It’s a Foghorn Leghorn Market

February 26, 2023 – Weekly comment

SFRM4 was down an astonishing 38 bps on the week to 9551, with the next closest, SFRH4, down 34 to 9508.  The high settle this year in M4 was on Jan 18 at 9683.5, a plunge of 132 bps in the space of a little over a month.  The lowest settle in this contract last year was on Nov 7 at 9564.  These moves have been extraordinary.  And, at 9551 or 4.49%, the contract is STILL pricing over ¾% of easing from the expected peak terminal rate, as SFRM3/SFRM4 one-yr calendar is -88. 0QM3 9550p, which had been bought in large size for 5.0 on February 1, settled Friday at 32.5.

The initial large catalyst was the Feb 3 payroll report with NFP of 517k.  Not all the news was hotter than expected over the month, but Friday’s PCE prices of 5.4% yoy with Core 4.7% vs expected 4.3% certainly was.  On Friday alone SFRM4 fell 21 bps and the 2-yr note jumped nearly 12 to 4.807%. That’s a new high for the cycle in twos, and the highest since the end of the last major hiking cycle of 2004-06 when the 2y yield topped at 5.28%, essentially equal to the FF target peak of 5.25%.  In mid-2006 all treasury yields topped around 5.25%, then fell back into the end of the year, and by mid-2007 tested or slightly exceeded the 2006 highs.  Then yields collapsed.  

As we move into March, it’s worth noting that the employment report is not the first Friday, but rather March 10.  The FOMC meeting is a week and a half later on March 22.  April treasury options expire on March 24.

Repeating from last week: “From February 2 on, the Fed Effective rate has been 4.58 except for one print at 4.57.  If the Fed hikes 25 in March the new EFFR should be 4.83, if 50 then 5.08.  April FF, which prices for the March 22 FOMC, made a new low this week, printing 9512.0 or 4.88.”  Last week was another new low at 9508, and the settlement was 9512.  Moving towards NFP and FOMC, it wouldn’t be surprising to see odds closer to 50/50 for a half-percent hike, meaning a price in FFJ3 around 9505. 

Two weeks ago the lowest contract on the FF strip was FFQ3 at 9470.5.  Last week August, Sept and Oct are tied at the low point, 9460.5 or around 5.4%. The assessment of the terminal rate has been adjusted a bit higher and nudged back.

Consider these one-year FF calendars:  FFJ3/FFJ4 settled positive 9 (9512/9503).  April is a ‘clean’ month, with no FOMC meetings.  On January 18, this spread had been -98.5.  So, in a little over one month the market changed perception, from an ease of 1% to NO EASE over the year.  Now look at FFK3/FFK4, just one month forward.  There is an FOMC on May 3 which is being fully priced for a 25 bp hike (FFJ3/K3 is 24 bps, 9512/9488).  FFK3/FFK4 is negative 33.5 (9488/9521.5).  Just like April/April, 100 bps of projected ease has been squeezed out as the spread rallied from -135 to -33.5 in the past month.  But the comparison of J3/J4 at +9, to K3/K4 at -33.5 still conveys a message of, “the more you hike, the more you’re going to have to cut.” 

2/10 remains pinned near historic lows at -86.  While there are signs of fraying at the edges, for example American Car Center, a sub-prime auto lender, just sub-merged, the Fed is focused on strong jobs and too-high inflation. And, though the Fed tiptoes around the stock market, the BOE’s Silvana Tenreyro isn’t timid: *BOE’S TENREYRO: SQUEEZE ON WEALTH WILL BRING DOWN INFLATION.  There.

Other news this week includes Chicago PMI on Tuesday.  At 44.3 last, there were only a few lower marks in the past 20 years outside of the GFC and Covid.  ISM Mfg is Wednesday.  Same thing, it’s at the low end of the last 20 years, eclipsed only by the GFC and Covid spikes.  ISM Services is Friday, and that of course, has not seen a sustained downturn.  Speeches by the Fed’s Jefferson on Monday, Goolsbee on Tuesday, and Waller on Thursday are likely Fed highlights.

OTHER THOUGHTS/ TRADES

Friday featured a new buyer of 100k 2QZ3 9775/9875 call sprd 7.0 to 8.0.  2QZ is a December midcurve on SFRZ5, settled 9.0/1.25 ref 9653, so 7.75. Perhaps just an opportunistic buyer given that Friday’s settle in Z5 is nearly 100 off the year’s high, set on Jan 18, of 9740.5.

While the recent sell off has been dramatic, consider the chart of SFRM4 below.  There have been two previous sell-offs corresponding with the Fed’s tightening cycle, both of nearly 200 bps.  The first started in March 2022 and ended mid-June, three and a half months.  The next started August 1 and ended Nov 7, a bit over three months.  This one began Jan 18 and has gone 132 so far.  If the time duration is similar, mid-to-late April, right in front of the May 3 FOMC would mark the bottom. 

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.

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