OXI

Oct 27, 2019 — Weekly Comment

Tomorrow, October 28th, is NO day, the Greek holiday commemorating prime minister Metaxas’ refusal to let the Axis occupy strategic locations in Greece.

From Wikipedia: This ultimatum, which was presented to Metaxas by the Italian ambassador to Greece, Emanuele Grazzi, shortly after 03:00 am on 28 October 1940, who had just come from a party in the Italian embassy in Athens, demanded Greece allow Axis forces to enter Greek territory and occupy certain unspecified “strategic locations” or otherwise face war. It was allegedly answered with a single laconic word: όχι (No!). However, his actual reply was, “Alors, c’est la guerre!” (so this is war!)

When are markets and Central Bankers going to say “no” to levitated valuations?  Kevin Muir of TheMacroTourist blog and Market Huddle podcast has often said that Trump is the MMT (Modern Monetary Theory) president.  Figures released last week bear this out: The fiscal deficit for 2019 was released at $984 billion, “the first time since the early 1980s that the budget gap has widened over four consecutive years. (RTRS)  “Total receipts increased by 4% to $3.5T but outlays rose by 8.2% to $4.4T.”

This, in a time of record low unemployment.  The government appears to be driving growth as opposed to counter-cyclically providing stimulus as the economy slows. That will come later (we hope, if the bond market is accommodating).  As I understand it, the limit to MMT is determined by increased inflation which hasn’t really been showing much in terms of acceleration.  The question becomes, when does the massive increase in federal debt run into the wall of interest rate resistance?   Low rates have been associated with decreased levels of inflation.  Higher rates could conceivably produce the opposite reaction.  In any case, we’ve now seen a small example of the market saying ‘no’ with the September repo scare. 

There’s usually a bit of a build-up to “NO”.  I am not the first to make this comparison but Bear Stearns in 2007 and WeWork today provide some interesting parallels.  According to thebalance.com, in April 2007 bond dealers told the managers of two Bear Stearns funds they should write down the value of their assets.  These two funds, High-Grade Structured Credit Strategies and High-Grade Enhanced Leverage, owned CDOs based on  subprime.  By June of 2007, the Wall Street Journal framed it this way: “Injection of $3.2 Billion caps days of drama… Bear Stearns’ dramatic decision to lend as much as $3.2 billion to one of its two troubled hedge funds staves off the risk of a fund collapse that could have damaged its position as a major Wall Street bond player – and had the potential to ripple though a jittery subprime-mortgage market.”  All in the past tense.  Crisis averted, staved it right off. 

In March of 2008, it ended for Bear.  Continuing from TheBalance article, “Like many other Wall St banks, Bear relied on short-term loans called repurchase agreements.  It traded its securities to other banks for cash… Bear hemorrhaged cash when the other banks called in their repos and refused to lend more.  No one wanted to get stuck with Bear’s junk securities.” It wasn’t until September of 2008 that Lehman filed for bankruptcy, but the Bear problems were percolating well over one year beforehand.  Of course, it’s one thing to have repo backed by subprime, and another altogether to see hesitancy to lend in the repo market with US Treasury securities as the collateral. 

In any case, by December of last year, the Saudis balked at investing more money into Softbank’s planned $16 billion injection into WeWork (then valued at $42 billion).  Softbank CEO Masayoshi Son trimmed the investment to just $2 billion.  It’s worth noting that the second pillar of KSA’s Mohammed bin Salman’s Vision 2030 is the “…determination to become a global investment powerhouse” to diversify revenues.  The Saudis are major investors in Softbank’s Vision Fund, and the WeWork fiasco has certainly crimped Vision 2030.  So what’s the official response when things go pear-shaped?  It’s the Bear response.  Fund it yourself.  Softbank has now taken control of WeWork and is trying to right the ship amid a glut of non-leased space.  Softbank is also trying to launch Vision Fund II, but due to lack of interest, is advising Softbank execs to back it by lending them up to $20 billion. (RTRS)  As a client once told me, “The road to hell is paved with positive carry.”  Meaning of course, that what appears to be positive carry presently can swiftly turn into cement shoes.  Coincidentally, KSA once again had to pull its IPO for Aramco, having been advising wealthy Saudis to fund it.  Worth noting as well is that famed stock-picker Jeff Vinik shuttered his fund because he was having trouble raising $3 billion. These aren’t exactly examples of ultimatums, but they clearly are examples of a lot of NO.   

Much of today’s confidence in the US economic picture derives from the perceived values of assets.  So what happened in 2007?  As NorthmanTrader.com points out, “…don’t forget there is precedence for a July high followed by an October high.  That marginal new high in October 2007 was a life time selling opportunity.  The driver of that rally to new highs then?  The Fed cutting rates in September all the while saying things were fine, no recession coming.” (NorthmanTrader/Zombieland).  This was after the Bear mortgage fund implosion.  In the same piece Northman notes that this past week in SPY “Volumes collapsed to the lowest volume week ever (outside a holiday week with a half day thrown in) with daily volumes barely making it to 30-35m shares.  It’s stunning.”  (Current avg daily volume is about 73m).  One thing I learned as a youngster in this business is that if a move is not confirmed with high volume, it’s highly suspect. 

This Wednesday we’ll have the FOMC decision to cut rates to 1.50 to 1.75%.  November Fed Funds settled right near mid range, at 98.385 or 1.615%.  While private investors say no, central banks say yes.  And, just like Bear, when the private marketplace no longer wants to buy what you’re selling, then fund it yourself.  It’s not QE.  Call it by its real name, PANIC. 

In spite of economic data that was on the soft side this week, yields still rose with tens gaining 5.4 bps to end at 1.801%, the high of the last few weeks.  On Friday, we’ll have the Employment Report with NFP expected 90k and Average hourly Earnings +3.0% yoy.  As Jill Manfreddi highlights from ChallengerGray, “…this year, employers have announced plans to cut 464,869 jobs from their payrolls, 26.9% higher than the 366,058 cuts announced in the same nine months last year.  It is the highest January-September total since 2015, when 493.431 cust were announced.”

10/18/2019 10/25/2019 chg
UST 2Y 155.8 162.6 6.8
UST 5Y 155.2 162.7 7.5
UST 10Y 174.7 180.1 5.4
UST 30Y 224.5 229.3 4.8
GERM 2Y -66.3 -65.2 1.1
GERM 10Y -38.2 -36.2 2.0
JPN 30Y 40.9 39.5 -1.4
EURO$ Z9/Z0 -36.0 -34.5 1.5
EURO$ Z0/Z1 -3.5 -4.0 -0.5
EUR 111.70 110.81 -0.89
CRUDE (1st cont) 53.87 56.66 2.79
SPX 2986.20 3022.55 36.35
VIX 14.25 12.65 -1.60

https://www.reuters.com/article/us-usa-economy-budget/u-s-governments-annual-budget-deficit-largest-since-2012-idUSKBN1X426T

https://www.thebalance.com/bearn-stearns-collapse-and-bailout-3305613

https://www.reuters.com/article/us-softbank-group-vision-fund/softbank-plans-to-lend-up-to-20-billion-to-employees-to-invest-in-new-fund-wsj-idUSKCN1V70FM

Posted on October 27, 2019 at 3:40 pm by alexmanzara · Permalink
In: Eurodollar Options

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