The Tenth Contract
August 21, 2022 – Weekly Comment
Attached is a chart of Green December Eurodollar, currently EDZ’24, the tenth quarterly contract. I chose to highlight this contract for a few reasons. First, it settled down 20 bps on the week at 9697.0, which is the largest net change for any eurodollar contract aside from green March, EDH’25, which settled -20.5 at 9705.5. By comparison, on the treasury curve the ten year was weakest, with the yield up 13.4 on the week to 2.983%. Second, it’s an end of year contract, which makes it appropriate for comparison with the Fed’s SEP, which indicates end of year Fed Funds targets. Third, it has an interesting technical set up, having closed just below the 50% retracement from the middle of June low (inflation data) of 9633.5, to the Nancy Pelosi Distraction (NPD) high of 9763.5 (Taiwan trip). Amazingly enough, that was a range of 130 bps, made in just 33 sessions. Notice that nine of the ten days from August 3rd to the 16th had a low of 9716.5 to 9715.0, essentially at the 38.2 retracement. Having broken this level strongly suggests a look at the 61.8 retrace of 9683.5.
At the June FOMC, the projection table indicated a median forecast for Fed Funds at 3.8% at the end of 2023 and 3.4% at the end of 2024. In the March projections, both end of 2023 and end of 2024 were pegged at 2.8%. On Friday, EDZ’23 settled 9648.5 and EDZ’24 settled 9697.0 a spread of -48.5. This level is fairly close to the -40 spread indicated by the FF projections in June. However, the LEVELS are quite different. EDZ’23 rate is 3.515% and EDZ’24 rate is 3.03%. Looking at SOFR, SFRZ3 settled 9674.5 or 3.255% and SFRZ4 settled 9723.0 or 2.77%, also a spread of -48.5. Of course, the difference between forward ED and SOFR contracts is 26 bps, as ED contracts will transition to SOFR after the middle of next year. The point is that end of 2024 rates are about 60 bps LOWER in the market than what was projected by the Fed in June: 2.8% in the market and 3.4% by the Fed. The Fed’s March projections are much closer to where the market is presently.
In terms of the actual dot plot, 8 of the 18 dots for end of 2024 were 3.25 to 3.5%. If the Fed were to hike 100 bps more by the end of THIS year, we’d be there. What is somewhat curious is that the Fed is making a concerted effort to disabuse the market from pricing eases NEXT year, even as the Fed’s own projections point to an ease from 2023 to 2024. I saw several news clips expressing this theme, captured by the FT on Sunday morning: “Some traders fear markets underestimate US central bank’s determination to stamp out inflation.” As a Fed plant, this one’s a bit clumsy, as if the FT carefully polled “traders” to identify their fear triggers with respect to the all-powerful CB.
The market continues to strongly suggest that the Fed will complete rate hikes by the end of this year or by the first quarter of next year. Eases are projected to follow (in terms of market pricing). However, the Fed’s protestations about rate CUTS being priced too soon did influence the week’s action. Reds and greens weakened on a relative basis, in front of Powell’s Jackson Hole testimony on Friday. For example, the most negative one-yr SOFR is June’23/June’24 at -60.5. EDM3/M4 is also the lowest. From Friday to Friday SFRM3/M4 went from -75.5 to -60.5. Last Monday the spread settled -78.0, essentially at the low for ANY 1-yr spread over this cycle.
The stunning reversals across many markets on August 2, when Pelosi visited Taiwan without generating much of an overt response by China, is telling. I personally am not convinced that we can turn the page on China’s non-response. In any case, the move in EDZ4 has been as clear of a marker as anything in terms of direction, having closed the week and the month of August at the beat low on Friday. In the early part of the upcoming week, in front of Powell’s speech on Friday, the pressure will likely continue.
With respect to Jackson Hole, Dudley’s article on BBG last week was as good a summary as any. Dudley said he expects Powell to emphasize three things: “that the economy still has forward momentum with an extremely tight labor market and unacceptably high inflation, that the Fed must tighten monetary policy further to restrain the economy and ease pressure on the labor market, and that the Fed won’t relent until it’s sure it has done enough for long enough to achieve its 2% inflation target.”
If Dudley is correct in his analysis, then it’s likely rates will continue August’s trend higher. Going into the speech I would expect that the October Fed Fund contract, which prices odds for a September 21 hike, will stay close to 9704.5, halfway between 50 (price of 9717) and 75 (price of 9692). FFV2 settled Friday at 9705. My bias is that Powell will attempt to convey a strong inflation fighting front, while indicating that hikes will be stretched over a longer timeframe in smaller increments. I think he would like to see how the market responds to the $95b/month QT going into the September FOMC
| 8/12/2022 | 8/19/2022 | chg | ||
| UST 2Y | 325.5 | 326.0 | 0.5 | |
| UST 5Y | 297.7 | 310.9 | 13.2 | |
| UST 10Y | 284.9 | 298.3 | 13.4 | |
| UST 30Y | 311.7 | 322.1 | 10.4 | |
| GERM 2Y | 60.8 | 82.4 | 21.6 | |
| GERM 10Y | 98.7 | 123.0 | 24.3 | |
| JPN 30Y | 109.7 | 107.9 | -1.8 | |
| CHINA 10Y | 274.3 | 263.0 | -11.3 | |
| EURO$ U2/U3 | 25.0 | 33.8 | 8.8 | |
| EURO$ U3/U4 | -69.5 | -56.0 | 13.5 | |
| EURO$ U4/U5 | -26.5 | -28.5 | -2.0 | |
| EUR | 102.61 | 100.40 | -2.21 | |
| CRUDE (active) | 91.46 | 90.44 | -1.02 | |
| SPX | 4280.15 | 4228.48 | -51.67 | -1.2% |
| VIX | 19.53 | 20.60 | 1.07 | |
