Bottlenecks that don’t open
May 27, 2021
–Yields edged slightly higher with tens up just over 1 bp at 1.574%. Once again, three month libor set a new historic record low yesterday at 13.5 bps, as the Fed’s monster RRP operation totaled $450 billion. Huge buyer of 50k EDU1 early at 9986.5 supported a final settle of 9987 or 13 bps, with EDM1/U1 settling at a new low of just 0.25. There was a chaotic trade in the US bond roll, with the June/Sept spread surging from around 1-19 to 2-24 on a massive buy; the exchange let all trades stand but capped the price at 1-26.25. A change of 2/32’s on a day is big. This error was extremely expensive with the spread settling 1-19. Trade was said to be over 200k contracts. 7/32’s on 100k contracts is $22mm.
–Quarles gave a balanced speech on the outlook of the economy, acknowledging economic strength and that inflation is significantly above 2%. His outlook is mostly optimistic about sustained strong growth due to savings and the continued re-opening, but he warned a couple of times on supply bottlenecks that could keep inflation elevated and said it would be appropriate to discuss tapering at upcoming meetings. He noted elevated asset prices and business debt, but also said cash flows were ample. Not as forceful as Kaplan’s comments have been, but his opinion likely carries greater weight within the FOMC.
–With money-market rates at rock-bottom lows, a change in IOER is almost certain to cause a small jolt to the short end. The lower these yields go in a blistering economy, the more likely that Dudley’s warnings about a taper ‘tantrum’ are likely to come true.
–Supplier delays are a form of inflation, and a leading headline from the FT highlights the situation: “Tesla set to pay for chips in advance to overcome shortage. Electric car maker also explores buying foundry but analysts warn of high costs.” When Quarles warns of the risk of continued bottlenecks, here’s a solid example.
–Durables and Capital Goods today, along with Q1 GDP adjustments. Jobless Claims expected 425k, Seven year auction.
https://www.federalreserve.gov/newsevents/speech/quarles20210526b.htm
