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FxWirePro: Spotlight on US Job markets, USTs, and Rates Derivatives Strategies
As the February US job market data disappointed massively with only 20k new jobs, the labor market report for March out today will, of course, be of particular interest to the market and the US dollar. In particular, as on Wednesday the ADP index, which the market likes to use as an indicator for the non-farm payrolls, already came in below market expectations. February is likely to have been an outlier (to the downside), just as the January result had already been at 311k (to the upside).
According to our economists, the result for March should be around 185k. The US needs on average around 100-120k new jobs per month to absorb new entries to the labor market. As the unemployment rate has been at very low levels for a long time the number of jobs created should slowly going to ease back into that sort of region over time anyway. If job growth was to slow significantly faster this would, of course, constitute a relatively clear signal for the Fed. And today also for the market. If a number well below the 180k expected by the market were to be published today, contrary to our expectations, this would no doubt fuel recession fears, causing the dollar to appreciate as a result, with EURUSD slipping back below the 1.12 mark towards the end of the week after all.
Though the Fed’s dovish surprise was arguably the highlight since we last published, to start we focus on the somewhat mysterious behavior of swap spreads for the past several weeks. We have noted on numerous occasions the structural factors in favor of widening, including bringing forward expectations—now realized – around the end of balance sheet normalization, as well as netting efficiencies associated with the growth of sponsored repo reducing the cost of leverage in the system.
More immediately, the Fed balance sheet policy has shifted in favor of wider spreads. First, the Committee has now committed to ending Treasury runoff in September, a bit earlier than was expected. Second, and perhaps more importantly, also starting in Q4 up to $20bn of MBS paydowns per month will be reinvested in Treasuries via open market operations (as opposed to add-ons; for details, see Treasuries). Both are supportive of wider spreads.
Short gamma positions should remain biased towards shorting ATMF straddles
The confirmation at this week’s FOMC of a median Fed funds rate projection for 2019 unchanged from the current target level appears a bearish medium-term signal for vol.
Year to date, we have preferred holding selective longs in short-tailed gamma, motivated in part by heightened economic and monetary policy uncertainty since December, as well as deteriorating liquidity (e.g., price impact; see discussion below). Moreover, we also find evidence in favor of holding vol surface flatteners, which tend to perform well amidst a repricing in inflation risk premia, justifying longs in 3Mx2Y vs 3Mx30Y ATMF straddles. Courtesy: JPM & Commerzbank
Currency Strength Index: FxWirePro's hourly USD spot index is flashing at 64 levels (which is bullish) while articulating at (10:44 GMT).
For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex