March 13, 2018. Front end weakness persists approaching EDH8 expiry
–Treasury supply was absorbed fairly easily with TYM trading a tight range around 120-03 both before and after the auction (Settled 120-06+). Yield was 2.889 with 2.5 bid to cover. Prior to the auction 20k TYJ 120 puts were sold covered 120-03, at 20. So 46 in the straddle, which settled 45. Puts were an exit. Thirty year bond vol was crushed, with USM closing at 7.5, a bit surprising in front of today’s inflation data and auction. (New sales of USM 141p in 6k, closed 0’56 ref 143-23).
–Today’s news includes CPI expected +0.2 both headline and core. Core yoy is expected +1.8, same as last, with headline +2.2.
–On the short end the main feature was continued widening of fra/ois spread. As a proxy the spread EDH8 to FFJ8 closed at 50 (+1.25), having pulled back to 41 earlier in the month. Further out the curve these spreads also made new highs: EDM8/FFN8 settled 42.5, having been 35.5 in early March. EDU8/FFV8 closed 36.5, not quite a new high, and EDZ8/FFF9 closed 37. This latter spread hit 40.5 in late Feb, pulled back to 32.0 on March 2, and has since rebounded.
–Front end weakness on the dollar curve has contributed to curve flattening. Red/gold euro$ pack spread ended 24.625, a new recent low and close to the absolute low of 19.25 set in the beginning of January. As March contracts expire on Monday, this spread could easily print new lows on a rolling basis, as EDH19/EDM19 settled 10.5 while EDH22/EDM22 is only 0.5. (Currently the M19 1y pack avg is 9816.5, and the 1y M22 avg is 96.975, a spread of 19.0). Does it make a difference? A flat or inverted curve is often associated with recession. The market already has three hikes fully priced this year with FFF9 printing 9783.5 or 2.165%, 74.5 bps above the current Fed effective of 1.42%. The Fed ‘dot’ projections may take on added importance at next week’s FOMC, especially for 2019 and beyond. The issues going forward are whether the fra/ois spread will revert lower again, and whether the next step-up in QT will start to bite (another $10 billion/month will roll off starting April, $6B treasury and $4b MBS). I believe the new rate is $30b month in total.
(Below charts, top is red/gold ED pack spread and underneath is Bond Vol).
