SOFR put fly: higher for longer
August 26, 2022
–It’s all about Powell today. Yesterday, rate futures rallied as those who had needed short hedges were already done by yesterday morning, leaving little remaining upside resistance. Tens fell 8 bps to 3.024%. On the eurodollar curve longer contracts led the way: red pack +2.5, greens +4.125, blues +5.75 and golds +8. There was a large new buyer of about 70k 0QZ2 9650/9600/9550p fly for 8.5 (settled 8.75). This trade is a midcurve which expires December 16 on SFRZ3 underlying (9665.0s).
–The lowest contract on both the ED and SOFR curves is March’23. EDH3 settled 9596 and SFRH3 9623. By Dec’23, the market anticipates easing, as EDZ3 is 9639 (a rate 43 below EDH3) and SFRZ3 is 9665 (42 lower in yield than SFRH3). If the curve stays the same, then the Dec’23 contracts will roll down over time, and the Dec put fly that traded would naturally end up in the money. However, there are only 3 1/2 months until short Dec expiration. In my opinion, the large put fly isn’t so much about the idea of Powell being aggressively hawkish, it’s more that he will try to convince the market of a steadfast stance against inflation, which may mean either that hikes are stretched out over a longer period or that once a terminal objective is achieved, it won’t be coming down any time soon. If that’s the thought process, then it might make sense to do something like buy SFRZ2/SFRZ3 spread. But that’s already had a significant rally to -30 from around -65, so the fly is clearly more limited in risk, and not really dependent on 50 or 75, but on the idea of higher for longer, with a terminal rate around 4%.
–FFV2 settled 9701, still tilted toward 75 in September. FFF3 settled 9636 or 3.64%, currently projecting that the Fed needs to hike by 131 bps in the next three Fed meetings (Sept 21, Nov2, Dec 14).
