Fed policy pivot 2H 2023
April 29, 2022
–Yields rose yesterday and the curve flattened, even as US Q1 GDP was reported at -1.4% vs expected +1.1%. The two year rose 7 bps to 2.646%, while tens added 5 to 2.863%. There were a couple of large trades in euro$ options: early buyer of 25k 0EQ 9750/9775cs for 2.5 (settled 2.25 vs EDU3 9654.5). Exit seller of 45k 0EZ 9550/9500ps at 6.25 to 6.0 (settled 6.25 vs EDZ3 9665.0). These underlying contracts, EDU3 and EDZ3, are only three months apart; the futures spread settled -10.5, and yet strike prices are 200 apart on these option trades, simply indicative of a huge range of possibilities in a market that was completely staid a few years ago.
–The attached chart is also focused on this part of the curve, namely the reds, or the second year forward on the eurodollar strip. The chart is the spread EDM’23 to EDU’23, which settled at a new low of -9.0 yesterday (9645.5 and 9654.5). The lowest low for a 3-month calendar was set last Friday and it was the next spread forward, EDU’23/EDZ’23 at -11.5 (settled -10.5 yest). On the SOFR curve, M3/U3 settled at -1.5, while U3/Z3 is the low point at -10.5. As the chart shows, EDM3/U3 was +24 in early October, when we thought the Fed would hike at a slow and measured pace, but plunged on Bullard’s blather of front-loaded aggressive hikes. Market pricing is concentrated on the second half of next year for when the economic slowdown accelerates and potentially causes a shift in monetary policy with a bias toward easing.
–I included the SOFR spread for another reason. Libor will be discontinued after the end of June’23, and ED contracts will change to SOFR at a spread of ~26. The SOFR/ED spreads in U3, Z3, H4 are pegged within a bp of 26. However, SFRM3 to EDM3 is 34, which gives the bittersweet taste of what’s lost with the end of EDs, namely a credit aspect. SFRZ2/EDZ2 is a spread of 37.5 (9722.5/9685.0). The idea of a turn in policy in the second half of next year is still reflected in SFRU3/Z3 at -10.5.
–One other note about the initial trade cited, the 0EQ call spread. It expires Aug 12, which covers the July 27 FOMC. I would note that the KC Fed’s Jackson Hole Symposium, which might grow in significance as this year progresses, is usually at the end of August.
–Today’s news includes the Fed’s preferred measure of inflation, Core PCE prices expected +5.4%. There was a late buyer yesterday of TY week-5 (today’s) 119.25p, paying 14 for 33k…protection against an outlier high number? TYM2 settled 119-115 but easily absorbed the put buy and was trading 119-14 shortly after.
