The end of accommodation
January 27, 2022
–Can someone please tell Powell that employment is a lagging indicator? A few months ago his concern was that we needed to get the marginal worker re-employed, now he is amazed at how strong the employment market is (which he repeated several times). It was a much more hawkish performance than I expected, and he nonchalantly brushed off a question about the risks of a flat or inverted yield curve. The curve was the clue in 2018 that the Fed had gone too far, leading to a 20% drop in equities in Q4. In any case, near eurodollar contracts were absolutely hammered. Reds (2nd year) closed -9, but sold off another 9 before the end of the electronic session. FFJ2 (April funds) which price the March FOMC, traded 9961 late, which I think of as 25 bps with a 25% chance of 50 (should settle 9967 on a hike of 25 only). Powell has guided the market into expecting front-loaded hikes, and has moved the conversation on balance sheet reduction forward. EDH2/EDH3 settled 105, forecasting a bit more than four 25 bps hikes over the year, but interestingly, FFF2/FFF3 settled 107.5, the first time this nearer spread exceeded the latter.
–TYH 127p were quite active again, with open interest dropping 37k contracts to 317k. Early in the day they traded 19, but as TYH approached strike trading 127-08, a late day seller exited about 50k from 26 to 30. Settled 29. The most OI in any April TY put is the 126.5 strike with 40k open.
–CLH2 is at another new high 87.40 this morning. Bitcoin probably on its way to 30k as liquidity dissolves across markets.
–The added press release/link “Principles for Reducing the Size of the Fed’s Balance Sheet” was another zinger: “…planned approach for significantly reducing the size of the Federal Reserve’s balance sheet.”
“…reducing the size of the Federal Reserve’s balance sheet will commence after the process of increasing the target range for the federal funds rate has begun.”
“…the Committee intends to hold primarily Treasury securities in the SOMA, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.”
Translation, we’ve juiced the housing market by buying MBS, and now that we’ve sucked those buyers in, we’ll let spreads normalize. (Clarida probably already bought his puts on homebuilders…). https://www.federalreserve.gov/newsevents/pressreleases/monetary20220126c.htm
