Pulling the end of hikes forward
May 26, 2022
–For a long time, June’23 has been the inflection point on the euro$ curve. It’s still the cheapest contract on the curve at a price of 9685.5, However, EDH3 settled at 9886, essentially the same price. On the SOFR curve, March and June 2023 contracts did settle at the same price 9712.0 or 2.88%. As noted on the attached chart, in the past 11 sessions the H3/M3 three-month calendar has collapsed from 11.5 to zero. It’s telling us that the market perceives the end of the Fed’s hiking cycle to be moving nearer in time, at a terminal rate that is well below 3%. (Thanks MW, for pointing out). I’m not saying this signal is necessarily correct, but it’s unmistakable. Also note that the peak one-year calendar, EDM2/EDM3 made a new recent low of 136.25 yesterday. We’re only a couple of weeks away from the June’22 expiry, and the next one-year calendar is Sept/Sept, which is just 53 bps in euro$s and 52 in SOFR. Then EDZ2/EDZ3 is negative 5.5.
–The FOMC minutes start off with “Developments in Financial Markets…” The manager (Lorie Logan?) notes, “Viewed over a longer time horizon, financial conditions, as measured by many financial conditions indexes, had tightened by historically large amounts since the beginning of the year.” HISTORICALLY LARGE. From the staff section: “PCE price inflation was expected to be 4.3 percent in 2022. PCE price inflation was then expected to step down to 2.5 percent in 2023 and to 2.1 percent in 2024 as supply–demand imbalances in the economy were reduced by slowing aggregate demand and an anticipated easing of supply constraints.”
Risks to economic activity are seen as skewed to the downside, while risks to inflation seen skewed to the upside.
–Big trade on the day in the short end was a buy of 35k SFRH3 9725/9775c 1×2 for a credit of 1 to 0.5. SFRH3 settled 9712.0. That trade accounts for almost all open interest in March’23 SOFR calls. Upside breakeven just above 9825 or 1.75%. I’d like to see open interest changes for all SOFR options. BUT I DON’T SEE A SOFR DAILY BULLETIN on the CME website. Implied vol across rate products declined, with notable selling of EDZ2 and EDH3 straddles. TY vol now sub 7. Bullard inspired panic has now subsided.
–News today includes Q1 GDP 2nd revision expected -1.3. Job Claims expected 215k. KC Fed Mfg activity expected 18 from 25. This latter isn’t a big data point, but I will note that since the start of 2021 the low has been 19.
