Three hikes in a year?
October 22, 2021
–Interest rate markets continue to force the issue for hikes, with the red euro$ pack (2nd year) plunging 9.25 bps to an average price of 98.935 or 1.065%. At settlement, EDM’23 was the weakest contract, down 10 on the day to 9884.5. Going into the end of the session it traded as low as -13. This contract has fallen >50 bps since the start of September. Near one-yr euro$ calendar spreads made new highs. The peak is still EDU’22/EDU’23 at 85.5 which rose 3 on the day. The spread before, i.e. EDM’22/EDM’23, was up 5 bps on the day to 80. In Fed Funds, FFN2/N3 (July/July) settled at 74 bps. These year spreads are indicating certainty of 3 hikes starting from the middle of next year. How good are one-year spreads at forecasting actual hikes? I looked back at 2004 to 2006 and even though the Fed hiked at every single meeting for two years (200 bps per year) the ED calendar spreads didn’t fully reflect the consistency of hikes. In my opinion, on the basis of spread levels, one can make a case for buying reds. However, on the basis of actual inflation, buying any interest rate contracts becomes questionable.
–Inflation breakevens are making new highs with the ten yr treasury to tip spread at 2.66%. Powell speaks today; the Fed seems to have toned down the ‘transitory’ argument and now is trying to convince the viewing public that expectations remain solidly anchored at 2%. That is, of course, a fantasy.
–SPX made a new high. The Biden admin is saying tax rates will not be raised. Once again, what we’re seeing in the markets is continued large buys of puts on rate futures. For example, FVZ 121.0p 13 paid for 50k (settled 15 vs FVZ 121-195). Five year treasury made a new high yield on the year, leaping 6.3 bps to 1.21%. In euro$’s 2EZ 9800p were bought in size of 100k for 2.0, ref EDZ’23 9855.5. (settled 2.25 vs 9951.0). There was a large profit-taking sale of 50k EDM2 9962.5/9937.5 put spread at 5.25 (settled 5.5 ref 9964.5). With 3-month libor pegged below 13 bps, and taper expected to end in the middle of next year, EDM’2 at 22 bps above the current libor setting is rather aggressive.
