Pricing the Fed’s Resolve
April 26, 2022
–What has been the weakest (lowest priced) contract on the eurodollar strip bounced the most on Monday with EDM3 +14.5 to 9650.5, as the market re-assesses whether the Fed will have the resolve to walk the walk on aggressive rate hikes in the face of weakening stocks. From the highs in November, Russell is down 20%, Nasdaq Comp -19%, and from the high made in January SPX is down 10.4%. Heavy tech earnings reports in the next few days, with MSFT, GOOGL and TXN today (along with V, RTX, ADM…). A slowdown in GDP growth will also test the Fed, with advanced Q1 GDP expected 1.1 to 1.3% on Thursday. GDP Now from the Atlanta Fed is currently projecting 1.3. On Friday, the Fed’s preferred inflation data are out, with PCE deflator expected 6.7% from 6.4 last, and Core 5.3% vs 5.4 last. Lower growth, high inflation.
–The curve steepened, most notably on the ED strip, with reds, the second year forward, +12.25, but greens and blues only +7.125 and +7.25. The 2y note yield fell 8.7 bps to 2.626% in front of today’s auction. New recent low posted in EDU2/EDU3 spread at 76.5. EDU2 was +7 to 9732.5 while EDU3 jumped 13 to 9656.0. EDM2/M3 settled 161, so the difference in these spreads reflects front-loaded tightening. A new low in EDU2/U3 is consistent with a rapid move to “neutral” followed by stagnation. Indeed, the spread between FFN3 and FFF4 (July to Jan Fed Funds) settled at an inverted -7.5, 9680.5 vs 9688.0 with the former +14 and latter +20. According to this spread (which had been settling around +1 to +5), the bias for the second half of next year is for easing rather than tightening.
–Yesterday, I marked the long green atm straddle strip at 724 bps (sum of EDM4, U4, Z4 9687.5^ with EDH5 9700^). A couple of weeks ago, the strip (I believe it was all the 9700 strike at the time) traded 656. The long-dated straddles are pumped! I suppose it should be no surprise, given daily ranges like yesterday’s, where EDM4 had a range of 25.5, and the straddle settled 173.25. The back end of the dollar curve is inverted, with reds (2nd yr) at 9662 or 3.38% while greens (3rd) are 9689 or 3.11%. The takeaway is that uncertainty is highly priced, even in the not-too-distant future.
