Shorter runway to runoff
February 9, 2025
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Futures Clearing and Execution/ amanzara@rjobrien.com
Truckin’, like the doo-dah man
Once told me, “You got to play your hand”
Sometimes the cards ain’t worth a dime
If you don’t lay ’em down
Truckin’ – Grateful Dead
I always thought it was “…the cards ain’t worth a ‘damn’” not ‘dime’. Another one of my long-held beliefs, shattered. I’m getting used to it. But I’ll double check with Liesman anyway. He’ll know.
These are hard hands to play. Plenty of bluffs. Sometimes better to just fold and preserve capital.
*This note is a little long. Can probably skip the following section; the point is that reserves may not be abundant or even ample; the end of QT draws near. Long-dated swap spreads shifted higher last week. I think the Fed will be extremely careful as it doesn’t want to risk a repo blow-up like that of September 2019. Market color below the charts if you want to skip forward.
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The Fed’s ‘Monetary Policy Report’ was released Friday, in preparation for Powell’s appearance before Congress this week.
https://www.federalreserve.gov/publications/files/20250207_mprfullreport.pdf
The report is comprehensive, but almost feels dated in some respects. We’re in an environment where things can change rapidly, and the confidence that reserves are ample may be misplaced.
Pages 43 and 44 of the pdf (pp 33 and 34 of actual report) were interesting: Nonfinancial business and household debt-to-GDP trending down since 2020. Bank credit continuing to decelerate.
Regarding reserves, from the Jan 29 press conference, Powell said, “So the most recent data do suggest that reserves are still abundant. …As always, we stand ready to take appropriate action to support the smooth transition of monetary policy, including to adjust the details of our approach for reducing the size of the balance sheet…”
Page 52 of pdf (pg 42 actual report)
Reserves, the largest liability item on the Federal Reserve’s balance sheet, have edged down $68 billion since late June 2024 to a level of about $3.2 trillion. Since the beginning of balance sheet runoff, reserves have been little changed because the reserve-draining effect of balance sheet runoff was largely offset by a $1.8 trillion decline in balances at the overnight reverse repurchase agreement (ON RRP) facility. Since June 2024, usage of the ON RRP facility has continued to decline to levels below $200 billion (figure B). Reduced usage of the ON RRP facility largely reflects money market mutual funds shifting their portfolios toward higher-yielding investments, including Treasury bills and private-market repurchase agreements. Conditions in overnight money markets remained stable. The ON RRP facility continued to serve its intended purpose of supporting the control of the effective federal funds rate (EFFR), and the Federal Reserve’s administered rates—the interest rate on reserve balances and the ON RRP offering rate—remained highly effective at maintaining the EFFR within the target range. Following the December 2024 FOMC meeting, the Federal Reserve made a technical adjustment to lower the ON RRP offering rate 5 basis points. The technical adjustment aligned the ON RRP offering rate with the bottom of the target range for the federal funds rate.
Below is a chart of the RRP. Indicates to me that perhaps reserves aren’t as abundant, and that the end of balance sheet run-off might be a lot closer. The second chart appears to support the thesis, swap spreads surged last week. Another nugget in the Fed’s report is that Hedge Fund Leverage is concentrated in treasury basis trades. Bessent’s comments that the administration is more concerned with ten-year yields rather than the Fed Funds rate might also provide a nudge to end QT.
Market color
Friday’s employment report sparked an increase in yields, most notably in shorter dates. The 2y rose just over 7 bps to 4.277%. SFRZ5 and H6 were weakest on the SOFR strip falling 9 to 9599.5 and 9603.5. SFRZ5 at 4.005% is right on top of the Fed’s FF projection for end of 2025, 3.875%. Notable is that bond vol didn’t ratchet up. The market doesn’t seem all that concerned about the idea of long rates shooting higher. While the 2y jumped 7.1 bps and the 5y rose 6 to 4.331%, the 30y yield only added 3.8bps to 4.682%. Peak open interest in March TY options remains 108.5c with 187k (paper long). On Wednesday there had been a buyer of 100k TYH 109p for 26 down to 18. On Wed that strike settled 20 vs 109-24 with a delta of 32. On Friday, futures settled 109-075 and the put settled 25, 42d (there were exit sales Friday of 20k from 29 to 30). With flat vol, value should have been 29.8, or just above 27 if taking out weekend time value.
Could 2/10 invert again? Sure is starting to feel that way. There was heavy call spread buying in SOFR options last week, but SFRH5 settled 9572, the lowest settle since November. SFRM5 settled 9583, -6.0. In the last several months there is only one lower settle in M5, 9582 on Jan 13. Short-end charts look an awful lot like a hiking cycle since Sept, but they are actually NO EASE charts. How does 2/10 invert? The Fed holds firm, and if data supports economic deceleration, buyers will move a bit further back on the curve. Fed ends QT and we could easily see 2/10 back at the December starting point of 0. Stocks are the wildcard. A hard slide would instantly spark calls for rate cuts.
Inflation expectations seem to be creeping up. A lot of talk about eggs, but since end of September, Live Cattle up 9.2% (ath this year), Corn +14%, Coffee up 50% (ath), Gold up 8.6% (ath). On the other hand, CLH5 settled Friday at 71.00 bbl, down from a high of 78.71 in mid-Jan. Forward oil contracts are lower. For example, CLZ5 contract is 67.70.
On Friday the U of Mich 1y inflation expectation surged to 4.3% from 3.3% and the 5-10 yr measure firmed to a new high of 3.3% from 3.2%, highest since 2008. The five-year breakeven (treasury vs inflation-indexed note) which made its low of the cycle in early September at 187 bps, is 262 bps now, up 75 bps in the five months since the first Fed cut (high since early 2023). 10y breakeven is 243, up 40 bps since mid-Sept.
On Tuesday Cleveland Fed President Beth Hammack gives a speech on the economic outlook. She dissented at the December FOMC, preferring no ease given the healthy labor market and elevated inflation. Powell appears in front of the Senate at 10, just after Hammack’s speech.
In ESH5, the last two Mondays featured hard breaks. First related to DeepSeek and second to tariffs. On Friday 1/24 ESH high was 6162.25 and Monday’s low 5948 (Range 214, midpoint 6055). On Friday 1/31 the high was 6147.75 and Monday’s low was 5936.50 (Range 211, midpoint 6042). Friday’s high was 6123.25 and the settle was 6049.50, right in between the last two midpoints. Weekend risk is back. Tomorrow’s low 5913??? (210 off Friday’s high).
A friend mentioned that spreads between one-month SOFR (SER) and FF contracts have been widening. I would note that FFH5/SERH5 has moved from 0 on 12/17 to 3.0 now, and FFJ5/SERJ5 has gone from 0 on 12/20 to 2.5 now. Below is a chart of FEDL01 (Fed-effective rate) to SOFRRATE.
End of quarter tends to spike. Both FF and SER contracts are arithmetically averaged over the contract month. But these spreads bear watching as March is end-of-quarter and end of Japanese year (March 31 is a Monday). April 15 is tax day. I would NOT be inclined to sell SFRH5 premium at these levels.
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News this week includes:
Monday:
NY Fed 1-yr Inflation Expectations 3.0% last. Perhaps important due to huge jump in U of Mich 1 yr expectations at 4.3%.
Tuesday:
6:00 NFIB Small Biz Optimism
8:50 Hammack on Econ Outlook. Dissented in December
10:00 Powell testifies to Senate
1:00 3yr auction $58b
Wednesday:
8:30 CPI yoy expected 2.9 from 2.9, Core 3.1 from 3.2 Also Annual Revisions
10:00 Powell testifies to House
1:00 10yr auction $42b
2:00 Federal Budget
Thursday:
8:30 PPI and annual revisions. Jobless Claims
1:00 30yr auction $25b
Friday:
8:30 Retail Sales
9:15 Industrial Production
| 1/31/2025 | 2/7/2025 | chg | ||
| UST 2Y | 423.0 | 427.7 | 4.7 | |
| UST 5Y | 436.4 | 433.1 | -3.3 | |
| UST 10Y | 457.1 | 448.3 | -8.8 | wi 448.0 |
| UST 30Y | 482.2 | 468.2 | -14.0 | wi 468.1 |
| GERM 2Y | 211.9 | 204.8 | -7.1 | |
| GERM 10Y | 246.0 | 237.2 | -8.8 | |
| JPN 20Y | 192.6 | 196.6 | 4.0 | |
| CHINA 10Y | 163.0 | 160.6 | -2.4 | |
| SOFR H5/H6 | -33.5 | -31.5 | 2.0 | |
| SOFR H6/H7 | 5.5 | -2.0 | -7.5 | |
| SOFR H7/H8 | 7.5 | 4.5 | -3.0 | |
| EUR | 103.63 | 103.30 | -0.33 | |
| CRUDE (CLH5) | 72.53 | 71.00 | -1.53 | |
| SPX | 6040.53 | 6025.99 | -14.54 | -0.2% |
| VIX | 16.43 | 16.54 | 0.11 | |
| MOVE | 91.76 | 93.13 | 1.37 | |
