Market focuses two years forward for Fed changes
March 30, 2021
–Rumors of NFP even greater than the expected +650k and Wednesday’s expected $3 trillion infrastructure plan conspired against fixed income on Monday (with follow-on new lows this morning). New Fed Governor Waller categorically denied that the Fed will keep rates low to help fund the deficit. I’ve included a couple of speech snippets below, but omitted the hot mic, “We’re not Turkey, you know!”
–The ten year note rose 6 bps to 1.718%. Gold eurodollars (5th year forward) made new lows, falling 7.625. Red/gold pack spread posted a new high, just under 179 bps. with 2/10 just shy of its recent high of 158. The interesting aspect of yesterday’s curve trade is actually the jump in reds to greens, 2nd to 3rd year. Net changes: Reds -1.875, Greens -6.625, blues -7.0 and Gold -7.625. The kink here is obviously reds/greens….as if the Fed can hold the line on rates for the next two years (through reds) but will be nudged into action by the market by March or June of 2023. Similarly, 2’s/5’s had a nice boost of 3.4 bps yesterday.
–I’ve attached a chart of EDU2/EDU3/EDU4 futures butterfly which captures this dynamic, having jumped from -8.5 to flat in a couple of days as EDU2/EDU3 widened much faster than EDU3/EDU4. (thanks DK).
–Seller yesterday of EDZ1 straddle at 8.0, which then settled 8.5. Sort of amazing to me that with Archegos related stress at Credit Suisse and Nomura the market feels comfortable that nothing can happen over the next nine months into year-end. I’ll bet the Fed is happy they allowed banks to engage in share buybacks and dividends again, as they liberally employed off-exchange, off balance sheet CFD’s (contracts for differences) to abet Archegos. Buyer of 25k EDM1 9981.25/9975p 1×2 for 0.25 appears to be a roll up.
–Big Dallas Fed Mfg survey at 28.9 vs 16.8 expected. Price subsets also jumped. I have a cousin who owns a machine tool shop in St Louis (Precision Tools) who told me yesterday: “We have only seen a very modest increase in our raw materials prices, maybe 4-5% and this just recently occurred.” Half full can focus on “modest increase” while half empty can focus on “4-5% just recently”.
WALLER comments:
…Because of the large fiscal deficits and rising federal debt, a narrative has emerged that the Federal Reserve will succumb to pressures (1) to keep interest rates low to help service the debt and (2) to maintain asset purchases to help finance the federal government. My goal today is to definitively put that narrative to rest. It is simply wrong. Monetary policy has not and will not be conducted for these purposes.
Consequently, the argument goes that a hot economy may cause substantial inflation pressures that are hard to rein in politically, and which ultimately harm Americans in the longer run. This view is backed up by the political economy literature, which argues that having monetary policy under the control of political authorities may lead to excessive inflation and economic volatility that is not socially optimal.11 Put another way, it can lead to an unstable economy, on which households and businesses cannot rely.
