What’s priced
November 2, 2022
–Is the market that good on pricing? Previously, I had thought that one-year calendars on the euro$ strip were great guideposts for pricing the extent of hiking. Not this year. Early in the year, the peak one-yr spreads came nowhere close to capturing the aggressiveness of this year’s hikes. More below, but first, with a 75 bp hike, EFFR should go to 383 bps. FFX2 should be pegged at 9622 (given the first two days of the month at 308 and the rest at 383). Indeed, FFX2 yesterday settled 9621.5. The next meeting is December 14. January is a ‘clean’ month, though the first 2 days of Jan will be set at the turn rate. In any case, FFF3 settled yesterday at 9556 or 444 bps. If the new EFFR is 383, then the FFF3 rate is 61 bps higher, about halfway between a hike of 50 and 75 for the December meeting. That all seems reasonable. Here’s what doesn’t seem to be appropriately priced in terms of yesterday’s settles (Nov 1):
EDZ2/EDZ3 -27.0
SFRZ2/SFRZ3 -2.5
FFF3/FFF4 +19.5
FFG3/FFG4 -26.5
EDH3/EDH4 -73.0
SFRH3/SFRH4 -68.0
It’s like the children’s question in school, ‘which of these spreads doesn’t look like the others?’ That would be the POSITIVE one, FFF3/FFF4 at 19.5. All of these spreads cover one-year forward periods, and all are staggered by only a few months. Is the market that good that it has a hike priced for the Feb 1, 2023 FOMC (FFF3/FFG3 is 36.5, 9556/9519.5) and then prices about 3/4% easing from mid-March 2023 to mid-March 2024? In terms of the December based spreads, EDZ2/Z3 is priced as negative as it is because of ‘turn’ and credit concerns embedded in EDZ2. Indeed, SFRZ2/EDZ2 settled at a new high of 50.5 bps. This dynamic has also tended to pull SFRZ2/SFRZ3 lower, to -2.5. Does it seem reasonable for the difference between FFF3/F4 and SFRZ2/Z3 to be 22 bps? Probably not.
–The point here, without making specific recommendations, is that many spreads have become quite volatile. Consider EDM3/EDU3, just a three month period, made a new low of negative 21 yesterday (9472/9493). So, a hike is priced for Feb 1, but then a couple of months later the market leans toward ease! The other spreads which made new lows for the cycle yesterday were EDM3/M4 at -90.5 and SFRM3/M4 at -85.5. Weak hands (longs in EDH3 and EDM3) have been washed out in front of today’s FOMC.
–My personal guess is that the last hike of this cycle will occur this year. However, it would almost be unthinkable for Powell to guide that way. It was only two months ago at Jackson Hole that he said the Fed has to stick with restraint ‘until the job is done’. He has since said it would be appropriate to reduce the pace of hikes at some point. That message will likely be repeated at today’s presser. Also beware of a treasury buyback announcement this morning, which is likely to help with liquidity issues in treasuries for just about the same amount of time as raiding the SPR lowered gas prices at the pump.
