Notes on rates
February 12, 2023 – Weekly comment
On the week the US 2y yield was up 21 bps, just over 4.5% (4.511). The 5y was up over 26 bps to 3.926%, and the 10y was up 22 to 3.745%. The German 2y was also up over 20 bps to 2.76%.
On the SOFR strip, H4 and M4 were the weakest, both down 36 bps on the week! SFRH4 settled 9559.5 or 4.405% and SFRM4 at 9607.0 or 3.83%. At the December 2022 FOMC, the Fed’s year-end FF projection for 2023 was 5.1%. SFRZ3 settled at a new contract low 9514.0, down 30.5 on the week. This contract has never traded below 9500 or 5%. FFF4 settle was 9509 or 4.91%. The contracts that price for year-end 2023 are not quite at the Fed’s projection, but they are getting closer.
The SOFR contracts that ARE below 9500 (above 5% yield) are June’23, the lowest contract on the strip at 9482.0, and Sept’23 at 9487.0. These contracts are consistent with the Fed’s projections.
The Fed’s CPI projections at the Dec’22 FOMC were 3.1% by year-end 2023 and 2.5% for 2024. (Core 3.5 and 2.5). CPI is released Tuesday and is expected 6.2% yoy from 6.5% last, with Core 5.5% from 5.7% last. For year-end 2024, the Fed projects 100 bps of ease, with FF’s penciled in at 4.1%. SFRZ4 settled 9662.0 or 3.38%, and FFF5 at 9656.5 or 3.435%, so the market currently perceives more easing will occur than the Fed thinks. (Note there is really no open interest in FF contracts past June’24).
Summarizing weekly changes on SOFR contracts:
SFRH3 down 5 bps to 9507.0
SFRH4 down 36 bps to 9559.5
SFRH5 down 29 bps to 9673.5
SFRH6 down 21.5 to 9689.5 (this is the highest priced/lowest yield on SOFR strip)
In many ways Powell has to be pleased with the reaction to his guidance this week. Forward rates are moving toward the ‘higher for longer’ Fed view, and the pivot has been pushed back further in time. SFRM3/Z3 calendar was -54.5 three weeks ago, but settled at a new high -32.0 (9482/9514) Friday as rate cut expectations are slowly being pushed back. FFQ3 to FFF4 spread settled -27.0 (9482/9509) from -38 the previous week. That spread captures FOMC meetings in September, November and December. SPX was only down 1.1% on the week. The dollar strengthened. March WTI crude is nearing $80/bbl, up over $6 on the week.
A few large trades grabbed attention this week: Huge buying of SFRU3 9450/9400 put spreads, for 5.5 to 6.0 ref 9496/95; 150k. SFRU3 9462.5/9412.5ps 8.5 paid 50k. These put spreads settled 8.0 and 10.75 vs 9487.0. On Friday, there were new buys of 25k TY Week-3 Feb (2/17) 111p for 4 (settled 5 ref 122-22) and 13k 111.25p for 5 (settled 7). Currently the 111 put is about ¼% out of the money, approx. 4% on the current 10y assuming a parallel curve shift. At this time, the FF target range is 4.5-4.75%. If the Fed were to hike 25 bps at each of the next four meetings through July, the FF target would be 5.5-5.75%, right at the upper strike of the 9450/9400ps. It was less than one year ago on March 16 2022 when the Fed first raised from 0 to 0.25-0.50%. A 25 bp hike at next month’s meeting, which is fully priced, will put the FF target at 4.75-5.0%. That’s a lot of tightening that still needs to work thru the system.
There is huge open interest in the first four quarterly SOFR put options. March, 1.888m, June 2.388m, Sept 3.038m and Dec 0.808m. Over 8 million puts vs 4.89m open in the first four quarterly futures. Those put totals exclude 2.2m in April options and 1.05m in May (both with SFRM4 as underlying).
I am just summarizing some structural aspects of the market because it still appears as if the range of economic outcomes is quite broad. Geopolitical issues are fluid. There’s a lot of focus on China’s re-opening, though China’s ten-year yield is stagnant around 2.9%. The cap on Japanese Gov’t bonds is likely to be further relaxed with the installation of the new BOJ head, Ueda. Japan’s core consumer prices were up 4% yoy in December, vs a cap of 50 bps on JGBs. Japan is also reportedly reversing its stance on nuclear power.
On a more anecdotal level, it seems as if tech job cut announcements are large and accelerating, at odds with the huge payroll number last week. I went to the main RJO downtown office for the first time since COVID, and mid-morning pedestrian activity is depressingly sparse. A guy in the office said five Starbucks in walking distance had closed. On the other hand, an early evening trip for drinks found the bar completely packed. Then again, I took an UBER from the Viagra triangle to Wilmette at about 8:30 and the cost was only $34.95, whereas a cab would have been over $40 pre-covid. A friend said his daughter is looking at houses in the far western suburbs of Chicago and every home between $250 and $350k has a bid on it in the first day.
2/10 last week trade below -82. The treasury market is clearly signaling an economic slowdown, while the front end accepts the idea that crushing inflation is still the Fed’s number one job and is pricing further hikes accordingly.
Fairly big news week: CPI Tuesday. Retail Sales and Industrial production Wednesday, along with a 20y auction (w/I 3.96/3.955 vs 3.678 last month). PPI, Housing Starts and Philly Fed Thursday.
| 2/3/2023 | 2/10/2023 | chg | ||
| UST 2Y | 429.9 | 451.1 | 21.2 | |
| UST 5Y | 366.2 | 392.6 | 26.4 | |
| UST 10Y | 352.5 | 374.5 | 22.0 | |
| UST 30Y | 362.7 | 382.7 | 20.0 | |
| GERM 2Y | 254.7 | 276.0 | 21.3 | |
| GERM 10Y | 219.2 | 236.4 | 17.2 | |
| JPN 30Y | 151.2 | 158.4 | 7.2 | |
| CHINA 10Y | 289.5 | 289.2 | -0.3 | |
| SOFR H3/H4 | -83.5 | -52.5 | 31.0 | |
| SOFR H4/H5 | -107.0 | -114.0 | -7.0 | |
| SOFR H5/H6 | -8.5 | -16.0 | -7.5 | |
| EUR | 107.99 | 106.79 | -1.20 | |
| CRUDE (CLH3) | 73.39 | 79.72 | 6.33 | |
| SPX | 4136.48 | 4090.46 | -46.02 | -1.1% |
| VIX | 18.33 | 20.53 | 2.20 | |
