Liquidity Headwinds May Re-Emerge as Volatility Signals Trouble Ahead
Membership in Navigating the Market provides access to deeper analysis, along with ongoing updates on market dynamics that tend to receive less attention in broader market commentaries.
T-bill issuance is set to expand again this week, marking the first week in about a month in which the Treasury will not be adding cash to the overnight funding market through paydowns. This week, the Treasury will pay down approximately $16 billion in bills on January 13, followed by net new cash issuance of $23.4 billion in coupons and $4 billion in bills on January 15.
Net issuance should continue to increase beyond that point, and we will closely monitor whether overnight funding pressures re-emerge as the Treasury General Account rises, approaching month-end, and ahead of the quarterly refunding announcement.
This week will also feature a CPI report. Based on market pricing as of Friday, CPI swap prices were implying a print above 2.9%, effectively rounding to 3%. That, of course, is subject to change as the week progresses.
The market was pricing the zero-coupon CPI swap index value at 324.9487, which would imply a 2.95% increase from the 315.61 level that printed in December 2024. While this is clearly subject to change, it is worth noting and something I will be watching closely as the week begins.
CPI had been trending higher heading into the government shutdown, reaching 2.9% in August and 3.0% in September, and the November reading did not seem entirely consistent with that trend. As a result, I would not be surprised to see CPI come in above the 2.7% level currently being priced in by analysts for December.
There were also notable surprises in the labor report, with the unemployment rate falling and wage growth accelerating.
Speaking of the jobs report, which showed a solid improvement in the household survey in December, the 3-month Treasury bill 12-month forward minus the 3-month Treasury bill spread contracted to just -4 basis points. This is the highest level the spread has reached since early last year, which on the surface would suggest that the market is pricing in fewer rate cuts from the Fed in the future.
The obvious rebuttal is that Trump is likely to appoint a low-rate Fed chair. The obvious response to that, however, is that if you and I know it, then the market knows it as well.
The ironic part of all this is that, even though everyone knows Trump is likely to appoint a Fed chair inclined toward cutting rates, both the December 2026 Fed funds futures contract and the 2-year Treasury yield are once again on the verge of breaking out of their proverbial trading ranges and moving sharply higher.
USD/JPY weakened materially following the jobs report, but more importantly, the move came after Japan’s prime minister may consider calling a snap election. This once again highlights why the yen remains weak despite the narrowing of interest rate differentials. Rising rates in Japan are not only a reflection of inflation and Bank of Japan policy risk, but also fiscal policy risk—and for now, fiscal policy risk is winning.
Finally, equities rose on Friday, but that move had more to do with implied volatility being marked lower and call skew compressing. More interestingly, based on CBOE data, put skew did not decline and was essentially flat. That suggests the drop in implied volatility was driven primarily by calls rather than puts, which I found somewhat unusual. Not a very bullish perspective.
(CBOE)
Learn More as an Advanced Topics Member:
What is even more unusual is how low the 1-month implied correlation index already is, especially given how early we are in earnings season. The index fell below 7, placing it at the very low end of its historical range. Unless 1-month implied correlations are going to head back to zero and break below the July 2024 lows, a significant move higher in the S&P 500 is likely to be difficult.
Implied correlation levels this low are more often associated with market peaks than with the start of sustained rallies. See July 2024, January 2025, and October 2025.
-Mike
Glossary by ChatGPT
Basis Points – One hundredth of a percentage point, commonly used to measure changes in yields or spreads.
Call Skew – The relative pricing of call options across strikes, reflecting upside demand or sentiment.
CBOE – The Chicago Board Options Exchange, a major marketplace for options and volatility data.
CPI (Consumer Price Index) – A measure of inflation tracking changes in prices paid by consumers for a basket of goods and services.
CPI Swap – A derivative contract that allows investors to exchange fixed payments for realized CPI inflation.
Coupons – Treasury securities with periodic interest payments, typically notes and bonds.
Fed Funds Futures – Futures contracts reflecting market expectations for the Federal Reserve’s policy rate.
Household Survey – The employment survey used to calculate the unemployment rate, distinct from payroll data.
Implied Correlation Index – A measure of expected correlation among stocks derived from option prices.
Implied Volatility – The market’s expectation of future price variability embedded in option prices.
Interest Rate Differentials – The yield difference between comparable securities in different countries.
Overnight Funding Market – Short-term lending markets where institutions borrow and lend cash overnight.
Put Skew – The relative pricing of put options across strikes, often associated with downside hedging demand.
Quarterly Refunding Announcement – The Treasury’s regular update detailing borrowing needs and issuance plans.
Treasury General Account (TGA) – The U.S. government’s checking account at the Federal Reserve.
Treasury Bills (T-bills) – Short-term U.S. government securities with maturities of one year or less.
USD/JPY – The exchange rate between the U.S. dollar and the Japanese yen.
Zero-Coupon CPI Swap – An inflation swap settled only at maturity based on cumulative CPI changes.
Disclosure
This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.