Dislocations
April 9, 2025
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The bond market is breaking. The collapse of swap spreads is a terrible development. The pressure on the basis trade does not bode well. It shows funding issues, and also indicates that end demand for treasuries is drying up versus supply.
–From ‘Swap Spreads: Should We Be Worried’ by Kevin Muir, The MacroTourist, yesterday.
–ECB Ready to Ensure Financial Stability, Villeroy Says (Reuters this morning)
–News this morning is all about basis trades gone bad and swap spreads imploding. The thirty year yield exploded by over 30 bps in the past two sessions, ending at 4.706% yesterday. (higher overnight). My marks at futures close: 10y yield +9.7 bps at 4.25% while 10y swap was only +3.8 bps to 3.683%, Implied vol is screaming higher. All back SOFR calendars from SFRM6 back made new highs. Net changes in SOFR: Whites (1st yr) +4.125 bps, Reds (2nd) +2.125, Grns -3.875, Blues -6.625, Golds -7.25. Huge steepening. 10y auction today and 30s tomorrow, following a sloppy 3y yesterday.
–At the heart, it’s all about liquidity shutting down. Hedge funds ‘rent’ balance sheet from banks/dealers to enter these trades. If the financing window closes, panic ensues. The Fed WILL step in. If there’s a US treasury buyers strike (as intimated by Japan’s Ishida yesterday) that leaves the Fed as buyer of last resort. Powell is going to have to provide massive liquidity. Which in turn raises inflationary fears. Which in turn steepens the curve. By the way gold up $74/oz to 3064 (GCM5). High tick this month has been 3200. So far. We’ll see what the real definition of money is as April unfolds.
–What’s reflected in futures? First, there are obvious exits, but this is the pre-panic, not the actual panic yet. Open interest changes yesterday: TU +29k, FV -120k, TY -36k, UXY +2k, US -15k, WN -5k. These changes aren’t big enough to suggest massive unwinds. Yet.
–FFK5 traded to 9585.5 overnight, just one bp shy of certainty of a 25 bp ease at the May 7 meeting. Now prints 9578. Time to start thinking about a cut of 50 in conjunction with other programs. The Fed will not have the luxury of waiting for hard economic data.
–From late last month:
A panel of financial experts has urged the Federal Reserve to consider setting up an emergency facility to manage the potential unwinding of highly leveraged hedge fund basis trades – a move aimed at safeguarding the $29tn US Treasuries market from systemic risk, according to a report by Bloomberg.
Yes, the Fed is aware of and has been talking about basis trade risk for some time.
–I always remember the Asian financial crisis in the 1990s. There were articles about which hedge funds were at risk of failure. Someone interviewed Julian Robertson of Tiger. He said, we don’t have any exposure, when I started to see signs of trouble I told our traders to get out of everything related to Asian ccy’s. I didn’t want anything to do with it. The problem here is, you can’t avoid interest rate risk…
I am away the next few days.
