Master of your own domain
September 29, 2022
–Central bankers are in a contest to determine who is the master of their own (inflation) domain. Yesterday, Andrew Bailey walked in, slapped his money down on the table, and blurted “I’m out!” Like Kramer.
–Capitulation. First it was the LME with the margin call on nickel and now it’s the Bank of England, meeting the margin call for gilt longs. Teetering on the knife’s edge of financial disaster. Get used to it.
–Bostic favors another 75 bp hike in November. Evans was also out yesterday in support of higher US rates into the end of the year. Yesterday, ten-yr and bond futures made now lows for the move, had outside day ranges on heavy volume and closed near the highs of the day. Classic reversal formation. However, this morning much of those gains have been given back. If lows are breached, it’s going to be a puke. Going into the last quarter, risk is likely to be pared back and liquidity will suffer.
–Remember the “turn-of-the-year” phenomenon when December eurodollar contracts would invert due to technical demand for funding that covered year-end? It’s BACK. Yesterday, EDZ2 was +2.5 to 9533 and EDH3 was +14.5 to 9535. An inverted spread of -2, new low. SFRZ2 to EDZ2 closed at a new high of 42 (9575/9533). Yesterday, there was a buyer of a few thousand EDZ2 9475/9600 strangles for 9.0. This guy remembers. Settled 9.25 (4.50 and 4.75). One last hurrah for the eurodollar contract before it’s completely replaced with gender-neutral SOFR. SFRU2/EDU2 had compressed all the way to 10 before expiration. The December spread is a stark reminder that the bank funding window might get sealed shut for winter. DO NOT BUY EDZ2 contracts.
–Ten year note vs inflation-indexed tip yield ended at 234 bps, around where it was in the beginning of July. It was over 3% in April. The metaphorical storm surge in markets is like Hurricane Ian, submerging homes, tossing cars around, and I can almost bet we’ll have an academic central banker smugly remark, “Forward inflation expectations are well moored. It’s apparent in the breakevens.”
