The Last
June 11, 2023 – weekly comment
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“Every trail has its end, and every calamity brings its lesson”
James Fenimore Cooper – The Last of the Mohicans
A week from Monday will be the final settle of the last Eurodollar contract, EDM3. Eurodollar futures settle to three-month libor. As I recall, the survey question for final settlement was, “Where do you perceive the three-month offer rate to the best credits in the market?” It is an anachronism now, because of course the Fed backstops the biggest banks.
Above is a chart of 3-month libor. The top was 5.725% in September 2007. In the summer of 2006 (the last hike had been June 2006 to 5.25%) the libor settings were 5.50 to 5.52%. On Friday, the setting was 5.544%. Everything is almost exactly where it was at the top of the 2006 cycle. There’s a certain amount of symmetry here.
Someone had posted on twitter that when economic indicators are as weak as they are currently, the Fed is typically already easing. On the libor chart above, I list several such economic data points, and on the (busy) chart below I graph the data. Everything is weaker now than at the start of easing in 2007. EXCEPT, the unemployment rate now is significantly lower and inflation is higher. I.e. stagflation. One other point that bears mention. From June 2006 (last hike) to Sept 2007 (first ease) the ten year yield ranged from 4.5 to 5.25%. From Sept 2022 to now, the range in the ten year has been 3.375 to 4.25 (last at 3.74%). In that sense, perhaps the long end has already reflected easier conditions.
In the 2004-06 hiking cycle, SPX generally rallied. In 2007 it was clear there were problems in the mortgage markets, which the Fed deemed “contained”. On October 2007, SPX posted its high of 1565 (this was right after the first ease). By March 2009 SPX had lost 57%, bottoming at 676. Beware of the idea that Fed easing signals an “all-clear” with respect to stocks. The Fed eases when things are veering towards calamity.
This coming week has a lot packed in. On Monday and Tuesday are auctions: Monday: $58b 26-week bills, $65b 13-week bills, $40b 3-yr note, $32b 10s. Tuesday: $38b 52-week bills, $45b 42-day cash mgmt. bills, $18b 30-yr bonds. CPI is released Wednesday, expected 4.1% from 4.9% last, with Core 5.3% from 5.5%. NFIB Small Business Optimism expected 88 from 89. I believe the Fed will pause at this meeting and it will mark the end of the hiking cycle. However, I would guess that Powell will continue to project a hawkish outlook at the press conference. The goal is to convince the market that policy will remain tight, and that an ease will NOT occur this year. They’ve been pretty successful on that score after the March banking flare-up; SFRZ3 was 9575 in early May and is now below 9500.
The dot plot should be interesting. At the March SEP:
With SFRZ3 9496.5, it’s just a few bps from the year-end projected funds rate of 5.1%. SFRZ4 is 9642.0 or 3.58%, which is still quite a bit lower than the year-end ’24 projection of 4.3%. But SFRZ5 at 9680.5 or 3.195% is pretty close to the year-end ’25 projection of 3.1%. As of Friday, it appears as if the Fed has quite deftly guided the market towards its projections, outside of 2024. And even there, it’s worth noting that SFRZ4 has sold off by more than 80 bps in the past month.
OTHER THOUGHTS
When the CME floor was in its heyday it was a fantastic place to work. They called it highschool with a paycheck, but I always thought it would be hard to find such a wide spectrum of people crammed onto one floor, from pure idiots to geniuses, and a lot of street smart kids. There were plenty of insults and humiliation to go around. But, as the era of the eurodollar future draws to a close, I’ll just share a more human side of the pit.
A woman who had been working as a trade checker for a long time, had gotten backing for a seat. Trade checkers represented one or more pit traders and literally collected trading cards from them and confirmed trades during the day with other clerks (quantity, price, contract month). Anyway, this woman finally goes into the front month eurodollar pit as a trader, (we’ll call her Michelle). What happens the first day? One trader after another says “hey Michelle, you 8 bid? I’ll sell you 25. You at 9? I’ll buy 25.” That of course, was a trade infraction, but it was also a nice welcome to someone who worked their way up. By the way, that was not the case for someone who was trying to enter the pit and attempt to claim space as a new broker/local. I remember seeing a guy walk out of the pit bloody and sweaty because he was trying to take someone else’s floor spot, and he was not a small man.
Below is a constant maturity chart of the 3rd/7th/11th quarterly SOFR contract butterfly. Currently, that’s SFRU3 9476.0, SFRU4 9612.0, SFRU5 9676.5. So the butterfly is U3/U4 spread = -136 minus the U4/U5 spread = -64.5 or -71.5. This year has been sort of a roller coaster. From mid-Jan to March the fly went above 0 as the red (7th) contract sold off harder than the others. After SVB the fly plunged as the red contract outperformed to the upside. Now the fly is rallying again as the reds have led the sell-off since early May. I would be inclined to sell U3/U4/U5 if it can approach -55 to -50.
| 6/2/2023 | 6/9/2023 | chg | ||
| UST 2Y | 450.1 | 460.2 | 10.1 | |
| UST 5Y | 384.5 | 391.6 | 7.1 | |
| UST 10Y | 369.5 | 374.1 | 4.6 | |
| UST 30Y | 388.9 | 388.4 | -0.5 | |
| GERM 2Y | 279.6 | 291.6 | 12.0 | |
| GERM 10Y | 231.1 | 237.7 | 6.6 | |
| JPN 30Y | 126.5 | 125.3 | -1.2 | |
| CHINA 10Y | 271.5 | 269.0 | -2.5 | |
| SOFR U3/U4 | -156.0 | -136.0 | 20.0 | |
| SOFR U4/U5 | -52.0 | -64.5 | -12.5 | |
| SOFR U5/U6 | 0.5 | -6.5 | -7.0 | |
| EUR | 107.08 | 107.50 | 0.42 | |
| CRUDE (CLN3) | 71.74 | 70.17 | -1.57 | |
| SPX | 4282.37 | 4298.86 | 16.49 | 0.4% |
| VIX | 14.60 | 13.83 | -0.77 | |
NAPMPMI = ISM MFG
NAPMNMI = ISM Services
SBOITOTL = NFIB small biz optimism
EMPRGBCI = Empire State
OUTFGAF = Philly Fed
NYBLCNBA = NY Fed Biz Conditions
PNMARADI = Philly Fed Services
CHPMINDX = Chicago PMI
