Short end weakness weighs on curve
Oct 27, 2021
–Curve flattened yesterday with the 2y yield up just over 1 bp while tens fell 1.6 to 1.617%. Today 5’s are auctioned as the NY Fed desk buys $1.425b 10-22.5 year treasuries, adding to flattener pressure. 2/10 closed 117 bps and 5/30 just under 87, both hovering near recent lows. A spread that made a new HIGH is the attached ten year treasury to inflation-indexed note yield spread, now above 269. While the predictive power of this spread is questionable, it’s worth noting that it is testing the highs of the past 20 years (278). It’s somewhat surprising that the curve shows no signs of life even as this proxy for inflation expectations climbs. Implied vol in treasuries underscores a begrudging bid in long treasuries, with the atm TYZ 130.5 straddle slipping to 1’19 or 4.3, towards the low end of the recent range. On Friday TYZ 130.5 straddle settled 1’30.
–On the dollar curve the first two reds remain the weakest, with both EDZ’22 and EDH’23 down 1.5 on the day. EDM’22/EDU’22 notched a new high at 18, up 1 on the day. The peak 3-month calendar on the strip is EDU’22/EDZ’22 at 23 bps; this is even wider than EDM’23/EDU’23 at 21, which covers the end of libor. EDZ’22 has the most open interest of any futures contract on the strip, just over 1.5 million. At a price of 9921.5 or 0.785% (with Z1/Z2 spread at 59 bps) this contract has at least two 25 bp hikes priced in. It would thus appear to be ‘cheap’. The problem for longs is, shorts are in control and inflation shows no sign of abating. The Fed is giving up on characterizing inflation as transitory and buoyant risk markets are testing the Fed’s soft mandate for financial stability. Slightly aggressive pricing for hikes into next year is weighing on the curve.
