Feb 23. An – B A N G ! !

–BIG story this morning is China’s takeover of Anbang Insurance Group. (A couple of BBG links at bottom). There have been many stories about China taking steps to deal with bad debt and malinvestment, and this is a HUGE concrete example.  What happens when debts become unwieldy and debt service costs are met by piling on more debt?  Assets are sold.  Liquidated.  I have no idea how much this will ultimately reverberate through the markets, but it comes on the heels of HNA, another large Chinese company, saying it would sell $4B in US assets as the financing noose tightens.   At the margin, this means tighter credit conditions, certainly in China but likely everywhere.  It probably also means a tilt towards protectionism, which could feed into inflation.  I don’t know how many times I’ve read that China has a huge debt problem, but that the state was big enough to deal with it.  We’ll find out now. My bet is that it’ll turn messy.

–Not many people were familiar with AIG until the US financial crisis.  Same with Anbang.  Is this China getting in front of the problem?  Or is it the first step in a deluge of asset sales.  When ‘assets’ aren’t covering debt service costs and are put on the selling block, it often comes as a shock how little they are actually worth.  This is bad for China’s growth, and likely a negative for global growth.
–My first inclination is to buy short dated treasuries; look for the curve to steepen.  In the near term it should throw questions on the idea of constant Fed hikes.  Is this why someone bought 50k FFJ the other day at 9834.5/35?  Does this news account for the relative strength in the front end yesterday?  As of this writing it doesn’t seem to have much of an impact on US stocks or bonds (ESH 2717 and TYH 120-16).  March treasury options expire today, and I would certainly look to buy some high gamma treasury calls.  While the March Fed hike might not be derailed, June comes into question. This is BAD for risk.

–In terms of yesterday’s action, yields fell a bit as the treasury concluded the 7 year auction.  I obviously think some of yesterday’s buying was from those in the know about today’s news.  Eurodollar strip was +3 to +4.5 across the strip. FF/ED spreads came in a couple of bps, for example, EDM8/FFN8 settled 40 vs a high close of 42 on Wed.  EDZ8/FFF9 closed -3 at 37.5, retreating from the high of the move set Wednesday of 40.5.  Though a decent amount of trades went through, I will note buying of EDZ9 9800 and 9825 calls (paid 10 in strip vs 9712 in 20k and paid 4 for another 15k of 9825 vs 9714).  These buys appear to be covers, but I will once again note that EDZ9 open interest is most on the board at just under 2 million, was up 50k yesterday.


CDX Investment Grade…  financing conditions are going to tighten.

Posted on February 23, 2018 at 4:08 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 22. Yields are going the way of lumber : higher

–New high yields across the curve yesterday.  Ten year yield rose 4.8 bps to 293.9.  At futures settlement I marked the bond at 322.1, essentially right at the high yield mark of last year in March. Curve was marginally steeper; red/gold pack spread gained 0.625 bp.  On the dollar curve there were new high settlements made in a couple of one-year spreads, but interestingly they are slightly further back; EDU8/U9 settled 42.5 and EDZ8/Z9 37.0, both +2 on the day.  The peak spread is still EDH8/H9 which settled 53.75 only +0.75.  The extreme selling pressure on the front end of the curve is preventing near spreads from making new highs.  I mentioned yesterday the idea of buying EDJ (April) 9775 straddle for 8.5 which has EDM8 as the underlying.  Interesting to note that EDH8 9787^ settled 7.25.  In this environment I’d pay an extra 1.5 bps for the extra 25 days…

–Heavy buy of FFJ8 at 9834.5 to 9835.0.  Feb is 9858.25, so an avg price of 9834.75 is a spread of 23.5… it appears someone is paying 1.5 bps of protection against a stock crash that might take a March hike off the table.  Open int in the April contract +44k.  If FFG8 is 9858.25, then TWO hikes by June would indicate 9808.25 and July FF settled 9814.5.  So the market is getting pretty comfortable with 2 hikes in H1, while a spread like EDM8/EDZ8 only trades 26, and July/Jan FF 27.5.  So only 1 hike for H2?

–Off topic perhaps, but March Lumber closed at new record highs, 526.0.  This contract has surged from 410 to 526 since December, up 28%.  I’m sure there are specific reasons (perhaps it has to do with trade policies, which seem a bit more fluid these days), but in the big picture, price surges may not be so uncommon anymore.

–Late in the day there was a buyer of about 25k 3EH 9700p for 10 ref EDH21 9697.5.  The straddle, which settled 16.5, went to a solid 17.5 bid.  I would note that the underlying contract traded 9705 just after the FOMC minutes and fell 8 bps into the end of the day.  Vol in general has been muted over the past week, but the market is becoming a lot looser.  Treasuries are getting toward target or resistance levels; as mentioned above bonds equaled last year’s high yield and tens are nearing 3%.  This morning treasuries have rebounded slightly….however, that’s no reason to sell vol in my opinion.

–News today includes Leading Indicators expected +0.6.  Dudley speaks.  7 year auction.

Posted on February 22, 2018 at 5:15 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 21. Five year. Auction and calls

–Curve flattened Tuesday as the treasury auctioned 2 year notes.  Red and green eurodollars were weakest contracts on the board, -3.625 and -3.75. Tens rose 1.6 bps to 289.1. Good size buying in EDH9 9700p for 3.5 in size about 50k (OI +34k, EDH9 settled 9741.5 and puts at 3.25).  There were a few other trades which accentuated weakness in reds; fairly obvious from price action.

–The largest trade of the day was a buyer of >50k FVJ 114.5c for 8.5 to 10.5 up to FVM price of 113-26+ (OI +34k, 27 delta, settled 11.5 vs 113-29.25).  The 114.5 strike is right around 2.53% yield of current 5yr which I marked 2.646 at floor close.  The interesting note about this trade was a similar purchase in FV calls on 5-Feb; there had been a buyer of 50k FVH8 115.0 calls for 4.0, when FVH was around 114-15+.  At that time, the March calls had 18 days until expiry, and that very day (as stocks fell out of bed) FVH traded as high as 115-21.  So the calls went 42/64’s in the money.  Now, with March calls expiring Friday, it looks as if the 115 strike will be worthless, with FVH trading 114-07.  However, it’s worth noting that the trade displayed impeccable timing when initiated, and now the guy is buying calls with 30 days until expiration, still about 1/2 a point away, and paying about twice as much.  As my paranoid floor friends would say…’Hey, he KNOWS something.’

–Today we get FOMC minutes from the Jan 30/31 meeting, Yellen’s last.  At that time market indications of inflation were deemed slightly higher.  Also interesting that stocks had just made their all time highs on Jan 26 /Jan 29, before a very slight pullback pre-FOMC.  From a Sunday, Feb 4 interview where Yellen termed stocks as “high” and she also said this: “What we look at is, if stock prices or asset prices more generally were to fall, what would that mean for the economy as a whole? …And I think our overall judgment is that, if there were to be a decline in asset valuations, it would not damage unduly the core of our financial system.”  So Yellen de-emphasized asset values, and I would bet Powell feels the same.
–The minutes will be scrutinized for clues of four hikes this year.  There was a slight language change in the last statement that called for “further” gradual adjustments to rates.  I’m guessing that means…’further gradual adjustments’, but to some people it means “four”.
–Apart from the FOMC minutes, 5 year notes are auctioned today, followed by 7’s tomorrow.  Philly Fed’s Harker speaks on the Economic Outlook at 9:00.
Posted on February 21, 2018 at 5:15 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 18. Veisalgia – ‘Uneasiness following debauchery’

My web surfing research was freewheeling for this note.  First, I thought I would delve into the Chinese New Year, Year of the Dog.  Somehow, this morphed into Hair of the Dog, which turned out to be a much more productive and useful thread of inquiry, and led to this week’s title, “Veisalgia” which was apparently coined as a medical term in the year 2000 to describe a hangover.  This scientific word is formed from Norwegian ‘kveis’ (uneasiness after debauchery) and Greek ‘algia’ (pain). I don’t know why some pompous jackass had to come up with a ‘medical name’ for a hangover, but I knew I was going to use it when one site also referenced Vikings.

In any case, the term sort of fits with market action last week, subsequent to the Viking debauchery of vix, stocks and bonds in the previous week. This week stocks rallied, the dollar had a small bounce, vix fell.  It all feels a little better.  On the trading floor after a big night it would be comparable to working through the 7:30 data, followed by a trip to the Merc Club, and an omelet made by Carmen with her homemade salsa, served by the charming Idolina, while Onecimo or Alfredo set you up with a 7 oz Budweiser (or two), all the while with a view through the west windows of office workers streaming out of the Northwestern train station for their day’s 9 o’clock start.  Hair of the dog, all better.  The business was a bit more fun back then.  So…let’s try to recall some details from last week.

The big piece of data was CPI, which came out stronger than expected at +0.5.  Yields surged to new highs.  However, the curve flattened, and sensing the worst of the damage was over, vol on longer maturities was crushed going into the holiday weekend. I marked the USM straddle at just 8.2 vol, astonishingly low in my opinion. On the week, 5/30 dropped over 11 bps, from 62.3 to 51.1.

On Friday, the dollar index posted a slight new low, but then reversed with an outside day and closed higher.  EURUSD was a mirror image, new high and a reversal.  Everyone has now become a dollar bear, but I think it’s due for a good tradable bounce with more or less of a triple bottom set Jan 26, and then Jan 31, followed by Friday’s test which was slightly lower.  Stop out below Friday’s low, or above Friday’s high if shorting EUR.

What I keep reading now are references to old topics that have had new life breathed into them:  twin deficits, crowding out, trade wars.  So I used google trends on the first two phrases, expecting to see a surge in interest.  I didn’t.  But even though they’re not on google, doesn’t mean they haven’t crept back into the markets’ consciousness.

The big issues for fixed income remain, and are quite clear.  Increased supply in the context of increased inflation.  While the BoJ re-affirms its monetary stimulus with Kuroda’s reappointment and a new deputy who favors more monetary largesse, elsewhere things are tightening up just a little.  This is obvious in the front end of the Eurodollar curve, where both EDH8 and EDM8 settled at new lows.  The fall has been stunning.  EDM8 has surged over 75 bps in yield since September, from 9852.5 to Friday’s settle of 9777.5.  Friday to Friday change in EDH8 was 9804.5 to 9795.5 and in EDM9 9786.0 to 9777.5.  In contrast, the ten year note yield rose just under 5 bps on the week to 287.5 and the 30 yr bond was essentially unchanged at 313.5. By the way, weakest parts of the curve were the 2y (+13 bps) and red euro$ pack, -14.875.  Here’s a picture of fra/ois…looks like it wants to revisit highs made during the money market reform surge to nearly 50 bps in October of 2016.

In terms of ‘crowding out’ I would note that HYG spiked to a new low on Friday 09-Feb, but has been grinding higher over the past week.  I would mention once again, that corporate debt at $8.84T and total business debt at $14.06T are at record levels….not such a big deal given low rates and tight spreads, but debt servicing costs are going to chew up a bigger part of the budget going forward, for both gov’t and business, and with gov’t debt becoming more plentiful, the business sector may need to pay more of a premium for financing.

On the topic of trade wars, Commerce Sec’y Wilbur Ross suggested imposing hefty tariffs on steel and aluminum for national security purposes.  Trump has until April to decide, but China has already responded, and I wouldn’t be surprised if the threat of trimming reserves of US treasuries isn’t inferred as a possible response.

The point is, we’ve addressed the worst part of the hangover with a big greasy breakfast and hair of the dog, but now the market may be rested well enough for another foray into debauchery. Like Vikings.


This next section is redundant for some, as I put out a note late Friday regarding EDZ8 and EDZ9 positioning.  However, I am repeating some of the highlights here with updates.

There has been heavy accumulation of EDZ8/EDZ9 calendar spreads since the start of the year, including a block buy of 40k at 34.5 on Friday.  According to CME data, open interest in EDZ9 vaulted up by 93k contracts Friday to 1.822m, which is now the highest open interest on the curve, followed by EDZ8 at 1.750m (down by 21k Friday).  The next highest contract is EDM8 with 1.54m, so people are extrapolating position size of 400+k for the Z8/Z9 buyer.  I’ve previously noted Fed ‘dot’ projections for Fed Funds at year end of 2018 and 2019 at 2.1% and 2.7%, and with EDZ8 settling at 9753.5 or 2.465% and EDZ9 settling at 9719.5, or 2.805%, the market is pretty much accepting the Fed’s forecast (for the first time ever).

As a reminder, on January 5, there was a seller of >100k EDZ8/Z9/Z0 butterfly at 14.5.  On that day, EDZ8/9 settled 20 and EDZ9/0 at 5.5.  Over the next couple of days the low in the fly was 13, but on Friday it settled at a new high for the year at 24.0, and traded as high as 25.5.  In the interim, associated with the Feb 5 stock sell off, the fly touched 14.5 again.  On Friday, EDZ8/9 settled 34.0 and EDZ9/0 10.0.

There’s obviously a pretty good roll up the curve.  For example, EDH8/9 is 51.0, M8/M9 43.0, U8/U9 39.0.  However, the forward roll has become slightly less compelling recently, especially as fra/ois spread has blown out and near contracts came under heavy selling pressure.  For example, the high settle on 2-Feb in EDH8/EDH9 was 60.5, and it’s now 51.0. EDZ8/EDZ9 on 2-Feb was 36.0s.  So, at that point, the roll was 60.5-36.0 or 24.5 bps; call it 2.7 bps per month. But now that’s been cut back to a difference of 51 vs 34, or 17 bps over 9 months; 1.9 per month.  This is obviously simplistic, but provides a bit of context.  On 2-Feb the one year butterflies were as follow: March 29.5, June 24.5, Sept 24.0 and Dec 22.0.  Now they are 24.0, 24.0, 25.0 and 24.0.

In a more technical picture, the weakness of EDZ9 is ‘distorting’ markets.  For example, consider EDM9/EDU9/EDZ9 fly vs EDU9/EDZ9/EDH0 fly (3 month double butterfly).  It traded -7.0 Friday.  The doubles on either side are +4.0 (EDH9 start) and +6.0 (EDU9 start).  That’s quite a disparity, and indicates “cheapness” of EDZ9 contract.  Or consider plain 6 month butterflies: EDM9/EDZ9/EDM0 is 11.0/11.5 (11.0s).  The one in front, EDH9/EDU9/EDH0 is 7.0 and the one after, EDU8/EDH9/EDU0 is 6.0.

There are sev’l reasons that this situation might persist, (or might not).  First, perhaps the EDZ8/Z9 buyer begins to exit.  That doesn’t appear so likely.  Second, rel val players could come in and start buying EDZ9 in various fly configurations, which might rub the rough edge off of this curve ‘kink’.  That obviously is occurring, but may not be large enough to have much impact yet.  However, given the decline in front butterflies, players might be more emboldened to fade Z9 weakness.  For example, selling Z/Z/Z no longer appears to entail much in the way of negative carry.


2/9/2017 2/16/2018 chg
UST 2Y 205.7 218.7 13.0
UST 5Y 251.3 262.4 11.1
UST 10Y 282.6 287.5 4.9
UST 30Y 313.3 313.5 0.2
GERM 2Y -56.7 -56.8 -0.1
GERM 10Y 74.5 70.6 -3.9
JPN 30Y 80.5 78.5 -2.0
EURO$ H8/H9 46.0 51.0 5.0
EURO$ H9/H0 26.0 27.0 1.0
EUR 122.52 124.09 1.57
CRUDE (1st cont) 58.99 61.55 2.56
SPX 2619.55 2732.22 112.67
VIX 29.06 19.46 -9.60




Posted on February 18, 2018 at 1:45 pm by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 16. Volatility deflates as curve flattens and dollar falls

–Curve flattened and long end vol was crushed on Thursday. April 10y vol back at just 4.5. There were some large put trades on near contracts, exit seller of at least 75k EDU8 9800/9775ps at 20..5, but a buyer of EDM 9775/9762ps, 3.25 for at least 40k, and buying of 0EM 9725/9700ps for 3.5 in 30k during the day.  EDH8 settled at a new low of 9797.5; a couple of weeks ago the atm EDH8 9812 straddle was sold at 3.75 which is now 15 intrinsically, and yet somehow people feel comfortable selling EDM8 9775^ at 13.0 with 123 days until expiration.

–Stocks rebounded, VIX back below 20.  It’s all getting back to “normal”.  Kuroda got another stint as the head of the BOF, with the added monetary turbo-boost of deputy Wakatabe, who advocates more aggressive easing.  It would be like handing the keys of the Fed to Kocherlakota.  On the other hand, $/yen fell; it hasn’t been this weak since we were afraid Hillary was going to be elected.  USD looking ever more vulnerable to a crash which should continue to underpin higher inflationary expectations.

–Market trades as if nothing can deter the Fed from near term ‘normalization’ but longer term growth and inflation will falter. 5/30 was over 62 on Friday,  but closed just below 51 yesterday.  Feb midcurves expire today in euro$’s.

Posted on February 16, 2018 at 5:14 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 15. End of Day…Fixed Income Vol Hammered

Treasury vol hammered Thursday, Feb 15.  Most of the inflation news was already released this week (Wed CPI was the big one) and the curve flattened.  5/30 was 61.5 last Friday and 51 late Thursday.

Posted on February 15, 2018 at 3:10 pm by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 15, 2018. The Zimbabwe Rally

February 15, 2018.  The Zimbabwe Rally

–Huge day in fixed income as inflation concerns jumped with yesterday’s 0.5 print on CPI.  Core yoy was +1.8 and Retail Sales were a bit soft (-0.3 vs +0.2 expected), but the remaining piece of the rate rise puzzle had been price acceleration, and this data, along with the 2.9% yoy increase in Avg Hourly Earnings in the employment report was enough to provide a tipping point.  The ten year yield rose 7.4 bps to 291 (and was higher after the floor close).  Fives surged 9.7 bps to 264. The green euro$ pack was weakest on the dollar curve, down 10.625 bps.  All treasury yields posted new highs.  At the 2pm floor close, TYH was 120-105 with ten-yr 290.9.  With DV01 of 74.70 that puts 3% at approx 22/32s lower or 119-205.  In USH, the settle was 142-12 vs 317.2.  The high closing yield mark of 321.3 in 2017 is thus approx. 24/32’s away or 141-20.  (Charts below indicate breakout in 30 yr yield, and a possible confirmation breakout in the ‘real’ ten year yield, the inflation indexed note).
–Surprisingly, stocks ramped up on the day after a brief spike lower on the data.  No good reason for this except for the decline in USD (I refer to Zimbabwe because stocks there exploded higher as a store of value when the currency evaporated).  Stocks are higher again this morning with a weaker dollar; once again there are references to ‘twin deficits’ in the US.  I defer to Paul Tudor Jones: “It is incredible that at full employment we have passed a tax cut that will push our deficit to 5% of GDP. Can you imagine what will happen to the deficit and debt in the inevitable downturn? This is what the dollar is sensing.”

–Huge buyer of EDU8 9762/9750ps for 4-4.5, >150k.  EDZ9 fell 11 bps and (according to prelims) open interest surged 108k.  EDZ8 and Z9 have the most open interest of any contracts, Z8 1.744m (+11k) and Z9 1.678m (+108k).

–News today includes Job Claims, PPI expected +0.4 with Core +0.2, Philly Fed 21.0, Ind Prod +0.2.

–Interesting article by Ambrose Evans-Pritchard yesterday: The Fed Can’t Legally Save the World Financial System in Another ‘Lehman’ Crisis

The Dodd-Frank Act, rushed through in a pageant of self-congratulation in 2010, prevents the Fed from rescuing individual companies in trouble (there must be at least five, and they must be solvent) or lending to non-banks in a panic. It can lend only to “insured depository institutions” through its discount window with the Treasury’s permission. Fed chieftains Ben Bernanke and Don Kohn warned that these curbs were extremely ill-advised. They were ignored…

 30 year tentative breakout and 10y tip yield


Posted on February 15, 2018 at 5:00 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 13. Adjustments back to normal?

–Rates were slightly higher as equities rebounded.  Tens rose 3 bps to 285.7.  In dollars, greens, blues and golds were down 3.5 bps.  It was an adjustment day.  Open interest in ESH was -89k.  Implied vol across the interest rate curve plunged.  For example, On Friday, 3EH 9712^ settled 25.0 and yesterday just 21.5.  2EU 9725^ settled 47.5 on Friday, and 45.5 yesterday.
–On a longer time frame comparison, on Nov 12, there were 33 days until expiration for the front Dec midcurves.  ATM straddles were 0EZ 9800^ 11.5, 2EZ 9787^ 15.5 and 3EZ 9775^ 17.0.  Currently, with 32 days to go ATM March straddles are: 0EH 9762^ 14.0, 2EH 9725^ 19.5 and 3EH 9712^ 21.5 (of course this is after yesterday’s declines).  After adjusting for the higher strikes, premium is barely elevated.  As a simplistic example, 17 bps for the blue dec straddle at a strike of 2.25% (9775) is 7.55% (17/225).  The current blue march straddle has a strike of 2.875%, and 21.5/287.5 is 7.4%.  What is probably a pretty high probability trade…well, I will put that out when I get to the desk.  What I will say is this, libor is going away as a benchmark in 2022 and the golds don’t have much in the way of additional premium.  In any case, the next month has some potential market moving events: CPI tomorrow, Powell testimony at the end of the month, Italian elections, and run-of-the-mill escalations in military conflicts.  I would actually say vol is getting back towards cheap in the interest rate arena.

Posted on February 13, 2018 at 4:59 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 12. Stockman’s been sounding that same warning (for the past 33 years)

–In an echo of Ronald Reagan’s administration, US Budget Director Mick Mulvaney said larger deficits this year may cause interest rates to “spike” and said further, “…rising budget deficits are “a very dangerous idea, but it’s the world we live in.”  In Reagan’s day the budget director was David Stockman, the supply side guru who said in a magazine article, “None of us really understands what’s going on with all these numbers.”   He, like Mulvaney, was concerned about deficit spending.  He resigned in 1985, critical of the Congress; he had favored “a reduction of government spending to offset large tax decreases to avoid the creation of large deficits and an increasing national debt.”  Sound familiar?  Today the administration is set to unroll its infrastructure program (WSJ).


–On Friday rates eased slightly with the ten year down 2.7 bps to 282.6.  This morning stocks are trading a bit higher, fixed income again under pressure due to Mulvaney’s comments and concern about this week’s inflation data, with CPI on Wednesday.  The bond market is increasingly uncomfortable with the idea of growing supply in an era of QT.  However, there are flashes of disaster insurance purchases, for example, a buyer of >100k EDJ 9812c for 1.25 on Friday.  New highs in many curve measures, with red/gold pack spread gaining 3.25 bps to a new recent high just over 42 bps.  5/30 jumped 7.5 bps to 62.3.

Posted on February 12, 2018 at 5:13 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Feb 11, 2018. The Gibraltar Aluminum Siding Company (aka The Fed)

This past week, the actor John Mahoney passed away.  Though famous for larger roles, I always liked him as Moe Adams, an aluminum siding salesman in Barry Levinson’s Tin Men.  The movie is a nostalgic look at early 1960’s Baltimore, in the days of classic 20 foot long Cadillacs with tail fins.  Because these salesmen ran so many scams, they ended up having to testify before the newly formed Maryland Home Improvement Commission regarding deceptive sales practices, with many losing their licenses.  Moe tells the story of another sales pro, who cut the middle few inches out of a yardstick and glued it back together so square footage would be higher when he measured a job, “Nobody looks at a yardstick to see how long it is.”

As Tilly (Danny Devito) says to his partner Sam in front of the commission, “What’s he talking about? The man got the job for $2400 which is what it cost in aluminum siding… I don’t know if this is deception…” https://www.youtube.com/watch?v=3T89tMPDLwk

If the stock market sell off continues, we’ll see a replay of the above scene, except the Congressional panel will be interviewing sponsors of various volatility products.  “Sir, our prospectus clearly states that our products attempt to capture moves in the VIX index.  These products have many beneficial characteristics for homeowners investors.”  (In answer to a question posed by a stern Congressman, reading glasses halfway down his nose, a derisively incredulous look on his face).

Aluminum siding simply covers up the exterior flaws on a home; it doesn’t address core structural issues.  The central banks of the world have done much the same thing.  By slashing rates, they overtly forced investors out the risk curve.  In an attempt to generate yield that disappeared from conventional products, investors increasingly turned to volatility strategies to add a few basis points.  I think they call it “alpha”.  Complacency peaked, with corporate spreads tight and yields low. Debt levels increased, the curve flattened, and volatility fell across all markets. Conditions were ‘easy’ for financial engineering. The rally in paper assets was indeed a stimulant for the real economy, but by some, was mistaken for BEING the real economy.  This sentiment was embraced most heartily by President Trump, who took credit for the rise in equity wealth at every opportunity.

Now central banks are trying to engineer a graceful reversal of policy, led by our very own Gibraltar Federal Reserve.  The tax cut stimulus and related stock market blast-off is something the Fed had to respond to.  The factors causing various market reversals are clear, and have been articulated by many large investors, Fed officials, think tanks, and ratings agencies (Moody’s) well before last week’s wild ride.  NY Fed President Dudley, in a BBG interview Wednesday termed the move so far “small potatoes”, saying “magnitude and duration is the issue for central bankers”.  In that same interview he clearly laid out conditions that are negative.  He has repeatedly warned about the US government’s fiscal position.  He said that gov’t “debt service costs are likely to go up a LOT” as deficits double and rates rise.  Just last week that theme was echoed by none other than Paul Tudor Jones, “If I had a choice between holding a US Treasury bond or a hot burning coal in my hand, I would choose the coal. At least that way I would only lose my hand.”  He further wrote, “It is incredible that at full employment we have passed a tax cut that will push our deficit to 5% of GDP. Can you imagine what will happen to the deficit and debt in the inevitable downturn? This is what the dollar is sensing.”  Even I have written about it, and no one is going to accuse me of having the news first.  As Dudley said last week, bond yields are going up with the view that monetary policy around the world is going to become less accommodative.

I could blab on and on about concise warnings that have fallen on deaf ears.  However, now I will focus on market clues that may put the idea of “duration and magnitude” in context. First, here is a long term chart of the VIX spread, 1st contract to 2nd contract.  As you can see, the typical configuration is that the first contract trades at a discount so the spread is positive (represented by green on the lower panel).  During times of panic, the near contract trades at a premium.  This premium, at 7.9 late Friday, shown as a negative value, is as high as it has been since the 2008 crash. To my way of thinking, that indicates more to come.

The next thing I will note is that the curve steepened hard this week.  The two year yield fell 9.4 bps and the 30y bond yield rose 3.9.  It’s instructive to observe the way TYH traded in relation to stocks.  On Monday’s plunge below 2550, TYH rallied to just above 122-16.  Flight to quality.  On Tuesday’s ESH rebound to 2725, TYH fell to 121-12, and continued down on Wednesday to post the week’s low at 120-17.  But on Friday, as ESH again spiked below 2550, TYH could only briefly poke above 121-16, a full point below Monday’s high.  In other words, maybe the ten year isn’t exactly the ‘quality’ haven it used to be.  This captures the bearish sentiment regarding the long end of the treasury market.  Stocks initially started to sell off due to concerns about rising interest rates.  For the third week in a row, I will cite Dalio who warned, “It just takes a little change in interest rates to have a bear market.”  So what are bonds concerned about?  1) Less accommodative central banks 2) a huge prospective jump in the deficit which means more bond issuance 3) continued QT 4) higher commodity prices and a weaker dollar, both of which contribute in increased inflation expectations 5) higher wages due to tight employment markets, also adding to inflation concerns 6) a stimulative jolt due to tax cuts.  As we say on the floor, “It’s not rocket surgery.”

The next question is, are stocks therefore likely to rebound if rates retrace lower?  The answer is, maybe, but probably not.  As noted, the big themes are bearish for rates, especially if inflation starts to accelerate (and we’ll have CPI and PPI this week Wed and Thurs).  However, increased supply of treasuries is a given.  Tightness in labor markets is another factor that’s not likely to change quickly.  And the tax cut is now law.  What might change is the Fed’s response to falling asset prices, particularly if ‘magnitude and duration’ grow.  In that case, one would expect that near Eurodollar calendar spreads would decline relative to more deferred, as the back end of the curve is likely more responsive to inflation expectations.  And, that is exactly what has occurred.  For example, a week ago Friday the EDH8/EDH9/EDH0 butterfly was 29.5, with EDH8/EDH9 60.5 and EDH9/EDH0 31.0.  This week the fly settled 20, with EDH8/9 at 46.0 and EDH9/0 26.0.  In treasuries the same thing is reflected by the 2/5/10 fly.  2/5 went from 44.6 to 45.6, an increase of 1 bp, while 5/10 went from 25.1 to 31.3, +6.2.   As I have said in the past, the new Fed is not as likely to come to the defense of the stock market as rapidly (and that’s just what Dudley meant by the ‘small potatoes’ remark).  But even if they do slow down projected hikes, negative factors for the long end remain.  And IF inflation becomes an issue (be careful of what you hope for…) then both stocks and bonds will face additional headwinds.

(Chart below shows EDM8 97.875p and the recent decline in open interest)

The short end of the market has issues as well, related to both positioning and an increase in fra/ois spread.  A surge in t-bill issuance is expected to widen this spread further. There’s been huge liquidation of short positions in EDM8 9787.5 puts, as shown on the chart above.  These puts have soared from 1 bp at the start of the year to over 10, settling at 8.75 Friday.  Open interest declined from nearly 1m to 519k as of Friday’s close.  The same thing has occurred in EDH8 puts.

The next chart shows the fra/ois spread. It’s not as high as the money market reform spike of October 2016, but it appears to want to test that level.  Again, the idea of funding stress is a nagging concern, and that fear is reflected by heavy selling pressure on the first two Eurodollar contracts.

Another indicator to watch is corporate spreads.  Gundlach consistently pointed to relative weakness in HYG (the junk bond etf).  It plunged this week, though it still has a long way to go to reach depressed levels associated with the energy disaster in early 2016.  Another interesting feature late last week was a jump in Investment grade CDX.  Absolute levels are still low, as the long term chart below shows.  However, the trend appears to have changed.  The cost of bond protection is increasing.  Corporate spreads are sure to follow.

In summary, stocks were initially spooked by interest rate concerns.  Prior to Chairman Powell’s testimony before Congress on Feb 28, the Fed will likely resist taking steps to overtly support stocks.  Unless inflation data are decidedly weak (CPI and PPI released Wednesday and Thursday), pressure on bonds is likely to continue, and rallies in stocks will find willing sellers.


2/2/2018 2/9/2017 chg
UST 2Y 215.1 205.7 -9.4
UST 5Y 259.7 251.3 -8.4
UST 10Y 284.8 282.6 -2.2
UST 30Y 309.4 313.3 3.9
GERM 2Y -54.0 -56.7 -2.7
GERM 10Y 76.7 74.5 -2.2
JPN 30Y 81.7 80.5 -1.2
EURO$ H8/H9 60.5 46.0 -14.5
EURO$ H9/H0 31.0 26.0 -5.0
EUR 124.59 122.52 -2.07
CRUDE (1st cont) 65.45 59.20 -6.25
SPX 2762.13 2619.55 -142.58
VIX 17.31 29.06 11.75



Posted on February 11, 2018 at 8:01 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options