Euro$ futures pricing is clear. Crypto, not so much
July 10, 2022 – Weekly comment
Stronger than expected Jobs report solidified expectations for another 75 bp hike at the upcoming July 27 FOMC. Twos, fives and tens all started the week just above a yield of 2.8% but ended around 3.1%. Tuesday to Friday changes: two-yr 2.82 to 3.11, five-yr 2.82 to 3.14 and ten-yr 2.81 to 3.095. Thirty bp moves are not indicative of stable markets, and indeed the MOVE index posted a new high on Tuesday at 156, just shy of the covid surge high in 2020.
August Fed Funds (FFQ2) settled 9767.5 or 232.5 bps. Current Fed Effective Rate (EFFR) is 158, so another 75 bps takes it to 233. The lowest print on FFQ2 was June 15 at 9765, the date of the last FOMC meeting. At that point, the market was just slightly tilted toward fear of 100 in July. I suspect that will also occur this week, that is, we’ll see a print below 9767. The intervening high print on 7/1 was 9778.5, so even with that day’s weak Mfg PMI and decelerating new orders and employment components (49.2, 47.3) odds never favored 50 bps over 75.
Consider the changes in one-year Eurodollar calendars since June 15, the last FOMC. First, note that all near one-year calendars were in decline over that time frame, and the only positive one was EDU2/EDU3 which settled 54.5 on June 15. On Friday it settled 11, having plunged to -15.5 on July 5. The most negative one-year calendar is EDH3/EDH4, currently at -71. On June 15 it was also the lowest, but at that time it was -48.5. The point here is that even though all near contracts took a dive this week, forward spreads are clearly pricing more and more of an eventual ease. Below are levels:
June 15 July 8 change
EDU2EDU3 +54.5 +11.0 down 43.5
EDZ2EDZ3 -28.5 -61.5 down 33.0
EDH3EDH4 -48.5 -71.0 down 22.5
EDM3EDM4 -48.0 -64.0 down 16.0
EDZ2 9598.0 9614.5
EDZ3 9626.5 9676.0
EDH3 9587.0 9618.5
EDH4 9635.5 9689.5
A couple of things to note. On June 15, the lowest contracts on the strip, EDZ2 and EDH3 were above 4%. Now they are 3.80 to 3.85%. The EDH3/EDH4 spread has almost 75 bps of easing priced over that year period. The lowest any one-yr spread has settled over this cycle occurred last week with EDZ2/EDZ3 at -76 while EDH3/EDH4 was at -74. That’s not to say that the Fed is going to be successful in stopping inflation cold. It does however, suggest that large rate increases now will be quite effective in slowing the economy next year.
Why not just go 100 bps now to further crush forward inflation expectations? (The ten year breakeven has gone from 302 bps in April to 230 last week, ending Friday at 238). After the last 75 bp hike, which occurred in November 1994, forward one-year calendars plunged. For example EDU95/EDU96 (4th to 8th at the time) went from +68 in early November to -25 by mid-Dec. In the current episode, calendars have already moved to much more significant inversion. In other words, market signals already indicate recessionary conditions. There’s little to be gained by going more than is already being priced, especially with USD at its highest level since 2002.
Below is a chart of an indicator cited by Jeffrey Gundlach, the copper/gold ratio vs the US ten-yr yield. This chart suggests a further decline in the 10-yr yield, though there are a couple of caveats. First, it’s true that Dr Copper has had a hard break since May. On a long term chart, it’s clear that gov’t stimulus (related to covid) lit a fire under copper in 2020, just as it did during the post-GFC period. The waning of gov’t support for the economy is now a factor which is withdrawing support from copper prices, similar to 2011. However, China likely plays a larger role now than before. Also, CPI peaked at 5.6% in 2008, significantly lower than what is expected this week at 8.8%. US Govt debt to GDP was 64% in 2008, had risen to 84% by the end of 2009, but is now 125%, while the Fed is now engaged in QT. All of which suggests a floor for 10 yr yields which may make this chart less useful.
Auctions this week begin Monday with the 3-year ($43b), 10s on Tuesday ($33b) and 30s on Wednesday ($19b) raising $31.6b of new cash. Williams speaks Monday at an end-of-libor event. Barkin on Tuesday should be nothing new; last speech was June 22. Waller on Thursday on the economic outlook; his main concern is in arresting inflation. Bostic on Friday.
CPI is released Wednesday, expected 8.8% from 8.6% last, with Core yoy 5.8% from 6.0% last. Beige Book on Wednesday afternoon. Bank of Canada expected to hike by 75. RBNZ and S Korea also on Wednesday, with 50 bp hikes expected by both.
PPI is Thursday, expected 10.7% from 10.8% last, with Core yoy 8.3% from 8.3%
Retail Sales on Friday.
NFIB Small Business Optimism is Tuesday, expected 92.5 from 93.1. The 2018 peak was 108.8. From the last NFIB “Small business owners remain very pessimistic about the 2nd half of the year as supply chain disruptions, inflation and the labor shortage are not easing.” Chart below shows that the Russell exploded higher as the Fed and Federal Gov’t poured on the covid stimulus. It appears as though small business owners never really bought into it.
OTHER MARKET THOUGHTS/CONCERNS
On Friday, July 8, Fed Vice Chair Lael Brainard gave a speech on crypto assets as related to financial stability. Here are a couple of excerpts:
We are closely monitoring recent events where risks in the system have crystallized and many crypto investors have suffered losses. Despite significant investor losses, the crypto financial system does not yet appear to be so large or so interconnected with the traditional financial system as to pose a systemic risk.
There are two specific areas that merit heightened attention because of heightened risks of spillovers to the core financial system: bank involvement in crypto activities and stablecoins. To date, crypto has not become sufficiently interconnected with the core financial system to pose broad systemic risk.
Brainard lists risks with crypto that are similar to traditional finance: leverage, settlement, opacity, runs and regulatory evasion. In both of the passages above, she says that crypto does not pose a systemic risk…yet. Her hedged language might make even the casual non-crypto observer a bit uncomfortable. Perhaps it’s no coincidence that two damning crypto stories hit my e-mail this week. The first is by Matt Taibbi, ‘The Financial Bubble Era Comes Full Circle’ dealing with an utter lack of opacity related to the Circle Reserve Fund (Fidelity and BlackRock are reportedly investors). The second is Doomberg’s ‘Wen Bazooka’ citing the failure of Terra/Luna, which spilled over to Celsius, and then to Three Arrows (reportedly with $3 billion in assets). I won’t attempt to sum up the details. I would only note that stories about crypto linked to financial stability, along with the Vice Chair saying the risks aren’t systemic only makes me conclude one thing. The risks are systemic.
| 7/1/2022 | 7/8/2022 | chg | ||
| UST 2Y | 284.1 | 311.7 | 27.6 | |
| UST 5Y | 289.4 | 313.9 | 24.5 | |
| UST 10Y | 289.9 | 309.5 | 19.6 | |
| UST 30Y | 312.7 | 326.4 | 13.7 | |
| GERM 2Y | 51.5 | 52.7 | 1.2 | |
| GERM 10Y | 123.2 | 134.5 | 11.3 | |
| JPN 30Y | 122.6 | 124.2 | 1.6 | |
| CHINA 10Y | 282.9 | 283.9 | 1.0 | |
| EURO$ U2/U3 | -13.5 | 11.0 | 24.5 | |
| EURO$ U3/U4 | -42.5 | -47.5 | -5.0 | |
| EURO$ U4/U5 | 8.5 | 3.0 | -5.5 | |
| EUR | 104.30 | 101.86 | -2.44 | |
| CRUDE (active) | 108.43 | 104.79 | -3.64 | |
| SPX | 3825.33 | 3899.38 | 74.05 | 1.9% |
| VIX | 26.70 | 24.64 | -2.06 | |
https://taibbi.substack.com/p/the-financial-bubble-era-comes-full
https://www.federalreserve.gov/newsevents/speech/brainard20220708a.htm
