The Underdog
February 27, 2022
You got no fear of the underdog
That’s why you will not survive
-Spoon, The Underdog
The fight is here; I need ammunition, not a ride.
On Tuesday, President Biden delivers the State of the Union. He will probably try to reassure the American public that his administration is doing whatever it can to hold down prices. In Ukraine, they’re handing out rifles to ordinary citizens. There are times when we incur costs for supporting what’s right.
On Wednesday, Powell, who has yet to be confirmed by the Senate, begins the Fed’s semi-annual testimony. The Fed’s preferred measure of inflation, Core PCE prices, was released Friday at 6.1%, a new high for the cycle. The conflict in Ukraine likely adds to inflationary pressure, not just because of immediate pressure on natural resources, but because it sharpens the need for the US to become less reliant on global suppliers; to develop more capabilities at home, even at higher prices. The current administration has pursued the opposite path with respect to fossil fuels.
Of course, the Russia/Ukraine conflict raises uncertainty along many contours of the global economy. The March 16 FOMC meeting is now being priced much closer to 25 bps rather than 50. On Feb 11, the low in April FF was 9943.0, pricing near certainty of 50 bps. The high on Thursday was 9965.5, pricing near certainty of just 25 bps. Friday’s settle was 9960.0. The conflict has not taken away the need to price for a hike, but has rather moved the prospect of future hikes a bit further out the curve. For example on Feb 11, EDH2/EDM2 ticked 66 bps (but closed at 58). By Friday that spread had declined to 52.25. However, EDU2/EDZ2 on Feb 11 settled at 28.0. On Friday, this spread had moved to a new high of 35.5, and settled 34.5. Below is a picture of the condor (17.75s). I had never expected it to trade over +2 bps, as I had believed in Powell’s previous guidance of measured tightening. The market is now slightly lessening odds of front-loaded hikes and beginning to spread such actions further back in time.
With Thursday’s Russian invasion, there was some evidence of a flight to quality in treasuries. However, by Friday afternoon the ten year yield was back above 1.98% just 6 bps below the high for the move at 2.045%. The ten-yr yield is holding just above late 2019 (pre-covid) highs. The conflict reduces global trade and increases price pressure at the margin. But it also likely increases the Treasury’s reliance on domestic private sources for funding (rather than the Fed). This was alluded to in the last FOMC minutes. Positive carry is integral to this effort. As mentioned previously, June’23 3m SOFR contract is 9795 or 2.05%, about 7 bps higher than the 10y yield. A slower pace of FF tightening, along with high inflation, should cause an increase in longer maturity yields, which will support demand.
With respect to financial conditions, here’s an interesting clip from Almost Daily Grant’s:
“Meanwhile, a barren primary funding market underscores the chilly conditions in the fixed-rate speculative credit realm. Apart from double-B-plus-rated Twitter, Inc.’s sale of $1 billion in eight-year notes on Wednesday, no other high-yield issuers have managed to come to market during the last two weeks. Yesterday, single-B-rated protein shake maker BellRing Brands offered $840 million in 7% notes due 2032, before pulling back when it was unable to source sufficient demand with a 7.75% yield, Bloomberg reported.
That freeze-out underscores a diametric change in primary market conditions. Domestic junk bond issuance footed to $465 billion last year according to S&P Global, topping the previous record of $435 billion set in 2020. For context, new supply averaged $215 billion over the five years through 2019, while the peak of the prior cycle in 2007 saw $150 billion in issuance. Then, too, first time borrowers accounted for $100 billion of supply last year, a contingent that had never topped $60 billion in sales during any pre-pandemic year.” ADG 2/25/22
If the bell doesn’t ring, can it still signal a top?
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On April 26, 1986 the Chernobyl power plant disaster occurred. On April 15, 1986 Dec Wheat was 252. On April 30, it closed at 300. The high settle was 303 on May 8, by July it was back under 250.
On February 18, May Wheat settled 804. If the threat of radioactive contamination to food supplies increases, a percentage move of the same magnitude as Chernobyl 1 would put wheat over 960. Friday’s high happened to be 960 ¾ with a settle of 859 ¾. Exactly 14 years ago on 2/27/08, front wheat hit 1334 ½. This is the same year that WTI reached $145/bbl. It all coincided with the start of the GFC. (Russia and Ukraine combined produce 14% of global wheat and supply 29% of all wheat exports).
OTHER MARKET THOUGHTS/TRADES
There was a notable new seller of about 7k EDH3 9787.5 straddle on Friday, starting at 86. Settled 84 vs 9786. SFRH3 9812.5^ was also sold on a block, 10k at 81.0 (settled 81.5 vs 9809.0). These futures settlements on EDH3 and SFRH3 are with 5 bps of the low settles, which were made this month. EDH2/EDH3 calendar spread settled Friday at 146.75; the highest settle has been 147.25. The straddle sales suggest that downside in reds may be limited from here. Look to buy call spreads on reds.
| 2/18/2022 | 2/25/2022 | chg | ||
| UST 2Y | 150.0 | 158.4 | 8.4 | |
| UST 5Y | 182.5 | 188.3 | 5.8 | |
| UST 10Y | 193.0 | 198.3 | 5.3 | |
| UST 30Y | 224.9 | 229.3 | 4.4 | |
| GERM 2Y | -47.8 | -37.7 | 10.1 | |
| GERM 10Y | 19.2 | 23.1 | 3.9 | |
| JPN 30Y | 93.9 | 92.4 | -1.5 | |
| CHINA 10Y | 281.0 | 278.9 | -2.1 | |
| EURO$ H2/H3 | 137.0 | 146.8 | 9.8 | |
| EURO$ H3/H4 | 17.5 | 14.0 | -3.5 | |
| EURO$ H4/H5 | -11.0 | -13.5 | -2.5 | |
| EUR | 113.22 | 112.73 | -0.49 | |
| CRUDE (active) | 90.21 | 91.59 | 1.38 | |
| SPX | 4348.87 | 4384.65 | 35.78 | 0.8% |
| VIX | 27.75 | 27.59 | -0.16 | |
