ED Z8-Z9 is looking too low now at 33.5. Current FF is around 141 bps + 20 bps 3mo LIBOR-FF gives us 161 bps 3mo LIBOR ex March hike pricing. Z8 is 248 bps. 248 – 161 = 87. Diff between 2018 and 2019 hikes and the ratio is too high. If the Fed has to tighten at pace of 3.5 hikes this year, then pricing 1.5 hikes for the next year is too dovish. I am not sure having 3.5 hikes in 2018 stacks up with the board’s thinking. Williams and Mester might be up for that. Dudley wanted three, Bostic wanted 2. Powell, Barkin and Brainard have been quiet. Alternatively more weak inflation prints or whatever else push some of the tightening from 2018 to 2019. Logically the risks are expectations of major economic deceleration in 2019 and/or Z9 getting crushed in bull market because of a higher beta than Z8. I’m bit late with this as Z8-Z9 started going up from around 20 bps on 10/01/2018, but back then Z8 was 224 bps, so 224-161 = 63 hikes for 2019. The ratio of 2019/2018 was even higher (3+) but difference was smaller (43bp then vs 53.5 now).
It’s been a while since I visited the Fed’s balance sheet. It was more than 150b of extra treasury purchases ago when there was no info how the reinvestments would be phased out. For some reason I didn’t see this discussed in the media, but my understanding is that this year we are actually going to see more treasury buying from the Fed as there are around 475b of principal and coupon payments remaining in 2018 compared with around 230b outstanding for rest of the year in April 2017 (when I looked at it last time). The reinvestment phase out will cut the purchases from 475 to 290b. With treasury gross issuance at 2.2t this is down from 20% to 13% of gross issuance. The reinvestments will go down from 290b to 200b in 2019. The Fed also has 1.7t in MBS with around 60b per year coupon payments and unknown prepayment rate. At 15% prepayment this is 255b per year. The reinvestment phase out would cut the principal 255b figure to 87b a year, 60+87=147b. I don’t know if this is supposed to impact mortgage rates and not sure that it has. 30y mortgage rate is 4.64%, so about 150 bps over 30y treasury. This compares with around 135 bps in early 2017, 115bps in early 2016. I am not sure about exact composition of the portfolio, but equally-weighted portfolio would have average maturity around 2039. If we insert that into excel duration function with 15% coupon and 4.5% yield, we get duration of around 11. This means MBS reinvestment phase out weighs disproportionately on the longer end. WN-UXY steepening has been a sucker idea so far. It went down from 40 bps on 14/11/2017 to 27 bps on Friday with 19 bps low recently.
Another follow up on lira. Effective bank funding rate is up to 12.75% from around 12% in November. 2y bond is down around 110 bps to 12.6%. 2s5 stayed at roughly -60 bps. The markets are again flirting with idea of a few rate cuts in 2019. The answer to the question posed in November in this case has been a cap to longer run rates so far. Lira is now marginally stronger at 3.78 versus 3.88, but doesn't look like a good long yet with 5y yield too low. Looking at inflation data hitting central bank forecast of 7.9% looks feasible. Services mom prints have been consistent with this. Goods prints was a big improvements in Jan, and consistent with the central bank narrative that it's all cumulative fx deprecation effect that will die out. Yet January is an inflationary (and hence more volatile), so curious to see the Feb inflation data to draw conclusions. The cb is saying there will be less demand pressures as loan growth will moderate this year with credit guarantee fund at the upper limit but for the reason below I cannot check that. Confidence indicators have been up and PMIs are up but GDP will grow at 4-5% after 6.5% last year. I now “see” that TCMB website has been updated. The main website for some reason IP blocks me. The separate statistics section has been updated and straightforward excel files have been updated with idiotic GUI where you have to fill elements from a number boxes before generating series you want. PR 0/5 move.
roll time H8 -> M8: -2 XT: 97.215, 97.165 +2 UXY @ -0.4609375 +1 UXY @ -0.4609375 +5 UXY @ -0.4609375 -2 WN @ -0.84375 -3 G @ 1.01 +3 RX @ -2.66 +1 RX @ -2.66 -1 IK @ -1.73
I think there’s a chance that markets have underreacted to economic data since the last Bank of Canada meeting in January. Data was poor - PMI inch down, core failing to take off, exports poor, retail sales down, housing starts okay, unemployment okay. BA U8 up +11 from 97.86 to 97.97 and BA U9 up +4 from 97.54 to 97.58, so hikes are postponed rather than cancelled. BA U8-H8 is 32.5 bps, hardly changed from the previous meeting. April meeting with forecast is before the March CPI, so they will have seen only 1 more CPI print, so a no-goer. H8-U8 then covers July forecast+meeting and half of October forecast+meeting. This is bit much to price 32.5 for 1.5 meetings given poor data. Steel tariffs are not helping NAFTA negotiations, oil price is down, stocks underperformed S&P and down some 6%. I don’t know if there is sector composition explanation for SPX/SX5E outperformance, but it’s up 14% since last March (and more than 20% since last May when Macron won). Given that equity weakness originated in the US last month and that the US’s P/E is higher, I’d expect SPX/SX5E to have fallen. A number of conference-calls by multi-asset fund managers I listened to in December had almost consensus view that Eurozone and Japan are the place to be in 2018 and US market is too expensive – and this was before the January outperformance by SPX. White and red IR’s do not look too interesting right now. IR Z8-H8 at 16 (and Z8-Z9 at 34) suggests that markets do expect RBA to make a move eventually. I am somewhat skeptical that RBA are at this point convinced that wage growth is coming and will be hawkish this week but market pricing does not look too wrong. The absolute bottom in those spreads were closer to 10 bps and 25 bps when we had poor CPI and very dovish comments. This looks like absolute bottom pricing, so Z9 looks like a good short if RBA are dovish and it’s down some 7-10 bps in the coming weeks. AUDNZD looks more interesting here. It’s gone down some 3% in February and looking 2-5% too low to me. RBNZ are no more hawkish than RBA are (and rate differential moved <5 bps in favor of NZD), so either FX players are pricing a more dovish RBA than STIR players are (and STIR players seem to price it okay) or someone decided that NZD is no longer a commodity price and should be immune to S&P and metals going lower. Australia – US 10y widening has been an absolute disaster so far and gone from 40 bps in November to zero now in swaps (and negative in XT-UXY), though my voodoo magic model showed it was 10 bps too narrow at 40.. and 15 bps too narrow at 0. As alluded above, I am happy with pricing rate pricing in the next two years, but not sure about 2s10 at 70 bps. This looks bit too low for a central bank that will be slow and gentle in the near future but with a high neutral rate (3% above current rate). It’s trading in the mid of the 2017 range and should probably go higher given improved global econ growth. If budget deficits do matter, then this should also weigh. Scott Morrison’s balanced budgets are about as credible as Chan-o-cha’s promises to hold elections in Thailand. An interesting observation is that in the past year the three times Australian 10y yields went up the causes were beta global movements (Sintra, global risk-on in Sep, BoJ stealth tapeR), and subsequently were dragged down, so it seems someone found 2.9-3% yield attractive. The question if it’s still attractive given no spread over US.
Another poor quarter with -0.65% qoq, -0.2 SR (and still undershooting vol target by half). The detractors have been flattening of the US curve and Australian 10 year yields falling relative to US. The catalysts for latter seem weak CPI in late January, wage data in Feb, unexplained in mid-march and unemployment rate ticking up in late March. This has now opened opportunity to get into 90 day bill rates widener Z8-Z9 at 22 bps, which is down from around 40 before the CPI report in mid Jan. It would probably take plenty of poor data to price out the single in 2019 so downside seems somewhat protected here. With US flattening I am wondering at what point to admit that Fed will indeed stop tightening next year, deficits and supply will not be a problem, 30 year US bond is attractive at 3.10%, economic cycle will turn over and we will return to secular stagnation discussions like in 2015-2016.
+15 IR Z8 @ 97.99 -15 IR Z9 @ 97.69 / yuck, it's 30 bps, earlier saw it 22 bps ..because looked at Z8-U8. -2 6N @ 0.7259 +2 6C @ 0.7821 / cad looked 3-5% too cheap due to nafta uncertainty, moved a lil bit yesterday on rumours that trump is forcing a nafta deal, but expect more.