Euro$ calendars portend a larger rate shift

Oct 18, 2019

–Rates edged slightly higher yesterday in spite of weaker than expected data with Housing Starts -9.4%, Ind Prod -0.1 and Philly Fed just 5.6.  There was notable put buying in treasuries prior to the day session, with a new purchase of 55k TYZ 128p for 12. (settled 13 ref 129-29).  During the day there was a buyer of 15k TYX 129.5/129 p 1×2 for 1 which appears to be a roll-up in strike as open interest fell in 129’s.  

–In eurodollars, EDH0/EDH1 one-year calendar posted a new high of -20.5 and was -20 bid just after the settlement. Near one-year calendars have had a significant rally since early September, when this particular spread EDH0/H1 bottomed near -40.  The takeaway is that forward expectations of actual rate cuts have declined, especially in the wake of QE lite.  The March/March spread has made a complete round-turn from -20 in late July, to -40 in early Sept, to -20 now.  However, treasuries are no where near the lows made in late July.  For example, TYZ had traded 127-20 at that time and  is now near 130.  Does action in forward ED spreads portend an adjustment to higher rates in treasuries?  Could be a good reason for some of the large put buys…

–China GDP was 6.0% vs 6.1 expected, a new modern low.  Bloomberg reports that “The total number of Chinese onshore company bond defaults this year just equaled the record set for the whole of 2018.”  And, as mentioned yesterday, the IMF says that global corporate debt could lead to the next crisis: “The $19 T in ‘corporate debt at risk’ amounts to almost 40% of total corporate debt in the eight economies studied.”  We’ve been close to the BBB cliff in the US, but it never seems to spill over, in spite of WeWork, etc.  Here’s a great tweet from Charlie Bilello indicating crazy valuation.  “Beyond Meat’s market cap just passed Conagra.  Conagra: Founded in 1919 (Duncan Hines, Slim Jim, Orville Redenbacher, Healthy Choice, etc…) 18,000 employees, $9.5 BILLION in Revenue.  Beyond: Founded in 2009.  Fake Meat, 383 employees, $95 MILLION Revenue.”  Some guys in office tried a Burger King Impossible burger yesterday… no rave reviews.  

Posted on October 18, 2019 at 5:19 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Sharknado

Oct 17, 2019

–This morning EDZ9 is the weakest contract on the board, trading -3 at 9808.5 (red pack -1.75 as of this writing).  It appears as if tightness in funding markets is expected to persist thru year-end.  Interestingly, yesterday’s settlements in near Fed Fund contracts show increasing certainty of an ease at the October 30 FOMC.  Oct/Nov FF spread settled -21.0  with FFV -0.25 at 9816.5 and FFX9 +3.5 to 9837.5.  However, the Nov/Jan spread settled at just -10, so odds of an ease at the Dec meeting are falling.  A couple of weeks ago, the Nov/Jan spread was much more negative than Oct/Nov; this relationship has flipped. Ease NOW rather than later.  With the advent of QE lite, the market is less inclined to project forward easing (after October).  Of course, comments like Lael Brainard’s yesterday also figure into the equation:  She views “…the cost-benefit assessment of negative rates as unattractive” for the US.  EDH0/EDH1 and the one-year calendars immediately behind edged to new recent highs, with March/march +0.5 to -21.0.

–Retail Sales weaker than expected at -0.3%.  Today’s news includes Housing Starts expected -3.2%, Philly Fed 7.6 vs 12.0 (range so far in 2019 -4.1 to +21.8) and Industrial Production -0.2%.  

–I read yesterday that the CEO of CSX said “It’s difficult, still very, very difficult to gauge where the overall economy is going”, as CSX rail volumes fell 5.3% yoy in the quarter.  Of course, he said much the same thing in July.  The Ass’n of American Railways website shows that current rail traffic at this point of the year is the weakest it has been in the last 4 years.https://www.aar.org/data-center/rail-traffic-data/

–Yesterday’s Beige Book was a slight downgrade.  Labor market tightness cited as an impediment to hiring. “A number of Districts reported that manufacturers reduced their headcounts because orders were soft. However, some firms were more concerned about the longer-term availability of workers and subsequently chose to reduce hours rather than staff levels.”  Is this a precursor to an actual reduction in staff?  The report also corroborated weak shipping data: “…some reports suggested that shipping rates remained lower than they were earlier this year because of excess capacity in the industry”.   Though the report was prepared by the Cleveland Fed, for some reason there was a “Sharknado” focus on Cape Cod suffering from weak tourism: “Media attention was “overly” focused on increased shark sightings and (rare) tornados.”.  You’re really gonna put that in the report Wilson?  Sure, I’ll bet you $5 that they don’t edit it out…

https://www.federalreserve.gov/monetarypolicy/beigebook201910.htm

Image result for sharknado
Posted on October 17, 2019 at 5:16 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Growth questionable, but rate markets trade like a bear

Oct 16, 2019

–Rates pressed higher Tuesday and the curve steepened as stocks soared.  A Brexit deal appears closer, supporting GBP and stocks, and of course, optimism surrounding a resolution to the US/China trade war is also a factor, though China is threatening to retaliate if the US passes a Hong Kong bill.  The ten year yield is at a resistance level of 1.77%, but shows scant evidence of pulling back.  Near euro$ calendars made new highs.  EDZ9/EDZ0 is still the lowest one-year, at -34.5, +2 on the day, while EDH0/EDH1 settled -21.5, +1.  2/10 edged to a new recent high of 14.9 bps. 

–There was a new seller of 20k TYZ 128.5/132.5 strangles early at 28 to 27, (settled 31, 23 and 8 ref 129-24+) but implied vol remained firm in tens.  In short, rates are trading a lot like a bear market, notwithstanding this morning’s bounce.  

–As expected Bank of Korea cut rates by 25 bps to match the 1.25% low seen through late 2016 and 2017. This move underscores weakness throughout Asia.  In the US, the Cass Freight report summarizes activity as follows:
• With the -3.4% drop in September, following the -3.0% drop in August, -5.9% drop in July, -5.3% drop in June, and the -6.0% drop in May, we repeat our message from the previous four months: the shipments index has gone from “warning of a potential slowdown” to “signaling an economic contraction.”  
North American Freight volumes negative year-over-year for the tenth straight month. 
https://www.cassinfo.com

Image preview
US ten year yield
Posted on October 16, 2019 at 5:00 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Treasury jitters

Oct 13, 2019 – Weekly Comment

Last Sunday, referring to the week ended 4-October, I wrote, “The two-year yield dropped over 23 bps… In my book, that’s an ease!”  What a difference a week makes.  Because this week, the market recaptured that ease, and then some.  Usually in the table at bottom, I just note one week changes.  But below, I show the past three Fridays (I mark treasury yields as of futures market settlements).  The two year went from 1.622% on 27-Sept to 1.388% and back to 1.616%.  A round turn.  Tens from 1.675 to 1.507 to 1.755.  That is a monumental move which suggests the first week of October was pure capitulation. 

The two dominant events were the Fed announcing a $60 billion per month t-bill buying program and PHASE I of the China trade deal.  The Fed wants everyone to think of this latest move as normal, everyday tweaking of the monetary levers to ensure smooth market functioning.  We’ll get to that below. 

The China deal is quite interesting in terms of strategy.  The election is just over one year away.  Every time the stock market goes up it’s due to “optimism on a trade deal” and every time it goes down it’s due to some sort of an impasse on a trade deal.  It makes a tremendous amount of sense to dribble out the easy phases of agreement to string along equity participants and manage expectations.  China was able to delay implementation of tariffs, and can likely wrangle more advantageous clauses as time goes on.  In fact, though there was a reasonable amount of day to day movement, SPX for the past three Fridays was fairly constant: 2962, 2952, 2970.  So, the giddy enthusiasm on Friday is somewhat tempered when looking at a slightly longer time frame. 

On the yield side, the implications aren’t clear, but the market is giving strong clues.  October Fed Funds on Friday closed +1.0 bp at 98.1775 or 1.8225%.  Pretty much right on SOFR and the Fed Effective rate.  In the very front part of the curve, the market has a high degree of confidence that the Fed will do whatever it takes to control repo.  However, April 2020 Fed Funds dropped 10 bps on Friday from 98.655 to 98.555 or 1.445%.  The 6-month spread between Oct FF and Apr FF is thus -37.75 with four FOMC meetings within the period, i.e. 1.5 expected cuts.  It’s worth noting that January 2020 Fed Funds (which capture only 2 FOMCs) settled as high as 98.565 seven trading sessions ago.  So 1.5 eases HAD BEEN priced for two meetings and has now been stretched to four meetings. 

On the euro$ curve, it’s a similar story.  The very front end of the curve is underpinned by the Fed’s efforts to supply liquidity.  Back contracts took a tumble.  As an example, EDZ9 fell 7 bps on the week, to 98.10.  However, EDZ0 fell 29.5 to 98.45!   Near calendars obviously made new highs, with EDZ9/Z0 up 22.5 to -35.0 and EDH0/EDH1 up 7.5 to -22.0.  The absolute measure on EDH0/EDH1 suggests only one ease over that year.  And of course, one-year calendar spreads from there forward are steady to positive.  EDH1/EDH2 is essentially flat at -0.5 and EDH2/EDH3 is +6.0.  The peak contract on the euro$ curve remains the eighth quarterly, now EDU21, at 98.545.  The highest settle of the 8th contract was on Sept 4 at 98.945, which would be consistent with a FF target of 0.75 to 1.0%, rather than the current level which would suggest a target of 1.25%. 

What about the immediate prospect of an Oct 30 cut?   Although market dynamics have changed, I think the Fed will continue to err on the side of extra liquidity and ease by another 25 bps.  This move had been substantially priced early in the week with Oct/Nov FF calendar around -19 bps.  However, the spread closed Friday at -15.75, still suggesting an ease, but with less certainty.  I think the Fed got a good scare out of the repo surge and can couch another ease in the context of low inflation expectations and somewhat soft data.  As an example, the NY Fed’s UIG (Underlying Inflation Gauge) was released last week at 2.4%, having steadily declined from 3.1% in late 2018.  The ten year treasury to inflation-indexed note spread has been anchored just above 150 bps. 

The longer end of the curve may provide the true “tell” for action going forward.  Often, treasuries rally when coming out of the third leg of the auctions.  Not this time.  While I think there is likely to be a brief bond market rally in the early part of the upcoming week, sentiment appears to have turned decidedly bearish.  The globe has been easing monetary policy.  The Fed is committed to liquidity.  The administration will probably do whatever it takes to juice the economy going into the election.  Implied vol firmed on the move down. I don’t perceive the bond market as being in a bubble, but it does seem as if long yields have a lot more room to the upside than downside. As recently as April the 30-year yield was near 3% and just under one year ago in November it was near 3.50%. (Friday close 2.216%)  Also worth noting is that the ten-year German bund yield ended at -44 bps on Friday, a rise of 14 on the week and the highest since early August; a downward sloping trendline since April was violated.

Perhaps there aren’t a lot of people in today’s market that recall this, but I remember a time when Greenspan fretted that there might not be enough government debt to appropriately conduct monetary policy.  I looked up a Greenspan speech from April 27, 2001 entitled ‘The Paydown of Federal Debt’.  Below are a couple of excerpts (linked at bottom):

Today I want to address a subject in which your group and the Federal Reserve share a keen interest–the paydown of the federal debt and its implications for the economy and financial markets. While the magnitudes of future federal unified budget surpluses are uncertain, they are highly likely to remain sizable for some time.     

…current forecasts suggest that under a reasonably wide variety of possible tax and spending policies, the resulting surpluses will allow the Treasury debt held by the public to be paid off. [Wow, what a difference a couple of decades makes.  30-year auctions were actually suspended for a while]

The effectiveness of our markets in allocating capital is one of our nation’s most valuable assets. We need to be careful not to impair their functioning.

Given concerns about the potential distorting effects of asset accumulation by the Treasury or in government defined-benefit plans, we need to carefully consider the appropriate path of debt paydowns.

A final valuable feature of the Treasury market is that it is a remarkably efficient system for funding federal government deficits. Because demographic and other factors are surely likely to lead to the re-emergence of deficits in the future, one might argue that it would be best to continue to borrow at least limited amounts from time to time in order to keep the market operating, so that it will be available when it is needed again. 

Currently, Treasury securities are the “permanent” assets that correspond to the currency that is the Federal Reserve’s main liability. Treasury securities have several features that make them particularly attractive assets for the Federal Reserve. First, the liquidity of the market allows the Federal Reserve to make substantial changes in reserves in a short period of time, if necessary. Second, the size of the market has meant that the effects of the Federal Reserve’s purchases on the prices of Treasury securities have been minimal. Third, Treasury securities are free of credit risk. Thus, the Federal Reserve does not itself take on such risk when it holds them. … we believe that the effects of Federal Reserve operations on the allocation of private capital are likely to be minimized when Federal Reserve intermediation involves primarily the substitution in the public’s portfolio of one type of instrument that is free of credit risk–currency–for another–Treasury securities. As I discussed earlier, it is important that government holdings of assets not distort the private allocation of capital, and this goal applies to the Federal Reserve System as well as to the Treasury.

Even before that time, the Treasury market may become less liquid, making it more difficult for the Fed to make purchases without affecting market prices. Moreover, declining Treasury debt presumably would, at some point, reduce the liquidity of the Treasury repurchase agreement (RP) market, complicating the use of such operations in adjusting the short-term supply of reserves.

A few key takeaways from this speech.  First, Greenspan was quite cognizant of the risks that the Fed might distort the proper functioning of capital markets.  That horse has left the barn. Of course, it’s not just the US horse, there’s a nagging recognition that negative rates and central banks’ accumulation of various assets have distorted markets globally. Second, the repo market is essential to the proper conduct of monetary policy.  A repo rate surge like the one we just experienced has the potential to sap confidence, which is why the Fed has taken strong and immediate measures to address it.  The t-bill about-face is not just a tweak.  The Fed was, as we used to say as kids, a-scared [that’s really REALLY frightened] that they let the market get away from them, exposing the fragility of funding the massive architecture of world-wide debt that has been created.    

To conclude, regimes that we take for granted as stable can change pretty quickly.  As the Fed supplies liquidity to the front end, long end rates may not respond favorably.  In fact, the hawks on the Fed may initially take solace that a rise in long end yields are doing the ‘heavy lifting’.  Banks, which are expected to show a yoy earnings decline this week, will welcome a return to a positive yield curve. (C, WFC, JPM, GS report on Tuesday, BAC on Wednesday).   But there’s a chance that the Fed, in correcting one aspect of the market that got away, might see dislocations accelerate in another part.

OTHER MARKET/TRADE THOUGHTS

Last week I wrote: “In spite of the end of week stock surge, treasuries closed near the highs.  Surprisingly, implied vol in rate futures is not confirming the move, and is slipping on new upticks, especially in bonds.  This may portend a change, where vol now has a chance to firm on downticks, which would catch many positions offsides.”  Last week’s yield reversal absolutely caught some participants flat-footed. 

Rather than consider trades for the week, I am a bit more inclined to take a longer time-frame view.  I think yields could easily decline in the beginning of this upcoming week.  In tens, I think there’s major yield resistance up to around 1.80%, vs Friday’s 1.755%.  I think an instant violation of that area is unlikely, but over the next few weeks we could easily surpass those yields.  The market has been conditioned to sell puts on all rate futures as yields increase.  I am more inclined to buy puts if yields fall, and to do that further out the curve. 

One chart I looked at last week was a synthetic 100 bp wide risk reversal on 3EH (the second quarterly blue midcurve).  Here’s an image (in terms of bps).  This is synthetic in that time until expiration is more or less held constant over the life of the chart.   What it shows is that puts are now gaining on calls on this move…call skew further out the ED curve has diminished appreciably.  Contact George Austin at PricingMonkey.com ( george@pricingmonkey.com) or check the Pricing Monkey blog for ideas.

100 bp wide 3EH0 synthetic risk reversal
9/27/2019 10/4/2019 10/11/2019 chg
UST 2Y 162.2 138.8 161.6 22.8
UST 5Y 155.1 132.4 158.2 25.8
UST 10Y 167.5 150.7 175.5 24.8
UST 30Y 212.5 200.4 221.6 21.2
GERM 2Y -77.0 -78.0 -72.0 6.0
GERM 10Y -57.3 -58.6 -44.2 14.4
JPN 30Y 31.8 34.6 38.3 3.7
EURO$ Z9/Z0 -50.0 -57.5 -35.0 22.5
EURO$ Z0/Z1 -8.0 -5.0 -7.0 -2.0
EUR 109.42 109.79 110.38 0.59
CRUDE (1st cont) 55.91 52.81 54.70 1.89
SPX 2961.79 2952.01 2970.27 18.26
VIX 17.22 17.04 15.58 -1.46

https://www.federalreserve.gov/boarddocs/speeches/2001/20010427/default.htm

Posted on October 13, 2019 at 12:20 pm by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Risk off in US bonds, but risk ON in mideast

Oct 11, 2019

–Yields continued to press higher, with tens up 7 bps to 1.656% as trade optimism leads to paring back of “risk-off” trades.  Eurodollars from reds to golds were -8.5 to -7.0.  Going into today’s October midcurve expiration, it’s worth noting that Green Dec (EDZ21) has dropped 17 bps in the week from last Thursday to yesterday, 9881 to 9864, bringing the 9862.5 put into play.  –While Core yoy CPI remained at 2.4%, the monthly figures were lower than expected.  The NY Fed also released its Underlying Inflation Gauge (UIG) yesterday, which showed a drop of 0.1 in the ‘Full data set’ to 2.4%.  This measure has been on a downward slide through 2019, having spent the last half of 2018 above 3%.  However, energy prices are making an effort this morning to buck the disinflation trend, as an Iranian oil tanker was struck by missiles near a Saudi port.  CLX9 is up $1.00/bbl to 54.55.  Stocks are also starting the morning with strong gains.  

–FFX9 (Nov Fed Funds) was a star performer yesterday, closing +0.5 at 98.36 when every other interest rate contract closed lower on the day.  Oct/Nov FF spread settled -19.25, still showing better than 3 out of 4 odds for a cut at the end of the month.  However, Nov/Jan is back to -14.5, so forward expectations of easing have, well, eased.  The most inverted one-year euro$ spread remains EDZ9/EDZ0 at -43.0, which rallied 5.5 bps on the day.  This spread had been around -60 in the early part of September.  

–Below is a twitter chart from @michaelbatnick showing the explosive increase in debt for just one company, AT&T.  It shows an increase from around $60b in 2011 to $170b currently.  These guys make the federal gov’t look downright miserly (Fed debt has only doubled since 2009).  

Posted on October 11, 2019 at 5:16 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

US yields edge up as Greece funds at negative rates

Oct 10, 2019

–Rates backed up a bit more on Wednesday, as stocks firmed on renewed hopes of progress in US/China trade talks.  Tens rose nearly 5 bps to 1.585% and EDU0 and EDZ0, the weakest ED contracts on the board, settled -7.5.  The curve was a bit flatter.  On Monday, the ten-year inflation indexed note had a yield of half a basis point.  In the two sessions since then it leapt to a ‘real’ yield of 10 bps.  EDZ9/EDH0 jumped 4 bps to -28.5 as Z9 is underpinned by expected near term rate cuts.

–News today includes CPI with yoy Core expected 2.4% (following weaker than expected Core PPI of 2.0% on Tuesday).  Thirty year auction today as well.  It’s worth noting that Greece just issued 10’s at 1.5%, a shade under the US rate, and issued 13 week bills at a slight negative yield.  That makes perfect sense, right?

–Back in the financial crisis, when no one thought housing prices could ever fall, the issue was excessive debt, without much of an equity cushion. Short term rates were adjusting higher, making cash flows unambiguously negative.  If, at that time, the Fed gave anybody with a mortgage a locked rate of, let’s say 1%, the negative asset spiral probably wouldn’t have occurred.  Without interest carrying costs, perhaps rents and other income could have covered property taxes and maintenance.  Of course, when lenders are private, they worry about things like resale value, and incomes (or at least they do now).  Rates tend to be higher for borrowers who seem stretched. 

–Currently we have a giant edifice of debt, both government and corporate, which doesn’t throw much off in terms of income.  Short term yields are very close to long term, so there is little in the way of positive carry.  The recent surge in repo is an indication that the private market is uncomfortable.  So the Fed has stepped in to GUARANTEE cheap funding, and indicates that rates will become cheaper yet, rather than risk letting the market clear.  That keeps the plates spinning, even in a world of extended valuations.  

Posted on October 10, 2019 at 5:11 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Fed has ONE mandate: Keep funding costs low

Oct 9, 2019

–Yields fell  with tens down 1.4 bps to 1.537%.  Curve slightly steeper as Powell said the Fed would once again expand the balance sheet by buying bills to create a reserve buffer. He said the Fed prefers to administer rates through reserves rather than continuous market operations.  The very fact that the Fed has to heavily intervene to keep funding markets from malfunctioning suggests that the underlying problem is going to manifest somewhere else.  For now, the market is pricing high odds of an ease at the Halloween meeting, with Oct/Nov FF spread closing at -19.5.  Even with expected monetary largesse, stocks closed negative with financials taking a beating.  XLF closed -2% while SPX was -1.56%. 

-Core PPI was lower than expected at just 2.0% yoy Core.  CPI is tomorrow.  Ten year auction today. 

–FOMC minutes are also released today.  However, the circular trade talks with China are a more immediate factor.  This morning stock futures have reacted positively to small signs of progress.  However, the NBA tweet blow-up exposes larger risks of firms depending on China as a growth market.  

Posted on October 9, 2019 at 5:20 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Fraying at the corners

Oct 8, 2019

–Yields rose and the curve flattened Monday on light trade, with upcoming inflation figures and supply weighing.  Tens up 4.4 bps to 1.551%.  Reds, weakest on the dollar curve, closing -6.375, greens -5.75, blues -5.125 and golds -4.125.  Implied vol declined.  For example, last Tuesday, ED prices were within a couple of bps of yesterday’s close, and EDM0 9862^ settled 49, vs 46.5 yesterday.   0EH 9875^ from 45.0 to 42.5 now, and 2EH 9875^ from 43.5 to 41.5.  

–Consumer credit, released yesterday afternoon, was up a healthy $17.9 billion.  However, revolving credit was DOWN $2 billion and non-revolving up $19.9B.  Let’s go back to school.  The democrats will pay for it! (Non-revolving is student loans and auto debt).  

–Today’s data includes PPI, with yoy Core expected +2.3%.  Three year auction as well, with tens and thirties to follow Wed and Thurs.  

–A couple of interesting charts cited by the Daily Shot yesterday indicate that credit conditions at the perimeter are fraying.  I have attached a St Louis Fed chart showing CCC yield spread, which is now at 11.08% testing the level from late last year when markets were unraveling.  I’m sure part of this is due to WeWork.  For now, it doesn’t seem to be seeping into markets at large.  For example, in late 2018, the last time CCC spread was over 11%, HYG had plunged to 80.  It’s now holding near the highs above 86.  

US Hi Yld CCC option adjusted spread


Posted on October 8, 2019 at 5:06 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

To start the week…

Oct 7, 2019

–In spite of a spirited 40 point rally in ES on Friday, (Nasdaq and SPX both up 1.4%), yields remain close to recent all time lows.  Tens fell 2.2 bps to 1.507%, and that’s in the face of this week’s supply of 3, 10 and 30 year paper.  In response to new highs in the curve on Thursday, a decent amount of flattening trades went through on Friday, bringing 2/10 down 2.8 bps to 11.9.  This morning stock futures have given back some of Friday’s gain, as China reportedly wants to narrow the focus on a trade deal, and N Korea talks hit an impasse.  Additionally, Bernie Sanders’ health scare was upgraded to a heart attack; one poll showed that his supporters would migrate primarily to Warren, leaving her as front runner.

–Record low unemployment rate of 3.5% (since 1969) reported on Friday, but wage growth decelerated to 2.9%.  This week we’ll get inflation data in the form of PPI on Tuesday and CPI Thursday, with the Fed minutes in between on Wednesday afternoon.  Just over three weeks until the Oct 30 FOMC, and spreads indicate that odds of an ease are > 70% as Oct/Nov FF spread settled -17.75.  Also worth noting that EDZ9/EDH0 edged to a new low of -36.0 on Friday (-0.5).  This partially reflects weakness in EDZ9 due to turn-of-year considerations, and also the idea of front-loaded easing.  With EDZ9/EDZ0 at -57.5, Z9/H0 comprises nearly 2/3rds.  EDH0/EDZ0 9-month spread is only -21.5.

–The ‘real’ ten year yield as shown by the inflation-indexed note is again zero.  Not exactly a sign of a robust economy.  One other interesting note:  An article on CNBC blames millennials for – get this _ a high savings rate!  https://www.cnbc.com/2019/10/06/millennials-are-to-blame-for-sluggish-economy-raymond-james-report.html
While I don’t know that I agree with the premise, I did go to the Fed website to get a chart of the savings rate (attached), and sure enough it’s over 8%. 

 

 

Posted on October 7, 2019 at 5:19 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Send Lawyers Guns and Money

Oct 6, 2019 Weekly Comment

How was I to know, she was with the Russians too.

–Warren Zevon 

The first comments on the thread of this youtube video are “I’m playing this loud, to annoy the neighbours, as revenge for waking me up with the hedge trimmer.”  In response, “I don’t always listen to Zevon, but when I do, so do the neighbors!” 

How was I to know Lawyers Guns and Money would be a global anthem? Play this one at top volume.  The neighbors will love you for it.

Lawyers for Trump, Guns for entire world and Money from the Fed.  The September repo scare focused the Fed on liquidity issues.  Since then it’s been non-stop repo operations, with no end in sight.  The two-year yield dropped over 23 bps this week.  In my book that’s an ease!  With a 2-yr yield of 1.388%, it’s back to where it was in Q3 2017.  That’s five hikes (and two cuts) ago for those keeping track.  Of course, tens and 30s are within spitting distance of new all-time lows, with tens ending at 1.507% and bonds at 2.004%, and that’s with supply on tap.   This week treasury auctions $38b 3’s, $24b 10’s and $16b 30’s, raising $54 billion in new cash.  Yeah, that stuff needs to be financed.  Or monetized. 

At the same time, corporate bond sales are off the charts with $434 billion in global corporate bond issuance in the month of September, a record. (CreditBubbleBulletin).  Borrowers are thrilled to refinance at these rates.  Lock in now and secure financing while we can. 

A quote from Almost Daily Grant’s (10/4/19) sums up the other side of the equation.  “Needless to say, this vanishing interest-rate epoch has been less kind to lenders, particularly pension funds which are chasing increasingly daunting annual return targets.  …Private equity has been all too happy to step into the void.”

Of course, private equity has experienced some shrinkage as well, thanks to WeWork, and to a lesser extent Uber (and let’s welcome Peleton to the club, the next Blue Apron).  A facetious staff memo from an imaginary founder written in the WSJ captures the environment.  It starts,
“Folks, I know everyone was excited about cashing in on our upcoming public offering, but it looks like this whole ‘profitability’ craze is here to stay, at least for a while.”

The problem from a macro perspective, is that these cash-burners employ people.  And those folks are about to become a statistic for future payroll reports.  It might just be a one-off, but remember how layoff announcements used to spark buying in the stock, as cost-cutting was perceived as improving profitability?  Well, Hewlett Packard announced layoffs of 7000-9000 of its 55,000 workforce, and the shares dropped 9.6% Friday with Nasdaq up 1.4%.  I’m sure it’s just an isolated event…

It was ISM data that sparked the latest yield plunge, with Mfg at 47.8 and Services, while still showing growth, much lower than expected at 52.6.  The Fed is responding with Money.  Below is a chart of the annual growth rate of M2 from the St Louis Fed, last at 6%.  Acceleration this year has been rapid and consistent.  A long time ago, M2 growth was considered a precursor to inflation. We’ll get a sense of whether it holds true now, with PPI out Tuesday, yoy Core expected 2.3% and CPI Thursday with yoy Core expected 2.4%.   Of course, workers’ earnings from Friday’s employment data slowed, to an annual rate of 2.9%.

M2 Growth- St Louis Fed

One other yield level worth mention is the ten year inflation-indexed note which ended the week barely above zero at half a basis point.  I.e. the real yield is zero.  The entire return comes from CPI.  After the 2018 tax package the real yield was over 1%.  Now it has vanished.  Like the neutral rate.  As can be seen on the chart below, the zero level also occurred in Q1 2015 and mid-2016, when all yields made their lows.  In 2012 it was significantly negative as the Fed tried to force investment further out the risk spectrum. 

I don’t know if the FAANG stocks are an appropriate measure for ‘seeking risk’ or now more of a flight away from to safety, but it’s sort of interesting to note that mid-2016, after the late 2015 oil and emerging markets plunge, is when US yields posted their lows, with tens for example reaching 1.36%.  So where were some of the high-cap risk stocks?  Here’s a partial list, with mid-2016 levels followed by current:  FB was 120, now 180.  AAPL 100 to 227, AMZN 750 to 1740, NFLX 100 to 270, GOOGL 800 to 1200, MSFT 55 to 138.  This, at the same time a shadow has been cast over IPOs.  Doesn’t seem as if it will be as easy to shift investors out the risk curve from these levels.  Warm up those helicopters.  With impeachment, Brexit, Iran & Saudi Arabia, stagnant China talks, Hong Kong, slowing EZ growth as Lagarde takes over the ECB, etc, uncertainties are piling up (with N Korea making a new push for the limelight).  It’s little wonder that money is seeking shelter.  It’s like the turtle hatch, when all those little turtles are racing for the safety of the sea.  A lot of them will be eaten and never make it, so the strategy is sheer numbers.  That’s where the Fed is, err on the side of big numbers.

Ten year inflation indexed note yield –St Louis Fed

While Mfg ISM decelerates, it’s also somewhat interesting to look at industrial mainstays oil and copper. From the lows made in early 2016 to the highs in 2018, both are around halfway retracements, with copper just below the midway area.  Oil continues to shrug off the attack on Saudi supplies, closing near the low of the week, essentially telegraphing that a global slowdown doesn’t require as much of the stuff. 

Fed minutes released this week on Wednesday.

OTHER MARKET/TRADE THOUGHTS

Since mid-Sept there has been an extraordinary short squeeze in EDZ9 of over 25 bps, with Friday’s settle pulling back a bit to 9817.0.  The spread between EDZ9 and FFF0 is still firm at 37.5, but it has pulled back from the low 40’s.  End of year funding tightness remains a concern. 

On Oct 1, I noted that Oct/Nov FF spread was -9.25 and Nov/Jan FF spread was -16.0.  These spreads more or less isolate the Oct 30 and Dec 11 FOMC meetings.  Both indicate that cuts are coming, but the odds of an ease at the Oct meeting were much lower than those for December.  Towards the end of the week, both spreads were below -19, with the market pushing for an October ease to counter weak ISM data.  Closes Friday were -17.75 and -20.5.  (Pricing one and a half cuts by the end of the year).

In spite of the end of week stock surge, treasuries closed near the highs.  Surprisingly, implied vol in rate futures is not confirming the move, and is slipping on new upticks, especially in bonds.  This may portend a change, where vol now has a chance to firm on downticks, which would catch many positions offsides.  A Fed which errs on the side of ‘easy’ to insure against a funding crisis, along with continued bond supply could conspire to push the inflation boulder just a little bit closer towards a slope where it picks up speed on its own accord.  While that particular narrative doesn’t have many proponents, it’s worth keeping in mind.  In 1993, when the Fed kept funds at the then unheard-of-low of 3% for a year, the 1994 rate increase jolt sent bonds into a tailspin.  The Bernanke taper-tantrum of 2013 had a similar effect.  In those instances, it was fear of central bank tightening.  Is it possible that (global) central bank laxness could now inspire the same sort of bust in the long end?   

One trade I mentioned last week was EDH0 9850/9875/9900 c fly for 2.25 ref 9833.5 (previous Friday settles).  I wasn’t looking for an instant 30 bp rally to Friday’s 9853.0.  This fly settled 3.75.  Worth holding as the market once again looks for the Fed to target a funds rate of 1.0 to 1.25%. 

October midcurves in eurodollars expire Friday.  EDZ0, EDZ1 and EDZ2 are all at the 9875 strike: 9874.5, 9879.5 and 9874.0.  The next strike lower, 9862.5 puts, settled 1.25, 0.50 and 1.25.  That was a low settle for 2EV 9875p, but any one of these could play over the coming week.    

9/27/2019 10/4/2019 chg
UST 2Y 162.2 138.8 -23.4
UST 5Y 155.1 132.4 -22.7
UST 10Y 167.5 150.7 -16.8
UST 30Y 212.5 200.4 -12.1
GERM 2Y -77.0 -78.0 -1.0
GERM 10Y -57.3 -58.6 -1.3
JPN 30Y 31.8 34.6 2.8
EURO$ Z9/Z0 -50.0 -57.5 -7.5
EURO$ Z0/Z1 -8.0 -5.0 3.0
EUR 109.42 109.79 0.37
CRUDE (1st cont) 55.91 52.81 -3.10
SPX 2961.79 2952.01 -9.78
VIX 17.22 17.04 -0.18
Posted on October 6, 2019 at 10:44 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options