Cheap Insurance
December 3, 2020
–Yields continue to press higher with tens up 1.7 bps yesterday to 94.8. Curve steepened with both 2/10, at 78.4, and 5/30, at 128, with a couple bps of the year’s high. Red/gold euro$ pack spread added another 1.625 to close 64.875. This spread has been boosted by the libor extension announcement, as reds jumped on the delayed fallback provision. As 3-month libor is now expected to survive until June 2023, the three-month euro$ calendar that has come into play is EDM3/EDU3, which has surged from 4 to 9 bps in the past two days! The spread gained 1.5 yesterday.
–Ten year treasury to tip breakeven ended at 187 bps, a new high for the year. The dollar index broke below 91 this morning, Dec Euro future is holding above 1.21. China yuan remains near the strongest level of the year vs USD at 6.56.
–As mentioned, EDM3/U3 spread is reacting to the announcement that three month libor will continue through June’23. The market generally thinks the Fed will stick to its promise to hold rates near zero for 2 to 3 years. What I find somewhat surprising is that the EDU23 9950 straddle is settling at just 40 bps, with 1019 days until expiration. That’s a long time from now. EDU3 settled 9951.5. EDU3 9900 puts settled 7.0, 9925p 11.25. There was an interesting article about Mexico having entered a long term put trade on the average price of oil, which this year paid off to the tune of a couple of billion dollars, saving the country’s budget from a huge hole. Uncertainty with respect to the price of EDU3 has been illuminated by the libor announcement. But there’s also a curve aspect, a question of Fed policy, the status of USD as a reserve currency, the prospect of inflation. EDU3 options expire well after the next midterm elections. If anyone thinks an unexpected surge in rates could blow a hole in their portfolio or business model over the next 2 and 3/4 years, here’s a cheap hedge. THIS IS NOT A RECOMMENDATION, EVEN THOUGH IF YOU BUY THESE THE MOST YOU CAN POSSIBLY LOSE IS THE PREMIUM SPENT.
