The Weekly
Weekly comment – June 20, 2021
I am starting with a couple of quotes from the week:
“I will be watching the Fed on Wednesday. If they treat these [inflation] numbers (which are material events)….if they treat them with nonchalance, then I think it’s just a green light to bet heavily on every inflation trade.” Paul Tudor Jones, just prior to the Fed meeting
“I will not be a party to this bullsh-t. …And I only mention that because it’s the insidious movement of them to take over absolutely everything.” Roger Waters of Pink Floyd
* I have stolen this week’s title from George Coyle who changed his newsletter title from ‘The Weekly’ to ‘Raw Materials’. His piece is a compendium of financial news quotes from the previous week, and from interesting books. See here to subscribe: https://twitter.com/gfc4/status/1405917104499576835
The Fed moved up the timing of the tapering/tightening schedule. In his rant, Roger Waters was talking about Facebook, but could have been talking about the Fed, with its insidious monetization of the Federal deficit and explosion of its balance sheet. Powell is now trying to take a baby step back from the bullsh-t of trying to control everything, while making sure the party continues. The chairman was upbeat on the economy, and relegated risks from covid to the background. It wasn’t just Powell, the dot plot ratcheted quite a bit higher. In March, three members looked for 1 hike and one for 2 hikes by the end of 2022. By Wednesday, five members saw 1 hike and two saw 2 hikes. Seven out of 18 suggests that a swing to a majority in favor of hiking in 2022 by the September meeting isn’t much of a stretch. The press focused mostly on 2023, where the median shows two hikes, but the distribution was much more hawkish, with 8 of 18 members seeing 3 hikes or more. The top two dots were 1.625%. Compare that to the EDZ23 eurodollar price of 98.88 or 1.12%. Bullard punctuated the week by saying “Fed Chair Powell has opened the taper discussion this week.” He also suggested that MBS purchases could be tapered first, due to the strong housing market. Many market participants had opined that a taper hint could be dropped at the Jackson Hole Symposium in August. In treasuries, implied vol had been relatively stronger for Sept options that expire on August 27. However, near vol exploded at the end of the week. As an example, TYN atm straddle was 50/64’s on June 11 with two weeks to go, and TYU was 2’00. On Friday, the straddle with 2 weeks left was July week-1 132.25^ which settled 64/64’s. TYN atm had only fallen to 44/64’s with one week left, and TYU rose to 2’08. The wide dispersion in Fed dots should cause increased volatility this summer. Additionally, the Fed doesn’t hedge its MBS portfolio. The private market does. If the Fed cuts its buying of MBS, there will likely be more demand for premium. One other note, near eurodollar calendar spreads all made new recent highs as a hike was put into play. EDZ’21/EDZ’22 jumped 13 on the week to a new high 31.5. FFF’22/FFF’23 settled 24.5, indicating exactly one hike in 2022. EDZ’22/EDZ’23 rose 6 bps to 59.5, just under 2.5 hikes.
The quote from PTJ reveals that large investors were already heavily involved in inflation trades, and leaning for a full court press on a dovish Fed. Chair Powell hadn’t disappointed on that score, always stressing the need to get back to full employment above anything else. The shift in tone caused a massive unwind in all inflation related trades; the Costanza of PTJ’s thesis. The dollar soared, precious and base metals were hammered, grains fell, the curve flattened. Most notably, 5/30 treasury spread dropped 26 bps on the week to 113.5. This is well through the trendline that started with the Fed’s framework change in August of 2020, retracing about 75% of the move. The long end rally has been breathtaking, with the 30yr falling 11 bps on the week to 2.025%. This, with the Fed’s Core PCE projection for 2021 at 3.0 percent, falling to 2.1% in 2022 and 2023.
However, the 2/10 treasury spread hasn’t retraced even to the 38% level of the August to March move of 40 to 158. Both the trendline and the 38% retrace come in about 112.5 to 113 versus Friday’s close of 119. The red/gold euro$ pack spread is slightly through the 38% retrace, at 124 bps vs Friday settle of 121.75. The trendline doesn’t come in until 92.
Zoltan Pozsar of Credit Suisse said in a note last week that the Fed’s increase in the RRP rate to 5 bps is too much, and will likely cause libor/ois to rise. Futures markets gave a small nod to this idea, for example EDM22 to FFN22 rose 3 bps on the week to 11.5. However, the three-month libor setting was up only 1.6 on the week to 13.49 bps from all-time record lows; it seems to me that front contracts could come under additional pressure this coming week. The two year treasury yield nearly doubled since June 11, from 14.7 to 25.8. This week features auctions of 2, 5 and 7 year notes. Bullard and Kaplan team up for the bearish Fed case on Monday at 9:45. Powell will hone the Fed’s message in front of Congress on Tuesday. Core PCE prices (Fed’s preferred measure) released on Friday, expected 3.9 from 3.6% last.
OTHER MARKET THOUGHTS/TRADES
From last week: The 2yr/5yr treasury spread topped at 77.5 in March. This week it made a low of 56.2 and ended at 59. The two-year note under 15 bps indicates not much of a hike chance over the period, though EDH’22/EDH’23 at a settlement of 26 forecasts at least one hike over that period. I continue to believe that the Fed will be forced into a hike in late 2022, as high inflation persists and financial stability is imperiled. I do not think Biden will retain Powell next year, and instead will move to Brainard, who may not bring as strong of a hand to the table in terms of Fed board allies. [New comment: 2/5 ended the week a bit higher at 63 as the 5yr note had the biggest bp surge in yield, up 15 to 88.9]
From last week: Red/green/blue Eurodollar butterflies have firmed since mid-May. These should rally on an ‘earlier hike than the market currently thinks’ theme. Example, EDZ2/EDZ3/EDZ4 fly settled 0.5. I would like to buy at -2.5, stop on close below -5.5. Objective +8 to +10. This is buying EDZ2/EDZ3 spread which settled 53.5 vs selling EDZ3/EDZ4 which settled 53.0. Might get a buying opportunity post-FOMC. [Never got the chance to buy my level, but these flies exploded and Z2/Z3/Z4 settled 18, up 17.5 on the week. Should be exited]
My thesis had been that Powell would continue to indicate that the Fed was on hold, which is why I thought the curve would steepen, forcing earlier than expected Fed hikes. That was wrong, though I continue to think the curve bounces from here (perhaps from a bit lower levels early in the week). Gold eurodollars, the fifth year forward, made new highs for the year on short covering. For example, EDZ’25 peaked in open interest at 207k just prior to the Fed meeting, by Friday 25% of those (short) positions had been closed out with OI down to 157k. At a price of 9824 or 1.76%, this contract is still well below inflation. In March, the low price was 9768.
China last week said it would begin to sell major industrial metals from state stockpiles in an effort to squelch factory gate price increases. I can’t help but think that’s going to work out about as well as “Brown’s bottom”. In 1999, the UK’s then Chancellor of the Exchequer, Gordon Brown, decided to sell off Britain’s gold reserves. The BOE were not for it. Between 1999 and 2002 the UK’s sales averaged $275 an ounce. The beat low. Ten years later the price was about $1000/oz higher.
https://www.bbc.com/news/business-48177767
| 6/11/2021 | 6/18/2021 | chg | ||
| UST 2Y | 14.7 | 25.8 | 11.1 | |
| UST 5Y | 73.9 | 88.9 | 15.0 | |
| UST 10Y | 145.2 | 145.3 | 0.1 | |
| UST 30Y | 213.8 | 202.5 | -11.3 | |
| GERM 2Y | -68.3 | -66.6 | 1.7 | |
| GERM 10Y | -27.3 | -20.0 | 7.3 | |
| JPN 30Y | 65.1 | 67.4 | 2.3 | |
| CHINA 10Y | 315.0 | 314.2 | -0.8 | |
| EURO$ U1/U2 | 14.0 | 24.0 | 10.0 | |
| EURO$ U2/U3 | 50.0 | 61.5 | 11.5 | |
| EURO$ U3/U4 | 53.5 | 44.0 | -9.5 | |
| EUR | 121.11 | 118.64 | -2.47 | |
| CRUDE (active) | 70.60 | 71.29 | 0.69 | |
| SPX | 4247.44 | 4166.45 | -80.99 | -1.9% |
| VIX | 15.65 | 20.70 | 5.05 | |
