Oct 16. Front end weakness
–Yields rose across the board yesterday with tens up 2.2 bps to 316.1. Front end contracts under pressure, a combination of an increase in the turn and libor/ois widening. Early new selling in EDX8 contract at 9742.5-42, contract settled 97.4125. Jan Fed funds were unchanged at 9762.0, while EDZ8 fell 2.0 to 9730.5, which caused a new high in the spread (EDZ8/FFF9) at 31.5. There was a buyer of 20k EDZ8 9712/9750 risk reversals covered 9732 early for 0.25, bought calls. Asymmetry to the market in near contracts as it’s perceived that nothing can cause faster and more aggressive hikes, but a large disruptive financial event could end or reverse the Fed’s tightening bias. Having said that, the evaporation in option premium makes it seem as if the US curve is locked in cement. The first two midcurve straddles in greens and blues fell 1-2 bps yesterday, with 2EZ 9675^ closing at 20.5.
–With regard to front end pricing, the Nov contract covers the 3 month period beginning 14-Nov. The FOMC is 19-Dec. There are 57 days in the contract at the ‘new’ rate out of 92 or near 62%. Prior to the Sept FOMC, libor was 2.33 to 2.34. and just after was 2.37-39. On a hike assume new libor of 2.38 + 0.25 or 2.63 (97.37). Of the 25 bps 62% in the Nov contract is 15.5 bps, which would put the Nov contract at 9746.5 on 100% odds of hike (9762-15.5). Yesterday’s settlement of 41.25 is a discount of 5 bps, and of course weakness in EDZ8 shows the same thing. Turn pressure could worsen.
–In the past couple of weeks there has been heavy short covering of small otm puts. Yesterday another 50k covered in EDH0 9575p, 1.5 paid vs 9675.5 with 10 delta.
