Long end weakness persists
February 3, 2021
–Nasdaq near ATH following AMZN and GOOGL results. Yellen stepping into the financial stability arena with investigative committees (uh-oh) as the spectacular short squeeze in GME et al abated.
–Weakness in the long end persists with tens and bonds up about 3.6 bps yesterday to 1.103% and 1.876% respectively. 5/30 treasury spread posted a new high of 143.3. On the euro$ curve, the red/gold pack spread (2nd to 5th year) made a new high just over 103, up 3.5 on the day as golds (5th year forward) fell 4.875 bps. The part of the curve that showed the most strength was the period straddling the June 2023 cessation of libor. For example, one-year calendars EDH3/EDH4 and EDM3/EDM4 made new highs at 44 and 46. The latter is the peak one-year calendar on the curve, just after libor ends, while EDU3/EDU4 is only 39. Of course, the three-month spread specifically covering the period, that is, EDM3/EDU3 closed at a new high of 17…recall that it was around 5 in late November just prior to the extension announcement. 3-m spreads just before and after this kink are 8.5 and 9.5.
–I’ve attached a red/green/blue pack butterfly chart which settled at a new low of -18.375, the difference between red/green at 23.75 and green/blue at 42.125. As can be seen the historical low on this fly is around -40, but its current level is the low since the end of 2013. Reasons for the weakness: 1) libor cessation plays a part 2) long end is building in an ‘inflation premium’ and 3) expectations that the Fed will be in a tightening cycle by that time. Perhaps out-of-control bond issuance is also a factor.
–A colleague within RJO had written a note about using long treasury vol as a replacement for the credit aspect of forward libor contracts when SOFR takes over. While I didn’t agree with some specifics, the broad point of treasury vol correlating with credit problems is certainly valid. With stocks near all-time highs and corporate spreads in the dirt, I suppose it’s reasonable that TY vol is languishing around 3.4. But if you think financial vulnerabilities are lurking just under the surface only to be exacerbated by the new Treasury Secretary’s focus on the issue, it might be wise to avoid heavy premium sales in treasuries.
