The oil “wrecking ball”
May 27, 2022
–July WTI crude settled at a new high for the move at 114.09, and printed a high of 114.99 this morning. The previous high settle was March 8 at 110.83. The Adventures in Capitalism blog posed an interesting question: How will the Fed respond if oil marches much higher into the end of the year? Especially if this summer’s additional rate increases slow both employment growth and the economy in general. The Fed’s goal in hiking is to deter demand; they’ve said it many times. But that might not stop oil prices, which are facing supply constraints due to both Russia and the US fight against fossil fuels. Certainly high energy prices act as a tax on the economy, but are also inflationary. My guess: they will just slow the pace of hikes but maintain a tightening bias.
https://adventuresincapitalism.com/2022/05/26/the-fed-is-fuct-part-2/
–Rates were little changed yesterday and implied vol continued to seep a bit lower. Tens up 1 bp to 2.754%. Large buying yesterday of essentially the same trade in ED and SFR: +25k EDU2 9775/9800/9812.5 broken call fly for 3.5 and +SFRU2 9800/9825/9837.5c fly for 3.25 in smaller size. If the Fed hikes 50 and 50 June and July and stops, EFFR will be 183 bps…both of these would probably be in-the-money. If the Fed is forced to stop earlier, then underlying contracts could conceivably rip through upper strikes and both still make 9. (Both the lower 25 bp cs and the upper 12.5 cs fill out, 25-12.5=12.5 less the initial premium paid).
–Today’s news includes the Fed’s preferred inflation measure PCE Core prices, expected 4.9 to 5.0 from 5.2%. U of Mich inflation expectations as well (final for May).
–One last note, EDM2 settled 9823 and the 9825^ settled 5.5 with 17 calendar days left and 12 libor settings. Three-mo libor set yesterday at 1.57486, so there’s 19.5 bps of convergence. Obviously the straddle level indicates that the libor settings will ratchet higher every day, however, a change in perception on another 50 in July could still prompt a settle in EDM2 above the 9825 strike. Very roughly, the July 27 FOMC is about halfway through the three month period priced by EDM2. Therefore a 50 bp hike at that meeting is “worth” about 25 bps to the period. What if the market suddenly shifts to the idea of the Fed only hiking 25 in July? FFQ2 settled 9918 (or 182 bps), the first baby-step in acknowledging this possibility.
