A look back at the 2018/2019 playbook
November 29. 2023
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Capitalism without failure is like religion without hell.
-Charlie Munger
–This is sort of funny, or maybe it’s not. I don’t really have time to do it justice but am throwing the ideas out anyway.
–This morning the Drudge Report starts with the headline: ‘Masks, Social Distancing Return to China – Europe on Alert’
Here we go again. I started to think about eurodollar call spreads that were bought in Q4 2019 in size.
–About a year ago, Nov 20, 2022, I wrote this on my blog:
“On Friday [nov 18] there was a buyer of 50k SFRU3 9700/9800 cs for 4.25 to 4.5 ref SFRU3 9615.5. Current EFFR is 383 bps.”
–What is amusing is that the same call spread, 9700/9800, 10 months forward has been bought in size this week at, of course, a much lower underlying futures level. SFRU4 settled 9538.5; U4 9700/9800cs settled 6.75. From the same blog linked above I wrote about the 2019 call spread buying. Of course at that time it was eurodollars:
In Q4 of 2018, Powell was talking tough on rate hikes. QT was proceeding at an increasing scale through 2018, and there were four 25 bp hikes in March, June, Sept and finally in December, to a peak 2.25-2.50%. Stocks slid hard in Q4 2018; the ED curve predicted ease with near calendar spreads inverted. From the end of December 2018 to the end of July 2019, FF were kept unchanged. Then there were three 25 bp eases, the last of which was October 30, taking the funds rate down to 1.50-1.75%. At that time, the Fed cited a strong labor market, inflation slightly below 2%, but weak business fixed investment and exports.
In November 2019, large buyers started pouring into 50 bp wide EDU’20 call spreads, starting with 9875/9925c spd for around 3.5 to 4.5 bps and moving up to the 9887.5/9937.5cs. It seemed odd, because EDU0 futures were stable at around 9840 to 9850. The market was expecting the Fed to remain on hold after the October ease.
–These EDU’20 call spreads were a covid play. If a new ‘pandemic’ hits the world, you’re not going to want to be short any 9700 sofr calls, I don’t care what the Fed says.
–However, the Fed isn’t talking about more hikes (well maybe Bowman is). Here’s Waller from yesterday’s Q&A according to ZH:
“If inflation continues to cool for several more months, maybe three to five months, and US central bankers feel confident it’s headed in the right direction, the Fed could lower the policy rate just because inflation is low.”
That doesn’t exactly sound like a sitting Fed Governor. It sounds more like a highly paid consultant. Or maybe a sitting governor lobbying to get on the consultant gravy train. But I digress.
–As noted by @rishisays it’s an invitation to put on the steepener, which of course, wasn’t lost on the market. Two and five year yields sank 10-12 bps, while the ten year fell just 5.2 to 4.336% and the thirty year just 1 bp to 5.522%.
–As mentioned, after the last ease in December 2018, all the trades in the short end were call spread buyers. History rhymes, as they say.
Yesterday: Buyer SFRH4 9487.5/9500/9512.5/9525c condor 1.75/20k
Buyer SFRJ4 9475/9493.75/9525/9543.75c condor 5-5.25/ 35k
Buyer SFR5 9650/9700cs 18.0/20k
This is just an example of some larger trades. On the SOFR curve the red pack was up 15.625, greens +13.625 and blues +10.
On the FF curve, the first contract at a rate below 5% is July’24 at 9503.5 (Note that after the Dec ’18 hike the Fed held steady until July) and the first contract below 4% is April’25 at 9600.5.
–Implied vol a bit higher in FV and lower in US, exactly what might be expected on a steepener that will likely cap any rallies in US relative to shorter maturities.
–News today includes 2nd estimate of Q3 GDP and Beige Book.
