Let’s run it thru the model
August 2, 2021
–A few things from Friday: the ten year yield fell 3.4 bps to 1.234%. There was a new buyer of 50k TYU1 133.5 put which settled 20 vs 133-145. On the short end, three-month libor set at a new all-time low of 11.775 bps. New recent low in EDH2/EDM2 at 4 bps, down 0.5 on the day.
–EDZ’22 which settled at 9960 is the first euro$ contract that prices one 25 bp hike (EDU1 is 27.5 higher at 9987.5). On the Fed Fund futures curve it’s necessary to go out to April’23 to find a contract that has a larger spread than 25 to the front contracts. FFQ’21 is 9991.0, the fed effective rate has been coming in at 10 bps, and at 9963.5, FFJ3 is 27.5 bps higher in yield than FFQ1.
–Employment data this week. Tracy Alloway of BBG notes that August can sometimes be a volatile month, noting the surprise 2015 China devaluation. The end of this month brings Jackson Hole, though much of the thunder of policy implications has already been stolen. It’s somewhat amusing that in May, China rebuffed US efforts to set a meeting between Def Sec’y Lloyd Austin and China’s top military leader, and again in July, snubbed Deputy Sec’y of State Wendy Sherman by refusing a meeting with her counterpart, but now China’s securities regulator is seeking closer cooperation with the US after the SEC tightened financial disclosure rules for Chinese companies seeking to list in the US. Money talks, as they say.
–The debt ceiling suspension officially ended, so now there will be nail-biting suspense relating to US borrowing plans. Spoiler: the US will raise the limit because it needs to borrow a LOT more.
–There’s a post on ZH which is an excerpt by Morgan Stanley’s head of US rate strategy. Although I agree with the conclusion that the ten year yield is too low, there’s not much meat regarding the MS argument. “We think that 10-year yields are too low versus our fair value estimate at ~1.60%, in large part due to positioning unwinds in recent weeks that have magnified the impact of negative COVID-19 headlines. In our view, yields do not appropriately reflect the strong US economy, or the Fed’s stance. With cleaner market positioning, our economists’ expectations for strong labor market and inflation data, and our base case for a deficit-funded infrastructure package, we see yields rising in the coming weeks.”
–So… the explanation for lower yields we have recently seen is due to short covering, as MS notes open interest in TY has fallen recently. There is also this line: “…most investors mistook the rise in yields as validation for a super-hot economy, and consensus bought into the idea that 10-yr yields were headed above 2%. We cautioned investors that yields had overshot relative to the economic reality.” OK, maybe these stats aren’t “super-hot”. Then again, maybe they are: Core CPI 4.5%, Core PPI 5.6%, Retail sales yoy in June 18.0%, Case-Shiller home prices yoy 16.6%, Q2 GDP 6.5%, Shot-and-killed in Chicago +9.0% yoy in July. Jalapeno or habanero? Finally, to get the “fair-value” estimate of 1.6, MS considers the timing and pace of rate hikes:
“Currently, 10-year yields imply that markets see the first rate hike in March 2023, and a pace of ~1.5 rate hikes per year thereafter. We think that this implied pace is too low, especially when one looks at the June dot plot…”
–So, here’s what we have: a short cover rally that took rates too low because the Fed will probably tighten more than the market thinks, because the economy is pretty darn strong. Makes it sound a little more impressive when a “fair value model” is inserted into the dialogue, doesn’t it?
https://www.zerohedge.com/markets/morgan-stanley-yields-are-ways-where-they-should-be
