As subtle as a sledgehammer

August 28, 2020

–Yields jumped on Thursday with tens up 5.7 bps to 74.2 and 30s up 9.7 to 1.497%.  The curve steepened with 2/10 up 5.3 to a new recent high of 58.6 and 5/30 nearing the high of this calendar year at 119 bps (hit 122 this morning).  There’s a double top in 2/10 at 68 and the high so far in 2020 for 5/30 is just above 122, which had not been previously seen since 2017.  The changes in money market funds offered by Vanguard was cited by Edward Bolingbroke of BBG as a catalyst for heavy selling volume in eurodollar contracts.  The link below crystallizes the sentiment change; “…Vanguard believes it’s better to seek to provide clients with a higher yield through lower expenses on a secure government portfolio than incurring risk in the prime market.”  They are changing one MM fund to a gov’t money mkt and letting commercial paper holdings roll off in other funds to be replaced with T-bills.  Large operators are perceiving risk at these paltry yield levels.  The front Dec EDZ0 contract settled 3 lower on the day, although EDH1 and EDM1 were only down 1.5.  The spread between FFF1 and EDZ0 perked up by 3 to end at 25. This spread had been hanging around 21.5 to 22.0 and is a forward lib/ois indicator.

–Added to the mix was Powell’s speech outlining the change in the Fed’s policy framework to incorporate inflation averaging.  It’s not as if this was unexpected, but market action both leading into and out of this announcement also reveals the possibility of a massive change.  The Fed fears deflation expectations even though they don’t appear to be a present risk.  Here’s an important snippet from Powell:  “In addition, our revised statement says that our policy decision will be informed by our ‘assessments of the shortfalls of employment from its maximum level’ rather than by ‘deviations from its maximum level’ as in our previous statement.  This change may appear subtle but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation.”  

–My personal experience is that subtle changes have a way of coming around to bite you in the ass.  The market latched onto the shift and is starting to process the ramifications.  My guess is that the smart guys have already positioned for a Fed trying to “buy inflation” (as Joe Carson put it) and are ready to press.  There’s no question that a lot of things have gotten squirrelly this year.  The curve was flattening recently, players were selling pre-election rate vol with barely a passing nod to the concept of risk, because we all KNOW the Fed’s on hold and that the Fed’l gov’t is pulling out all stops to support the economy.  Except this: Vanguard perceives credit risks. Capital One is cutting credit cards limits and boosting reserves due to withdrawal of gov’t support of households. Airlines are demanding additional aid to forestall job cuts.  The Fed is making not-so-subtle changes that could spill over into financial stability.  The Fed’l government has reverted to a bickering stalemate because they’ve bought into the idea that a levitating stock market means things aren’t all that bad.  Hmmm, maybe vol sales at these levels don’t really provide a cushion.  Hmm, maybe credit spreads aren’t really providing any measure of safety.  Hmm, maybe the Fed has inspired a move which has brought the discounted flow of future earnings WAY forward, and a steeper curve might cause our assumptions to fly out the window.  We’ve already had a bone-crushing year.  No, the capital markets are NOT back to normal, they’ve just been papered over with a monetary veneer.  

–Oh, and have you ever heard the one about insurance companies selling bond holdings to pay claims, like those associated with Laura and CA wildfires?

https://www.prnewswire.com/news-releases/vanguard-announces-changes-to-money-market-fund-lineup-301119722.htmlhttps://

www.zerohedge.com/markets/feds-policy-mistake-buying-more-inflation-will-lead-financial-instabilityhttps://

www.zerohedge.com/markets/capital-one-cuts-credit-card-borrowing-limits-us-reduces-support-unemployed-americans

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

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