Often Wrong, Never in Doubt

Weekly Comment – July 14, 2019

That’s a YZ saying.  “Often wrong, never in doubt.”  I don’t know whether he originally made it up, or heard it from someone else, but when he says it over a beer-drinking trading discussion with such obvious relish, it absolutely crystallizes everything about the trading profession and many people that inhabit it. 

I had the honor to be invited to Kevin Muir’s (the MacroTourist) + Patrick Ceresna’s podcast called the Market Huddle on Friday.  I knew what I wanted to convey, but perhaps muddled the message.  That’s why I generally prefer to write, rather than speak. ‘ Better to keep you mouth shut and appear stupid than open it and remove all doubt.’  I think that line is attributed to Mark Twain.  Maybe he heard it from YZ first.  Anyway, I usually include a few different topics in my weekly note, but this time, I am going to focus on the curve, specifically on 5/30.  I know which way it’s going.  Higher.  And I know where.  To 150 for a start.  (Currently 78).  It started the year at 48, having closed at 36 on Dec 20, the day after the last hike.

Generally, I don’t like to buy things right at the high.  On Friday, 5/30 closed at 77.4, near its recent high of 79.8, which is the high of the year.  I think it’s going higher.  At the very least, in this case, I am going with the year’s trend.  I don’t have the position on personally as I don’t trade futures.  I am long a small bit of TBT, which is the short bond etf, but that’s the closest thing I have to this idea.  These days the compliance people want to include a page of disclaimers on trade ideas.  Here’s my disclaimer.  I have been certain of many trades over time.  Used my own capital to express the view.  And been horribly wrong.  This could be one of those times.  But I don’t think so.  Having said that, there is nothing more painful than exiting a loser that you’ve done the analysis on, and added to as it dribbled against you. 

On Friday morning, someone checked on the floor, FVU 117 puts 4 times vs USU 152 puts one time.  The second I heard it quoted I was saying to myself, YES.  That is EXACTLY what you do here.  Buy the curve synthetically.  Sell FV puts and buy US puts.  Then a block posted.  40k FVU 116.75 puts at 11/64’s (117-145) vs 10k USU 151p for 41 (153-07).  Just completely obvious.  Of course, I didn’t know for sure that it was my way, but it turns out it was.  I mean you’d have to be an idiot to put that trade on the other way.  Did I just say that aloud?  Well, I was thinking it anyway.  ** Settles and data at bottom.

I was reviewing a slew of charts for Muir’s podcast.  I also skimmed some old central bank stuff.  For example Kuroda gave a talk at the Kansas City Fed in 2013, and was talking about the natural rate, and getting to the 2% inflation goal.  If you didn’t know it was from 2013 referring to Japan, you’d think it could be from any central banker today, sincerely making the same argument and assuring everyone that 2% inflation is right around the corner thanks to prudent policies and new tools.  OK.  Japan did get to a high inflation print of nearly 4% in 2014.  And then it came right back down and has only reached a subsequent high a bit over 1% in a couple of months since.  Last at 0.7%.  It’s Einstein’s definition of insanity.  Doing the same thing and looking for a different outcome.  Never in doubt. Tell me again why there’s a slight fraying in confidence in CBs?  I don’t even know what is so magical about this 2% goal.  But that’s a long post for another day.  Why do you want to keep trying to convince me that losing 2% of purchasing power annually is such a fantastic thing and the path to economic nirvana?  I have two words for you…

In the week prior to last, the curve was going bid.  Then employment data comes out stronger than expected.  They monkey hammered the front end because all of a sudden the Fed MIGHT NOT EASE.  In my mind, they HAVE to ease.  The important voices on the Fed have more or less said it.  And no, I am NOT talking about Bullard.  Of course, others including Mester and Harkin and Kaplan have expressed reservations about easing.  In the long run, they’re probably right, that additional stimulus may add to imbalances.  However, in the short run, if  the Fed doesn’t ease at the end of July, we’re going to be looking at some fierce volatility. 

Anyway, they flattened the curve in the aftermath of the employment data.  5/30 went from 76 on July 2 to 66 on July 9.  If you were long the curve, you were, at the very least, disconcerted.  Your inclination might be to exit in front of Powell’s semi-annual testimony.  However, Powell went before Congress and said there would be an ease.  I always love when people tell me that sort of thing:  “The guy said xyz.” And I usually respond, “Did you actually read the testimony?  Because I did, and he didn’t say that at all.  News bullet headlines can be very selective.”  Well in this case, Powell did say they’re easing.  No big deal right?  It was already priced.  Then, at the end of the week, the inflation data came out, a shade stronger than expected.  Chicago Fed’s Evans on Friday said a couple of rate cuts could bring inflation to the goal.  So what are the ingredients for a steeper curve?  A central bank that’s easing.  Inflation data starting to perk up just a little bit.  A LOT of supply. It’s not rocket surgery.  They’re BEGGING you to buy the curve.  Yeah, but are there any other clues?  Well, the German bund went from a capitulation low of -40 to -20.  Oats had a negative yield (Mon dieu, has the world gone crazy?) and then snapped back to positive.  30-yr treasury yields closed at a new recent high of 2.64%, with an outside range in July relative to June, having made a new low of 2.467 last week.  Long bond positions have gone bad. Pear-shaped.  Ten and thirty year auctions were a bit soft.  This ship has turned. 

Then on Friday morning, a big guy comes in with the option play.  I was talking about it with a friend, and he was asking, well vol is historically low, right?  Yeah.  What I do (unscientifically) is look at the DV01 of the contracts.  And I see that it’s 3.93 FV to one US ($48.5 to $190.6).  And then I look at price atm vol of the two contracts.  Obviously, bond vol shouldn’t be 3.93x higher. And of course it’s not.  Anyway, that vol ratio is currently 2.61.  And then I look at the ratios compared to each other.  In my observations, if that ratio is below 0.70, as it is now at 0.66, then bond vol is cheap to FV. Where SHOULD it be?  I don’t really know.  One could look through a lot of history and crunch a lot of data and give you an answer.  I’m not going to do that.  Because, in our recent interest rate history, there have been a lot of moves, some of them very recent, where people said, “it’s never been here before, this is the time to fade it”.  And it keeps steamrolling.  Then I look at something like the Gold/Silver ratio and say, hmmm, it’s never been this high before.  Maybe I should go the other way.  Or I look at something like the Russell/SPX ratio, and say, hmmm, if things are so good then why is this ratio at the 2016 low and within spitting distance of the 2009 crisis low?  Maybe this is the trade of the year: Buy Russell, sell SP.  All I know, again focused on 5/30, is that you usually can’t put an option trade like the one that occurred for a credit.  So, I think it’s attractive.  Combined with my curve view, it’s a no-brainer.   

Along the same lines, I was in a discussion about the nominal levels of red to blue euro$ midcurve straddles.  Just as an example, on Friday, 0EZ 9825^ settled 38 vs EDZ0 at 9830.  2EZ 9825^ settled 36.0 vs EDZ1 9824.0.  And 3EZ 9812.5^ settled 34.5 vs 9813.0.  Similar futures’ prices, cheaper straddles further back on the curve.  Doesn’t the back stuff seem a little cheap on a relative basis?  And my friend said,”It’s gamma vs grandma.  If you’re short in the backs [like the blues] it’s like grandma punching you.  It’s just not going to hurt as much.” Of course, what that pithy little saying meant is, “The Fed’s in play.  The front contracts are moving around a lot more.  The fronts are what’s driving the curve; the backs are pretty stable.  Obviously people are willing to pay more for the protection up front.  Makes sense. 

But here’s the seed I want to plant.  What if the thing that blows up next is the yield in the back end.  That, as a friend of mine likes to say, would set the cat among the pigeons.  What if the Fed is committing to ‘a couple, two, tree, whacks’ as we like to say in Chicago, just as demand for long dated paper is ebbing?  Arguments to that effect can be made on the basis of both technicals and fundamentals.  Sometimes things just reverse because everyone has ALREADY committed.   We’ll be watching nominal levels of back midcurve straddle levels relative to reds, the value of DXY, US vol levels, and of course, actual yield spreads to monitor this idea.

News this week includes another Powell speech on Tuesday, ‘Aspects of Monetary Policy in the Post-Crisis Era’.  Beige Book on Wednesday.  Data includes Retail Sales and Ind Production Tuesday, Housing Starts Wednesday, Philly Fed Thursday.

7/5/2019 7/12/2019 chg
UST 2Y 187.1 183.7 -3.4
UST 5Y 183.9 185.9 2.0
UST 10Y 204.2 210.6 6.4
UST 30Y 254.6 263.3 8.7
GERM 2Y -74.9 -72.3 2.6
GERM 10Y -36.3 -21.0 15.3
JPN 30Y 33.4 39.0 5.6
EURO$ Z9/Z0 -36.5 -32.0 4.5
EURO$ Z0/Z1 -0.5 6.5 7.0
EUR 112.26 112.88 0.62
CRUDE (1st cont) 57.51 60.21 2.70
SPX 2990.41 3013.77 23.36
VIX 13.28 12.39 -0.89

** FVU9 116.75p settled  8.5 with a delta of 21.   USU9 151p settled 30 with delta of 22.  Expiration date 23-August.

Posted on July 14, 2019 at 12:58 pm by alexmanzara · Permalink
In: Eurodollar Options

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