Financial Conditions Tighten from Bottom Up
November 12, 2023 – Weekly Comment
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This post concerns potential tightening of financial conditions from a layer or two below the obvious surface markers. We typically think of the Fed’s definition of financial conditions as comprised of short and long term interest rates, the value of the dollar, the equity market, and credit spreads. The items listed below can impact all of those categories, but are a level or two lower and may give an early warning before feeding into broader public awareness of tightening.
Inspiration for this note comes from this specific link from @JG_Nuke and @m3_melody
https://twitter.com/JG_Nuke/status/1722361440357462275
The video link above includes several news stories from last week that are perhaps under the radar but could significantly tighten financial liquidity. I have sourced every story and provided some links at bottom.
The big and obvious events from the previous week were Powell’s comments -which flattened the curve- and the awful 30-year treasury auction. On Friday afternoon, Moody’s put the US on notice for downgrade.
Below are other concerning news stories, primarily related to mortgages/agencies:
1) Freddie Mac to temporarily halt dealmaking with Meridian Capital.
Full details of the investigation were not immediately clear, but as [Meridian is] one of the biggest commercial mortgage brokerages in the United States with a robust portfolio of agency multifamily originations, there could be far-reaching impacts for the industry. After all, in 2022, Meridian took the crown for the most Freddie Mac and Fannie Mae (FNMA) originations through lenders for the seventh year running.
2) Mr. Cooper mortgage servicer hacked; mortgages temporarily couldn’t be paid or accessed. Largest holder is Blackrock at 16.7%.
Mr. Cooper, the largest home loan servicer in the United States, says it found evidence of customer data exposed during a cyberattack disclosed last week, on October 31.
The home loan servicer says it has a customer base of 4.1 million and is managing loans totaling $937 billion, according to Q3 2023 results reported in October.
3) Fannie Mae subjects broker-involved agency loans to pre-review. This is analogous to banks tightening lending standards to make sure correct documentation is in place, and to guard against fraud.
4) DTCC notification MBS-1280 23 from November 6, 2023 (linked at bottom). This is like higher margin requirements for MBS.
5) Banks will have more limited access to FHLB funding. This source of funding got a lot of banks over the hump during the March-May banking issues. Expect to see a lot more direct discount window borrowing.
US Calls For New Limits To Wall Street Bank Backstop After March Crisis (BBG)
November 7 – Bloomberg (Austin Weinstein): “US officials will seek to limit access to Federal Home Loan Banks after failing lenders turned to the $1.3 trillion system in desperate bids to survive March’s banking crisis. The Federal Housing Finance Agency will try to push FHLBs back to their roots in housing finance, and away from serving as lenders of last resort to troubled banks, according to a report
6) ICBC, Industrial and Commercial Bank of China, the world’s biggest bank, was hacked Thursday, with some saying that event contributed to Thursday’s weak US 30y auction (which featured a huge 5.3 bp tail). The alleged hacking group is known as LockBit. (BBG) A cyber-security expert said “The founder of LockBit runs it as if he were Steve Jobs, which is successful for them but very bad news for the rest of us.” More frequent ransomware attacks on payment infrastructure systems can contribute to illiquidity.
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Economic data this week includes CPI on Tuesday, expected 3.3% yoy from 3.7%. Core expected 4.1 from 4.1. PPI on Wednesday expected 1.9% yoy from 2.2% with Core 2.8%. Retail Sales also Wed, expected -0.1 to -0.3% mom, from +0.7%. Philly Fed Thursday.
Interesting tweet from Bill Gross:
“The best interest rate trade is to bet on a disinvertion of the curve. The US economy needs a positive curve to grow as fiscal stimulus wanes. The curve can disinvert by 10 year note [yields] going up, 2 years going down, or both. But a year from now the current negative spread of 40 bps will be positive.”
2/10 ended Friday at -43.2 (5.06 and 4.628). Issues relating to mortgages and agency debt could hasten the first Fed cut.
Below is an image of the Fed trying to keep track of various economic agents.
OTHER THOUGHTS/ TRADES
On the week, SFRZ4 and SFRH5 were the weakest contracts, settling 9540.5 and 9565.5 both down 28. The two-year note jumped 23 bps to 5.06%.
However, popular trades Friday continue to target easing into the new year.
BUYER 30k SFRF4 9468.75/9475.0/9481.25/9487.5 for 1.25 (Settled there ref SFRH4 9466.0)
BUYER 25k SFRH4 9475/9500/9525c fly 1.5 (Settled there ref SFRH4 9466.0). FOMC is March 20, after options expire on March 15. Best outcome is for highly expected 25 bp eases starting in March.
BUYER 10k SFRU4 9525/9550/9575/9600c condor vs sell 9350p, 0.5 credit. Condor settled 2.25 and put 3.0 ref SFRU4 9513.0
There are already similar structures in April and June options. The 100 bp wide call spreads in March and June are still open but seeing less action. I continue to like short FFF4/FFJ4 calendar to capture an ease at either/both Jan 31 and March 20 FOMCs, settled -0.5 (9464.5/9465.0). I would have been short already at -3.0.
| 11/3/2023 | 11/10/2023 | chg | ||
| UST 2Y | 483.0 | 506.0 | 23.0 | |
| UST 5Y | 448.6 | 466.4 | 17.8 | |
| UST 10Y | 454.0 | 462.8 | 8.8 | |
| UST 30Y | 474.0 | 473.2 | -0.8 | |
| GERM 2Y | 296.1 | 306.6 | 10.5 | |
| GERM 10Y | 264.5 | 271.7 | 7.2 | |
| JPN 20Y | 169.0 | 154.9 | -14.1 | |
| CHINA 10Y | 266.7 | 264.8 | -1.9 | |
| SOFR Z3/Z4 | -106.5 | -81.0 | 25.5 | |
| SOFR Z4/Z5 | -51.0 | -57.5 | -6.5 | |
| SOFR Z5/Z6 | 5.5 | -1.0 | -6.5 | |
| EUR | 107.32 | 107.18 | -0.14 | |
| CRUDE (CLZ3) | 80.51 | 77.17 | -3.34 | |
| SPX | 4358.34 | 4415.24 | 56.90 | 1.3% |
| VIX | 14.91 | 14.17 | -0.74 | |
https://www.dtcc.com/-/media/Files/pdf/2023/11/6/MBS1280-23.pdfhttps://blinks.bloomberg.com/news/stories/S3XI5PDWX2PS
on November 15, 2023 at 1:53 am
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Hello Alex, interesting post. When you are short the FFF4/FFJ4 calendar is that short the back month? Seeing the spread values you mention (-0.5, -0.3) it appears so. (Market conventions on calendars seem to vary). Also, as you mention the March FOMC,
you roll the F4 at expiry?
Only recently became aware of your blog. An excellent daily read.