Terminal and Neutral in Flux
June 12, 2022
Headline yoy CPI +8.6% with Core 6.0%. University of Michigan Consumer Sentiment 50.2, a historic new low. U of Mich 5-10 year inflation expectations 3.3, a level not seen since the 2008 peak of 3.4. Interest rate futures went into a tailspin, with EDH3 weakest on the ED strip, settling -28.5 at 9613.0. March’23 SOFR was also the weakest on that strip, settling -30 at 9641.0 or 3.59%. The lowest priced contract is EDM23 at 9608, -26 on Friday and -44 on the week, taking out May 3rd low settle by 23.5.
In treasuries, all maturities made new high yields except for thirties, which at 3.19% fell just a few bps shy of the May 6 high 3.23%. On the week, the two year note soared 38 bps to 3.047%. Twos and fives have now surpassed the high yields of 2018: 2y in 2018 hit 2.97%, now 3.065% and fives in 2018 reached 3.09% now 3.26%. Highs in 2018 for tens and thirties are 3.24% and 3.455% (vs current 3.16 and 3.195).
The market is now pricing a string of 50 (or more) bp hikes. I believe the first FOMC in 2023 is Feb 1, making Jan’23 a clean month for Fed Funds; FFF3 settled 9680.5 or 319.5 bps. Current Fed Effective is 83 bps, and there are five FOMC meetings before Jan’23 expiry, including this Wednesday’s. So that’s an average of 47.3 bps per meeting. Of course, near contracts have a bit more than 50 priced. For example, August FF which captures both next week and the July 27 meeting, settled 9803.5 or 196.5, an average of 56.75 for each of the two meetings. SPX down 5% on the week and Nasdaq Comp -5.6%.
5/30 re-inverted to -6.5 bps; the low in March was -12.9. What’s notable is that while red/gold euro$ pack spread settled at a new recent low of -56 (using the June contracts for one last day), it’s well above the April 1 low of -87. The attached chart is instructive.
That’s the Eurodollar futures curve. The amber dots are from Friday (June 10). The green dots are from May 3 when EDM’23 had put in its previous low settle at 9631.5. The blue lines are from 2 months ago. What is interesting is that, although the curve is inverted for the next couple of years starting in the middle of 2023, the amber dots from June 2026 forward are becoming steeper. I would take this as a rather bearish indication that forward inflation expectations are becoming more entrenched. That’s not quite borne out by the 5y5y forward inflation swap, which at 274 bps remains below late April (just above 280). I would simply conclude that the ‘terminal rate’ is moving steadily higher with much less certainty about its value. Weekend headlines like these: ‘US gasoline average price tops $5 per gallon in historic first’ (RTRS) and ‘Average rents top $2000 for the first time in US history’ only solidify rising inflation worries, and spill into a general sense of malaise.
Here are a couple of excerpts of Credit Bubble Bulletin commenting on the quarterly Z.1 report, emphasis added:
Household Net Worth was up $12.706 TN (9.3%) over one year, and $37.830 TN (33.9%) over three years – in history’s greatest inflation of perceived wealth. Household Net Worth-to-GDP declined to 612% (from 624%). But this compares to 491% at cycle peak Q1 2007, and 445% during peak Q1 2000. Years of asset inflation have fueled a consumer spending boom. The downside of the cycle will see sinking asset prices and tightened Credit conditions significantly restrain household spending.
…as bank and financial shares came under heavy selling pressure (with bank CDS moving sharply higher), gold enjoyed a burst of strong buying – ending the session up almost $24.
As yields rise, future streams of income are more heavily discounted leading to asset price declines. This dynamic is likely to be a major factor in the reversion of Household Net Worth relative to GDP. There have been several commentators, notably Bill Ackman, who have said that aggressive rate hikes now will cause longer dated bonds and other long maturity assets to rally. Refer back to the ED curve. The market is pricing in an ever more aggressive Fed, but the most deferred contracts are going down.
As a friend notes, gold is most responsive to crisis conditions in the global financial architecture, not necessarily inflation. The gold/silver ratio ended at 85.5. A key level appears to be 92 to 93, corresponding with the early 1990’s highs and the high from mid-2019. During 2020’s covid crisis it popped to 124. Gold itself has a double top around 2075, from the covid high and then the Russian invasion surge. XAU ended the week 1871.60. A close above 1915 portends new highs.
Any way they can do 75 on Wednesday? I calculate odds of just under 20%. Other news on the week includes NFIB Small Business Optimism, which was 93.2 last and has a covid low of 90.9. PPI also on Tuesday, yoy expected 10.8% with Core 8.6%. Retail Sales and the FOMC Wednesday.
OTHER MARKET THOUGHTS/ TRADES
SFRZ2 (December SOFR) settled 9674.0 or 3.26%. That’s higher than every on-the-run treasury yield except for the 20 yr, which implies NO positive carry. Current SOFFRATE is 75 to 80 bps.
EDH’26 settled 9684.0, which is near the highest price/lowest yield on the ED curve except for EDU2. The SEP quarterly projections from the Fed go out to 2024, and then “Longer Run”. In March, PCE inflation in 2024 was projected at 2.3% with longer run at 2%. There’s a reasonable chance that all inflation forecasts besides ‘Longer Run’ will be bumped up. 3EH 9500p (expires on EDH’26 underlying, 3/10/23) settled 5.25. 3EH 9600/9500ps settled 12.5. While there’s no open interest in Blue midcurve SOFR options to speak of, 3QH 9525p settled 4.75 ref SFRH6 9710.0s. The pit is making decent markets in SOFR midcurves. Given weakness in more deferred contracts, it’s worth looking at puts on this part of the curve.
| 6/3/2022 | 6/11/2022 | chg | ||
| UST 2Y | 266.7 | 304.7 | 38.0 | |
| UST 5Y | 295.1 | 325.1 | 30.0 | |
| UST 10Y | 296.2 | 315.6 | 19.4 | |
| UST 30Y | 311.2 | 319.3 | 8.1 | |
| GERM 2Y | 66.2 | 97.1 | 30.9 | |
| GERM 10Y | 127.3 | 151.6 | 24.3 | |
| JPN 30Y | 102.3 | 108.7 | 6.4 | |
| CHINA 10Y | 280.7 | 279.4 | -1.3 | |
| EURO$ U2/U3 | 72.0 | 87.0 | 15.0 | |
| EURO$ U3/U4 | -31.5 | -39.0 | -7.5 | |
| EURO$ U4/U5 | -8.0 | -21.0 | -13.0 | |
| EUR | 107.19 | 105.18 | -2.01 | |
| CRUDE (active) | 118.87 | 120.67 | 1.80 | |
| SPX | 4108.54 | 3900.86 | -207.68 | -5.1% |
| VIX | 24.79 | 27.75 | 2.96 | |
