Powell Semi-Annual Testimony

February 21, 2021


Last week I noted some short term targets in curve levels, most of which obtained last week.  2/10 closed out on the high at 123.4 bps, up 14.3 on the week; I targeted 125 to 127.  5/30 closed at 156, I am anticipating resistance at 162.  Red/gold Eurodollar pack spread soared by 23.25 bps to 136.625.  The ten year yield rose just over 14 bps to 1.34% and the thirty year just over 13 to 2.136%. 

Volume was heavy on Friday with notable continued weakness in the back end of the dollar curve where the gold pack (5th year forward) closed down 8.5 on the day and 24 on the week (nearly a Fed hike).  There is continued heavy trade in deferred Eurodollar options, mostly slanted toward higher rates.  As an example, on Friday there was a seller (adding) of 75k EDH3 9975 calls at 9.5 covered with a 40 delta from 9965 to 64.  Open interest rose on Friday to 327k, up over 200k since the end of January.    

Apart from this seller, implied vol is showing some signs of panic.  Early in the week I sold some EDU22 9962.5 put for 6.5 with futures trading 9974.5.  On Friday these were lifted at 7.5 with the same futures level.   

On Friday the Fed released the text of the semi-annual testimony to Congress; Powell will appear on Tuesday and Wednesday.  This report is biased to the downside with respect to inflation in spite of market action with stocks near all-time highs and the yield curve bear steepening.

Here are a couple of excerpts:

…weak aggregate demand and low oil prices have held down consumer price inflation. 

…domestic product (GDP) fell a cumulative 10 percent over the first half of 2020, and the measured unemployment rate spiked to a post–World War II high of 14.8 percent in April.
 

One of the new Fed talking points is that the jobs data understate true unemployment.  In the excerpt above it’s by referring to the “measured” unemployment rate.  On the inflation front there’s no such bias, even though most individuals (as evidenced by the U of M inflation expectations survey) feel like inflation is a problem.

The 12-month measure of PCE (personal consumption expenditures) inflation was 1.3 percent in December, while the measure that excludes food and energy items—so-called core inflation, which is typically less volatile than total inflation—was 1.5 percent. 

Spreads of yields on corporate bonds over those on comparable-maturity Treasury securities narrowed significantly, partly because the credit quality of firms improved and market functioning remained stable.   

Credit quality has improved???  If so, it is only because of low rates and government largesse.  What happens to credit quality over time if the back end of the Eurodollar curve is right about a forward projection of rates.?  Gold ED pack up 24 bps in a week!  Let’s hope nominal GDP growth is large enough so that interest carrying costs are easily absorbed.

A couple of more excerpts:    

Although government programs have supported business and household incomes, some businesses and households have become more vulnerable to shocks, as earnings have fallen and borrowing has risen. Strong capital positions before the pandemic helped banks absorb large losses related to the pandemic. Financial institutions, however, may experience additional losses as a result of rising defaults in the coming years, and long-standing vulnerabilities at money market mutual funds and open-end investment funds remain unaddressed.

The Committee’s employment and inflation objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it takes into account the employment shortfalls and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.

That is, we are emphasizing employment over inflation. 

OTHER MARKET THOUGHTS/ TRADES

Ark’s Cathie Wood whose high-flying new economy portfolios have made her firm a standout star, warned last week that higher interest rates could cause a reset of asset valuations.

As mentioned above, implied vols are perking up.  Treasury vol has been highly directional ended the week at new recent highs with TYJ 4.3 and USJ 9.7.  4EH 9850 straddle settled 20.5 with 19 days until expiry; EDH5 moved 22.5 on the week.

2/12/20202/19/2021chg
UST 2Y10.910.7-0.2w/I 11.0
UST 5Y48.557.79.2w/I 59.2
UST 10Y120.0134.114.1
UST 30Y200.4213.613.2
GERM 2Y-70.8-68.12.7
GERM 10Y-42.8-30.512.3
JPN 30Y66.368.42.1
CHINA 10Y324.3326.62.3
EURO$ M1/M25.06.01.0
EURO$ M2/M319.527.07.5
EURO$ M3/M450.560.510.0
EUR121.20121.200.00
CRUDE (active)59.3859.26-0.12
SPX3934.833906.71-28.12-0.7%
VIX19.9722.052.08
Posted on February 22, 2021 at 5:24 am by alexmanzara · Permalink
In: Eurodollar Options

Leave a Reply