Debt Ceiling & Fed

Debt Ceiling & Fed
Tomorrow the Fed will conclude its meeting. It's expected for them to cut back on some of their asset purchases – even if little, this will likely cause some volatility in markets. Tomorrow may present a great opportunity to use weekly options that are a cheap way to benefit from outsized movement. As of 8/1/2021, the US Treasury is once again at the debt ceiling. With no sign of resolution anytime soon, the Treasury will need to resort to “extraordinary” measures to pay its Bills and obligations. During the last few times there's been a debt ceiling “lockup”, bond yields tend to fall (prices up). The last 2x times we were in this predicament was March 15, 2017, and then again March 1, 2019. Notice how Bond Futures fell with an increase to the debt ceiling? Something else we can use here is the Volatility Visualizer. We can use it on either TLT or on /ZB.  This tool shows us the Expected Move of any stock, futures or ETF. What do we see? Take a look at the labels. Look at the upper right corner of the chart, there’s a label that says “CLOSE IN”… /ZB Futures contract has closed within it’s Expected Move 68% of the time going back 5 years Now let’s look at the same chart but instead of /ZB Futures, we are looking at /ES Futures. Over that same time period of 5 years the /ES futures closed within the Expected Move over 87% of the time. That’s a big number! For weekly options this data is even more compelling. In the two charts below we look back 5 years at the weekly options data (as opposed to the Monthly above). Now we see /ZB Close In it’s weekly range 68% of the time, while /ES closes within it’s Weekly Expected Move 87% of the time. That’s incredible. This boils down to telling us that /ZB options are far better priced for the buyer than are options on SPX or /ES. Options on the SPX (or /ES) these options are better for “sellers” when we look at these statistics.  Thus for the upcoming weeks, We will very much like the purchase of options on /ZB, with a bias to the upside given all of the above.

Unusual Options Activity

The Wallstreet Wiretapper has witnessed a ton of activity on $TLT. of TLT in the WT. Normally it pops up for a day or two, but this time around TLT has continued to appear for a large cluster of days. TLT went into the “Hard To Borrow” category for a few days sometime in June as well. Usually this means the security is heavily shorted. Framing this using the rubber band analogy, we saw prices fall and yields rise from Aug 2020 – March 2021. This was an almost 30″00 handle move down, resulting in rates climbing back above 2.2%.  However, even as bonds started recovering (and a clear shift in markets was observed too), many specs continued shorting bonds and notes. This hasn't gone too well for them, as prices have done nothing but rise (and lower yields) since then.  It's important to note that this turn around in bonds occurred just as the Fed turned on its Overnight Reverse Repo facility, and raised rates to 0.05%. Since April 2021, a surge of cash has gone into this repo facility. Currently it's doing around 850bln per day. If you were a bank with 100bln, lending this cash overnight to the Fed would leave you with 50m. And you can do this every night. But is it really worth it? 100bln vs 50m? The other benefit from this overnight deposit is that the bank lending cash to the Fed gets Treasuries as collateral.

This is the most important part

Are banks doing this to earn a measly 0.05% on their cash, or to get access to those treasuries so that they can then be used to fund bank balance sheet capacity in the repo market? My bet is on the latter.  There's a collateral crunch. And with Treasury auctions coming to a haut until further notice, I believe bonds will defy everyone's inflation fears and keep rising in price. All due to the demand for this pristine collateral.  Thanks for reading!  Pablo Lucena Jonathan Rose  

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