Dec 3. Teflon Don

Donald Trump was born in 1946.  In an ironic twist of history, that was also the year that Teflon products became commercially available.  From the Chemours website, “Upon checking a frozen compressed sample of tetrafluoroethylene, he [Plunkett] and his associates discovered that the sample had polymerized spontaneously into a white, waxy solid to form polytetrafluoroethelyne (PTFE). PTFE is inert to virtually all chemicals and is considered the most slippery material in existence.”  I am not making this up, check out the Chemours link at bottom.  PTFE was sold under the Teflon trademark name.  In another of its marvelously strange properties, PTFE can be dyed several shades of orange.  OK, I am making that last part up.

This, my friends, is no coincidence.  Rep. Pat Schroeder famously took to the House floor in 1983 and said of Ronald Reagan, “He has been perfecting the Teflon-coated presidency: He sees to it that nothing sticks to him.”  I would say that Trump has taken it up a notch; not even his own crazy tweets stick.

The market drama on Friday is a case in point, with a plunge in equities as ABC “News” announced that Flynn was ready to testify against Trump regarding Russian collusion.  Since that time, ABC retracted the story, saying that President-elect (as opposed to candidate) Trump asked staff to reach out to Russia.  ABC suspended reporter Brian Ross for the erroneous story, and a top FBI agent working for Mueller’s election probe was fired for anti-Trump texts.  How to respond?  Simply throw up… throw up your hands that is, and say, ‘Trump single-handedly created $5 trillion of market cap since he was elected, there’s no reason to think we can’t get another $5 trillion next year.   Get in there and BUY.’

Apparently, Goldman doesn’t quite see it that way, noting that global market cap was $74 trillion in June and has now soared to $93 trillion.   (So actually, Trump is responsible for nearly $20T of increased mkt cap, but humbly only takes credit for the US).  Anyway, the chart is reproduced below, from Business Insider.  From the article: ‘Goldman Sachs international analyst Christian Mueller-Glissmann and his colleagues think the “bull market in everything” is about to come to an end. “The average valuation percentile across equities, bonds and credit is the highest since 1900,” they write, and it will produce two likely medium-term scenarios: “Slow pain” or “fast pain” as a correction creates a bear market.’

Now this bear market that Goldman speaks of is probably also tied into the idea that the Fed will hike four times next year.  Deutsche Bank also modified its projections, and has jumped on the 4 hike bandwagon.  However, DB’s Capital Markets Outlook says stocks could continue to rise through 2018, while bonds won’t. “We expect interest rates to continue rising at both the short end and long ends of the yield curve in the US and the Eurozone.” (link at bottom)

At the start of the year, the ten year yield was 2.45%.  In the week just passed it popped just above 2.40%, but came back to close 2.32.  In other words, NO CHANGE.  The two year started 2017 at 1.20% but has seen a steady climb in the past three months, from 1.27 on Sept 8 to 1.78 this week, ending Friday at 1.73.  The five-yr has also seen a surge since September, from the year’s low of 1.64 to a new high for the year just above 2.14, (which was also the high in March) and closed 2.04%.

In September, as yields were making their lows, concerns about North Korea were at their peak.  Since then, growth prospects related to the just-passed tax legislation seem to have been the main driver.  Since early September, SPX is up about 7%.  Some members of the Fed have been fretting about frothy asset prices, and the short end is responding with wider near term calendar spreads.  In Eurodollars, the Dec’17/Dec’18 spread closed out the week just over ½% at 51 bps.  In Fed Funds, the Jan’18/Jan’19 spread closed at 45.  Both suggest that the market is comfortable with 2 hikes next year.  However, more deferred spreads remain compressed.  The red to green pack (2nd year to 3rd year) spread is just 14 bps, and green/blue (3rd to 4th) and blue to gold (4th to 5th) are both below 10 bps.  The 5yr to 10yr treasury spread clocked a new low beneath ¼% (closed at 24.6).  So there is very little concern that inflation is going to flare up; the market has embraced the idea of a terminal rate of 2.5% or so.  The 5yr 5yr forward expected inflation rate according to the St Louis Fed website is only 199 bps, having been as high as 220 in Q1.

If the new, genetically-modified Fed DOES hike rates at a more aggressive pace in 2018, then many commentators (including some on the Fed itself) fear that the curve will invert, signaling recession.  Indeed, given that the ten year in 2017 was pretty much unchanged, a new Fed Effective of 2.4% at the end of 2018 (4 more hikes assuming that a hike in 2 weeks is a done deal) would exceed today’s ten year rate.

What no one really seems to talk about is whether an inverted curve at rates of 5.25% is the same thing as an inverted curve with rates at less than half that level.  I am not sure if the implications are similar, but clearly there will be less room to maneuver in the event of a downturn.  It’s likely that the more dominant force will be credit spreads, and there have been preliminary signals that concerns are developing in that area.  For example, sell offs in hi-yld etfs are faster and associated with higher volume than rallies.  Additionally, while stocks didn’t really change much when all was said and done on the week, VIX  did close higher.

This week features the Employment Report on Friday.   Tax bill reconciliation between the House and Senate may also cause some market wiggles.




11/24/2017 12/1/2017 chg
UST 2Y 175.7 177.4 1.7
UST 5Y 207.2 211.6 4.4
UST 10Y 233.8 236.2 2.4
UST 30Y 276.0 275.7 -0.3
GERM 2Y -69.6 -70.5 -0.9
GERM 10Y 36.5 30.5 -6.0
JPN 30Y 83.2 83.2 0.0
EURO$ H8/H9 35.0 39.0 4.0
EURO$ H9/H0 14.0 15.0 1.0
EUR 119.32 118.96 -0.36
CRUDE (1st cont) 58.95 58.36 -0.59
SPX 2602.42 2642.22 39.80
VIX 9.67 11.43 1.76–deceptive-calm-coming-to-an-end-en-11728.htm

Posted on December 3, 2017 at 11:18 am by alexmanzara · Permalink
In: Eurodollar Options

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