Rates

Short-Term Yields And Rates Volatility Fall Significantly As Recent Front-End Pressures Ease

It may be a temporary reprieve though, with the Fed decision and Powell's speech likely to bring renewed volatility later this week as the market digests / prices in the latest FOMC statements

Published ET

September 2022 Eurodollar (EDU2) Implied Yield & 1 month by 2 year ATM Swaption Implied Volatility | Source: Refinitiv

September 2022 Eurodollar (EDU2) Implied Yield & 1 month by 2 year ATM Swaption Implied Volatility | Source: Refinitiv

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QUICK US SUMMARY

  • 3-Month USD LIBOR +0.41bp today, now at 0.1450%; 3-Month OIS unchanged at 0.0750%
  • The treasury yield curve flattened, with the 1s10s spread tightening -1.2 bp, now at 142.0 bp (YTD change: +61.6bp)
  • 1Y: 0.1270% (down 0.3 bp)
  • 2Y: 0.4480% (down 5.3 bp)
  • 5Y: 1.1427% (down 3.9 bp)
  • 7Y: 1.4138% (down 3.2 bp)
  • 10Y: 1.5470% (down 1.4 bp)
  • 30Y: 1.9583% (down 0.3 bp)
  • US treasury curve spreads: 2s5s at 69.5bp (up 1.4bp today), 5s10s at 40.4bp (up 2.5bp today), 10s30s at 41.2bp (up 1.1bp today)
  • Treasuries butterfly spreads: 1s5s10s at -62.6bp (up 6.1bp today), 5s10s30s at 0.5bp (down -1.2bp)
  • US 5-Year TIPS Real Yield: -3.7 bp at -1.7140%; 10-Year TIPS Real Yield: -2.6 bp at -0.9730%; 30-Year TIPS Real Yield: -4.2 bp at -0.3200%

US MACRO RELEASES

  • Chain Store Sales, Johnson Redbook Index, yoy% index, Change Y/Y for W 30 Oct (Redbook Research) at 16.90 % (vs 15.60 % prior)

FOMC PREVIEW / POTENTIAL RISKS

ENDING OF QE / TAPER PROCESS

  • The consensus for the pace of tapering is $15 bn / month ($10bn in treasuries and $5bn in MBS), with the process ending in June 2022
  • With wages rising rapidly (albeit at the lower end of the pay scale), the risk of inflation expectations becoming anchored at a higher level is real. Some economists see the possibility of the Fed having to accelerate the pace of tapering to $30bn / month, with the process ending in April/May 2022, in order to be free to hike soon thereafter.

Inflation & Wages Growth | Source: Nordea

RATES LIFTOFF / TIMING OF HIKES

  • When it come to rate hikes, nobody expects Powell to commit to anything, as he has repeatedly emphasized that the tapering process and rates liftoff are completely separate issues
  • Further, the Fed has made it clear that QE would need to have ended before any discussion of rate hikes.
  • In this context, there are three main paths ("tri-modal" as David Mericle might call it)
  1. Short-term inflationary pressure come down quickly and the Fed sees no need for hikes in 2022: this outcome would lead to a downward repricing of front-end rates and a steepening of the curve.
  2. Inflation is higher than the Fed expects but nothing crazy, and they start hiking at a modest pace of 1 to 2 hikes (25bp each) in 2022. That is pretty close to the current market consensus, and would likely not cause major moves in rates.
  3. Inflation turns out to be much higher than expected, pushing the Fed to end QE rapidly and start hikes In June 2022, perhaps with a 50bp shocker, followed by two more 25bp hikes in September in December, for a total of 100bp in 2022. That is definitely a non-consensus outcome, which would cause a rise in front-end rates and a violent flattening of the curve.

US 5Y & 10Y Treasury Yields Intraday | Sources: ϕpost, Refinitiv dataUS Treasury Curve Spreads Intraday | Sources: ϕpost, Refinitiv data

US FORWARD RATES

  • 3-month Eurodollar future (EDU2) expected hike of 43.5 bp by the end of 2022 (equivalent to 1.7 hikes by end of 2022), down -7.9 bp today
  • The 3-month USD OIS forward curve prices in 124.0 bp over the next 3 years (equivalent to 4.96 rate hikes)
  • The 3-month Eurodollar zero curve prices in 144.7 bp over the next 3 years (equivalent to 5.79 rate hikes)
  • 1-year US Treasury rate 5 years forward down 1.2 bp, now at 2.0377%, meaning that the 1-year Treasury rate is now expected to increase by 187.4 bp over the next 5 years (equivalent to 7.5 rate hikes)
Implied Hikes Priced Into 3-Month USD OIS Forward Curve | Sources: ϕpost, Refinitiv dataChanges In Implied Hikes Over The Next 10 Years | Sources: ϕpost, Refinitiv data

US INFLATION & REAL RATES

  • TIPS 1Y breakeven inflation at 3.94% (down -1.0bp); 2Y at 3.33% (down -1.1bp); 5Y at 2.93% (down -0.6bp); 10Y at 2.50% (up 1.0bp); 30Y at 2.29% (up 3.9bp)
  • 6-month spot US CPI swap down -7.1 bp to 3.622%, with a steepening of the forward curve
  • US Real Rates: 5Y at -1.7140%, -3.7 bp today; 10Y at -0.9730%, -2.6 bp today; 30Y at -0.3200%, -4.2 bp today
US 6-Month CPI Swap 2Y & 4Y Forward | Sources: ϕpost, Refinitiv dataUS TIPS Real Yields | Sources: ϕpost, Refinitiv data

RATES VOLATILITY & LIQUIDITY

  • USD swap rate implied volatility (USD 1 Month by 1 Year ATM Swaption) down -6.9% at 46.0%
  • 3-Month LIBOR-OIS spread up 0.4 bp at 7.0 bp (12-months range: 2.7-17.5 bp)
US Rates Volatility | Sources: ϕpost, Refinitiv data3-Month USD LIBOR-OIS Spread (Spot) | Sources: ϕpost, Refinitiv data

KEY INTERNATIONAL RATES

  • Germany 5Y: -0.470% (down -6.9 bp); the German 1Y-10Y curve is 4.3 bp flatter at 53.1bp (YTD change: +38.1 bp)
  • Japan 5Y: -0.086% (down -0.3 bp); the Japanese 1Y-10Y curve is 1.4 bp flatter at 17.5bp (YTD change: +4.2 bp)
  • China 5Y: 2.787% (down -1.4 bp); the Chinese 1Y-10Y curve is 0.9 bp steeper at 71.2bp (YTD change: +24.8 bp)
  • Switzerland 5Y: -0.361% (down -11.9 bp); the Swiss 1Y-10Y curve is 0.7 bp flatter at 70.0bp (YTD change: +43.6 bp)
Changes In Global Inflation Expectations | Sources: ϕpost, Refinitiv dataChanges In Global Rate Hikes Expectations | Sources: ϕpost, Refinitiv data