Fed target.
–Both 2s and 10s edged slightly lower in yield (less than 1 bp) ending as 4.882% and 4.118%.
–Today’s news includes PCE prices expected 3.3% yoy from 3.0 last, with Core 4.2% from 4.1% last. Jobless Claims expected 235k.
–Buyer yesterday of 30k SFRH4 9537.5/9625/9637.5 call tree for 0.25 credit to flat. Settled 16.5/8.75/8.0 so -0.25 vs SFRH4 9477.0. Given the explosive rally related to banking turmoil in March (see below), some might be uncomfortable with the open-ended leg. However, there had been huge buying of 9700/9800c spreads and 9675/9775c spreads, and IF this buyer is also long 100 point call spreads above, the open leg doesn’t seem particularly problematic. SFRH4 9700c settled 5.25.
Also a buyer of SFRZ3 9462.5/9468.75cs vs sell Z3 9443.75p for 5.0 credit, about 20k. Settles 12.0/9.75 vs 7.75. This trade works with no further hikes and a bias toward ease. It’s probably breakeven with just one more 25 bp hike.
–It appears as if the Fed is spending a lot of time on regulatory ‘solutions’ for potential banking problems [related to the inverted curve and declining credit quality].
–“The Federal Reserve has issued a batch of private warnings to lenders with assets of $100 billion to $250 billion.”
–Also, from the Fed website on Tuesday:
Federal bank regulatory agencies today requested comment on a proposal that would require large banks with total assets of $100 billion or more to maintain a layer of long-term debt, which would improve financial stability by increasing the resolvability and resiliency of such institutions.
Job market deceleration
August 30, 2023
-Two pieces of data sparked a large drop in yields and associated stock rally (SPX up 1.45%). JOLTS, expected at 9.5m was actually 8.827m. The high in 2018 was 7.594, so the level of job openings is still relatively high. Consumer Confidence was reported at 106.1 vs 117 last. The ten year note dropped 8.4 bps to 4.124%. The curve bull steepened as twos plunged 11.8 bps to 4.89%. On the SOFR strip, SFRU4 led the surge, settling +15.5 bps at 9543.5. The Dec’23/Dec’24 one-year calendar spread declined by 9 bps to -123 (9456.5/9579.5). As mentioned previously, the Fed’s June SEP indicates end of 2023 FF at 5.6% and end of 2024 at 4.6%, a spread of -100.
–Today we get more clues regarding the labor market, with ADP expected 195k from 324k last. Second revision Q2 GDP expected 2.4% from an original estimate of 2.0. Q/Q PCE prices expected 2.2% from 4.1. Tomorrow Personal Income and Spending along with PCE prices. Friday features the employment report with NFP expected 170k. ISM Mfg as well.
Do long end rates need to be more restrictive?
August 29, 2023
–Market has become more convinced that another 25 bp hike is likely before year end. Near contracts are clustered around 9450 or 5.5%. FFX3 settled 9450.5, SFRU3 9454 and SFRZ3 9450.5, all new low settles (since early March). Current Fed Effective is 5.33%. The two-year auction went off at 5.024%; two’s now seem comfortable around 5%, after having spent Q2 bouncing around 4% post-SVB. In 2006 at the end of the hiking cycle, fives and tens had gotten close to or slightly above the terminal 5.25% FF rate. Currently 5’s are 4.39% and 10’s 4.21%. On the other hand, the 30y mortgage rate is well above the 2006 level.
–Overall, yields eased slightly yesterday. The ten-yr fell 3.1 bps to 4.208%. Seven-yr auction today. Everything on the SOFR strip from SFRZ4 back was up 4 to 5 bps in price. Greens, blues and golds (3rd, 4th and 5th years forward) are all within a few bps of each other around 3.75%. Grn pack 9624.63, blue pack 9630.25, gold pack 9626.5.
–Today’s news includes JOLTS, expected 9500k, and Consumer Confidence, expected 116 from 117 last. Federal student loan debt repayment starts Oct 1. I don’t know if those rates adjust, but for the 2023/24 school year, the rate is currently 5.5%. To be fair, since education is a long dated asset, one might think it’s more appropriate to price it close to 10s.
