(USTs 'modestly higher' and curve flatter on extremely light volumes)while WE slept; another day another 'love letter'; 5yy; curves, X-dates, supply & "Buy <bonds> in May and Enjoy The Stay"
Good morning … I cannot believe I missed this one and so, as we are all waking up on an FOMC day I have another love letter to read and pass along. Forgive me if you’ve already seen (and shame on you for not having brought to my attention YEST) but …
This morning’s edition is from Liz Warren TO JPOW
AND despite or because of all this geopolitical wrangling past few days between policy makers of all strips AND given there have been shops advocating a LONG OF THE BELLY (MS for example), I thought I’d pass along a story from BBG and then a chart. First, from, well, FIRSTWORD <GO> (or something like that,
(BFW) Treasury Options Wager Targets 5-Year Yield Drop to 3% by May 26
By Edward Bolingbroke(Bloomberg) -- Large buying in June 5-year Treasury options Tuesday appears to target a yield decline of more than 40bp to about 3% by May 26 expiry. Premium paid on the position so far totals around $2.2 million.
10,000 US 5-year June 2023 111.00/112.00 call spread has been bought at 14 ticks thus far, says London trader
Open interest in the strikes as of Monday was 71,660 (111.00 strike) and 28,008 (112.00 strike), leaving open the possibility the trade was either a position unwind or a new bullish structure
Some information comes from rates traders familiar with the transactions, who asked not to be identified because they are not authorized to speak publicly
AND with folks advocating LONG 5s and an OPTIONS WAGER, a chart…
Momentum does appear to be stretched and so with THAT in mind, we (not me but really you, the longs in the belly and options monkeys) will hand things over TO the Fed and trust them to NOT muck things up (?) … Meanwhile … here is a snapshot OF USTs as of 705a:
… HERE is what this shop says be behind the price action overnight…
… WHILE YOU SLEPT
Treasuries are modestly higher and the curve modestly flatter as we count the hours until the Fed/Powell weigh in. DXY is UNCHD while front WTI futures continue to dive (-3.25%, see attachments). Asian stock markets that were open saw overall losses, EU and UK share markets are higher on balance (SX5E +0.6%) while ES futures are showing +0.13% here at 7am. Our overnight US rates flow color was limited with Japan closed but colleagues in London highlighted a 'jittery quiet' with a decent about of front-end (1-2yr paper) buying noted. Overnight Treasury volume was ~60% of average with Japan and other nations closed.… Select Treasury yield curves continue to probe historic depths and out first attachment shows 'Powell's curve' or the 3mo T-Bill rate versus the 18mo forward 3mo Bill rate. This curve almost down to -200bp inverted (opening this morning at -198bp) but do note that before recent recessions this curve has typically already steepened off its move low.
… and for some MORE of the news you can use » IGMs Press Picks for today (3 MAY) to help weed thru the noise (some of which can be found over here at Finviz).
From some of the news to some of THE VIEWS you might be able to use… here’s what Global Wall St is sayin’ … First up is a story which went around YESTERDAY on Terminals ‘cross the land and interesting timing ahead of FOMC (and SLOOS which will apparently be in hand at time of the meeting),
BBG (via ZH) — Global Bank Lending Standards Tighten To GFC Levels
Authored by Simon White, Bloomberg macro strategist,A composite measure of DM banks’ lending standards shows they are the tightest since 2009. Tighter credit conditions will be an impediment to central banks’ preference to keep rates “higher for longer.”
The ECB’s bank lending survey was released this morning, with banks further tightening their credit standards.
This has pushed an aggregate measure of bank-loan credit standards to levels not seen since the Lehman crisis.
This has been driven primarily by US and European banks; loan standards for Japan and UK banks are close to unchanged over the last year.
For Europe, the data released today showed a further rise in tighter credit standards for loans. Typically when banks make it harder to take loans out, this leads to lower demand for them. In turn, lower demand for loans is consistent with less supply.
This should keep pressure on money growth in Europe, but it is important to focus on the correct type of money. M3 was also released today, and showed a slowdown, but M3 is counter-cyclical. M1 is a more reliable leading indicator of economic activity and risk-asset performance.
Real M1 has fallen sharply over the past months, and the expected decline in bank loans will keep the pressure on real M1 even as inflation moderates. This points to weaker growth in Europe through the rest of the year.
Some have posited that M1’s significance is diminished as a rising-rate environment means more borrowers are terming out overnight deposits. But this is nothing new. M1 is a better measure because it is driven by demand deposits, i.e. money that is available to spend. It is therefore a pro-cyclical measure of future activity. If people are terming out deposits this is not a sign of confidence in the economy.
Credit tightening and weakening economic growth in Europe and the US will soon bring the pipe dream of “higher-for-longer” into contact with reality, with one part of the yield curve already making this plain.
Moving right along … Ahead of the FOMC (and next weeks SLOOS), perhaps a bit of DRAMA in order,
ZH: Labor Market In Freefall As Job Openings Slide, Quits Tumble To 2 Year Low
…With consensus expecting only a modest drop in March job openings after the February collapse and sharp downward January revision, what the BLS reported instead was yet another doozy for the third month in a row: in March there were just 9.590 million job openings, the lowest since April 2022, and a drop of 384K from the upward revised February print. Combined with the sharp drops in January (-671K) and February (-589K), the combined three-month drop in job openings was the 2nd biggest on record!
From the Global Wall Street inbox, a large French bank
Steepen or stall: US yield curve outlook and risks
We assess the outlook for the US yield curve at a pivotal point in the policy cycle. Though steeper than cycle lows, the slope of the US Treasury curve has been largely range-bound after the sharp steepening in March.
While historically extreme, the depths of inversion seen in portions of the curve in the current cycle have largely tracked what historical relationships would imply.
From here, our economists’ 2H 2023 recessionary baseline and expectation for 175bp of policy rate easing next year is consistent with 2s5s and 5s10s curves steepening modestly beyond what’s priced into the forwards by year-end.
Deeper cuts in the event of a harder landing would argue for greater broad-based steepening, while stagflation could keep curves stuck at historically flat levels provided the Fed remains committed to curtailing inflation.
We continue to think risk/reward favours curve steepeners, despite the carry headwind. We also prefer being short 10s on the 5s10s30s fly, given the relative steepness of the 10s30s curve.
(This in addition TO the near term forward - ie 18m forward 3m) offered HERE by large German shop just yesterday)
Speaking of Germany, this next note is on the ECB and who writes it is as interesting as it’s content …
CSFB: ECB to hike rates to 3.75% amid sticky inflation and fading banking stress - but continued tightening raises growth and financial stability risks into 2024
We maintain our ECB terminal rate forecast of 3.75% by July 2023 (i.e., 25-25-25bp rate hikes in May-Jun-July). That’s slightly above the current market pricing of a ~3.7% terminal rate by September 2023 (with rates at ~3.6% in July).
Recent growth and inflation data remain supportive of further rate hikes but justify a stepdown from 50bp to 25bp, we believe. Economic activity has accelerated modestly since year-start, especially in services, which may lead to sticky wage and services inflation. Indeed, although there are growing signs that core inflation may be peaking, we do not expect to see a clear sustained decline in core inflation until Q3 of 2023. That’s because still-rising wage growth and services inflation will likely offset any initial disinflation in core goods driven by lower energy prices, a weaker impetus from FX, and easing supply chain bottlenecks.
Meanwhile, the most acute part of the banking stress seems to be behind us, and the banking sector’s fundamentals remain sound. First, market-based measures of stress have eased. Second, European banks have higher capital and liquidity ratios and lower unrealised losses on their held-to-maturity (HTM) portfolios than US counterparts. Third, euro area has experienced smaller deposit outflows than the US in recent quarters, and rotation from overnight to term deposits has increased their stickiness. Fourth, corporate default rates remain low and are projected to rise only modestly in 2023-2024, according Moody’s. And last but not least, the euro area has a much stronger policy architecture to deal with banking stress than during past periods of stress.
However, there’s clear evidence that the ECB’s rate hikes are now feeding through to the real economy, which we expect to result in below-trend growth and ECB cuts from Q2 of 2024. Bank lending rates on new mortgages and corporate loans have risen (by ~190bp and ~240bp since 2021), credit standards are tightening, and loan growth is slowing sharply across all major economies. As a result, interest-rate-sensitive parts of the economy are weakening. Housing and non-residential investment have been in contraction for several quarters, and business investment is starting to weaken, too. Accelerating real income growth and high pent-up savings should prevent an outright recession, but growth will likely remain below trend at least through mid-2024. We expect the ECB to start cutting rates from Q2 of 2024 and deliver ~150bp of cuts next year in total (vs ~80bp priced in).
From this same shop as it turns its Swiss heritage and laser focus from the ECB to the USofA,
CSFBs US Economy Notes: Debt ceiling debate begins in earnest, but only just
Treasury Secretary Yellen’s announcement that the “X-date” after which the Treasury would begin to default on some payments is likely in early June finally creates a sense of urgency for Congress and President Biden to come to a deal.
However, we see a chance that Congress may grant a small extension of the debt ceiling of a month or so for the practical reason that its capacity to debate during May is constrained. Congress will be in session only 12 days from May 2 to June 1, while President Biden has trips to Australia and Japan this month.
We still think the most likely outcome is an increase to the debt ceiling or its suspension until just after the November 2024 elections. We expect either would come with minor spending cuts – e.g., an easy cut would be a clawback of unspent Covid relief funds – and caps on certain spending items. We doubt any cuts that emerge would affect the government’s fiscal impulse meaningfully given that Republican leadership and candidate Donald Trump have ruled out cuts to most entitlements and defense spending.
Of course, we cannot rule out that brinkmanship over cuts leads to an accidental breach of the X-date, even if we judge this risk to be very low.
In the event the X-date is breached, the transcripts of Federal Reserve leadership conference calls ahead of the 2011 and 2013 debt ceiling debates suggest strongly that the Treasury would prioritize payment of interest and repayment of maturities of federal securities over other payments. We judge a Treasury default on its securities as highly unlikely.
Some clarity about the terms of debate between Republicans and Democrats is likely to come from President Biden’s May 9 meeting with the leaders of Congress from both parties, but only some. History suggests substantive debate is likely to wait until the days before the actual X-date.
See here and here for our previous analysis of Fed and Treasury options.
Turning away FROM X-DATE if you can stand it and TO another fan favorite where normal lexicon of financial markets might have one thinking to SELL IN MAY and go away (see short hit HERE for some SWISS family technicals), the other side of the coin may just be,
LPL: Buy in May and Enjoy the Stay?
In this week’s Weekly Market Commentary, we noted the seasonal stock market pattern in which stocks generally produce the best returns from November through April and the worst returns from May through October (although we note this pattern hasn’t been true recently). But most investors may not be as familiar with the seasonal patterns in fixed income markets. Because of the seasonal pattern in equity markets, changing investor sentiment has translated into a strong demand tailwind for fixed income markets and the summer months have generated, on average, some of the best monthly returns of the year.
As seen in the chart below, some months appear more or less favorable for core fixed income, as measured by the Bloomberg U.S. Aggregate Bond Index, with August generally being the best performing month. However, May through August has, historically, represented the best stretch of average returns for the index over the last 20 years. Moreover, that stretch has also seen the highest median returns (averages can be misleading when you’re dealing with smaller numbers) and, except June, have seen the fewest negative monthly returns. All this suggests the preferred destination for the “sell in May” crowd may be the fixed income markets.
Now, we would certainly not advocate repositioning portfolios due to these popular patterns because, again, average returns can be misleading, especially during a year that feels anything but average. So, whether the seasonal patterns in the equity or fixed income markets persist this year or not, we think owning core bonds in a diversified portfolio makes sense. The fact that fixed income markets have performed best over the summer months, when equity market volatility has tended to increase, is no coincidence. Core bonds have historically been the best diversifier to equity market risk and despite that lack of protection last year, we think the back up in yields now allows bonds to regain that role in portfolios.
Thinking BEYOND May thru August time frame, an interesting chart of COUPON ISSUANCE TO RISE in 2024 comes from a note out of France where the national bank there is,
… Earlier X-date risks earlier supply increase. Our base case has been for the X-date (the projected day when the Treasury will run out of cash) to fall in the late July to August window with increased UST supply coming at the November refunding.
However, tax receipts have been weak, and Treasury Secretary Yellen announced yesterday that the X-date could come as early as 1 June. An earlier resolution to the debt ceiling opens up the possibility of increased coupon supply at the August refunding.
This risk, coupled with the recent strength in 10y spreads, leads us to close the position at -26.75bp for a total profit of 8.5bp including carry (USD412,500).
AND … THAT is all for now. Off to the day job…