Runaway train
September 15, 2022
–In my opinion, a rail strike would be bad. In previous years, I had the sense that major issues would be solved, usually at the last minute, but that worst case scenarios would be gingerly side-stepped. I now have no confidence in that viewpoint. It’s all like watching, well, a slow-motion train wreck.
–A whole new round of supply chain issues? A rate hike of 100 basis points ought to help solve that, right? I don’t think so. On the other hand, outside of mortgages, perhaps the average household isn’t as negatively (directly) impacted by higher rates as I have thought. In the three years from 2018 to 2021, total household debt grew by about 15% in total. The consumer credit portion was less than 11% growth. On the St Louis Fed website, credit card rates on ‘accounts assessed interest’ were 15.5% in May 2018, reached a high of 17.1 in May 2019 and in May 2022 are 16.6. Onerous, but not WORSE. Total business debt growth from 2018 to 2021 was 20%, and that’s where the rate hikes bite more, causing unprofitable businesses to close. Federal gov’t debt over the same time period grew 41%. Of course, that was done to save us…
–My point is that rate hikes work through culling the business herd. A company that takes on debt to buy market share while losing money on every transaction with the ‘innovation’ being rapid food delivery will be forced to retract. Higher rates accomplish this over time. It doesn’t happen instantly, but the Fed’s goal of higher unemployment to weaken demand will occur. However, the real driver of growth has been gov’t. MMT proponents think that gov’t debt can always be sold… to someone. (I used to think the worst outcomes could be avoided).
–In terms of activity yesterday, flattening continues on perceptions of the Fed bringing down the hammer on inflation. The 2y yield rose 2.8 while the 30y fell 4. Ten year yield down less than 1 bp to 3.416%. 5/30 treasury spread made a new recent low of -12.4. The low of this year was in June at -17, and in April the low was -12.6. Before that, a low of -11.2 in 2006 and before that, in 2000, a low of -67.5. 100 next week would like send us hurtling back to 2000.
–Treasury vol fell across the curve yesterday. A mkt maker friend mentioned that the Oct TY straddle seems cheap in front of next week’s FOMC, given uncertainty about the size of the hike (thanks RK). Yesterday morning, at-the-money TYV 114.5^ opened 114/116, and near the end of the day the atm 115^ was trading 108. Here’s a snapshot comparison to levels from the July week-5 straddle prior to the July 27 FOMC. [week-5 expired the Friday after FOMC, just as TYV does]. On Friday, 7/22 with TYU 119-285, the 120^ settled 116 (same as yesterday morning). On Monday, 7/25 two days prior to the FOMC decision, the atm 119.75^ settled 102 (just 6/64s below yesterday’s close). The thought is that time decay has already been sucked out of the Oct straddle, leaving a cheap gamma play.
