Fed Listens. Does it Hear?

May 19, 2019

Weekly Comment

On the week, both US and German ten year yields fell 6 bps, US to 2.393% and Germany to -10.4 bps. The German bund yield is now 5 bps lower than Japan’s JGB, which ended the week at -5.2 bps.  Of course, Germany runs a budget surplus while Japan runs a huge deficit and buys every available bond.  Switzerland’s ten year yield is -40 bps.  US swap spreads have been trending lower since the middle of 2018, with the 2 yr at 6.25 bps, just holding barely above the historic low of 4 bps in late 2015.  The 5 yr posted a low of -11 in 2015 and was slightly above +15 in 2018, and is now just 1.2 bps.  The 10 yr hit +8 in 2018 and is now -4.6.  In 2015 markets were in the midst of a commodity and emerging market sell-off.  SPX was around 2000. 

Three month libor is 2.52%, three month bills are 2.33% and again, the ten year is 2.39%.  In its “Fed Listens” initiative, the Fed seems to spend a lot of time discussing a low and falling neutral rate while, at the same time, trying to talk up inflation expectations.  Officials have repeatedly trotted out the idea of letting inflation ‘overshoot the 2% target’ while holding policy steady.  It reminds me of the philosophical question, “If a tree falls in the forest and no one is around to hear it, does it make a sound?”  If the Fed keeps talking about boosting inflation expectations and no one listens, do yields have to fall?  When Powell became chairman, some commentators derisively noted that he wasn’t trained in economics, yet Powell’s Fed seems fixated on the theoretical constructs of the neutral rate and household expectations.  Maybe that’s not exactly fair – when Powell became the Chairman, I think he genuinely wanted to separate the economy from the iron grip of over-valued asset prices which had become entrenched due to low funding rates  He was attempting, I think, to move the economy away from Wall Street and back to Main Street.  Events have overwhelmed this Fed. 

Perhaps now the Fed will have to spend a bit more time on global financial plumbing.  All sorts of prices don’t seem to make a lot of sense.  In a recent interview, Jeffrey Gundlach was literally nearly pounding on the table expressing the view that bond vol is too low.  The May tweak to IOER was a nod in the direction of unbalanced monetary flows.  The unrelenting rally in back eurodollar contracts and in treasuries sends a powerful signal.  On the eurodollar curve, EDH21 is now the highest contract, having traded above 98.00 this week and settled at 97.99.  Since the middle of November, this contract has rallied 125 bps and it’s 50 bps below the current libor setting.  In contrast. March’21 euribor has rallied about 60 bps since November, and is now 100.25.

The Fed points to all sorts of legitimate reasons for the neutral rate to be under pressure.  Brainard in her last speech said, “the decline in the neutral rate likely reflects a variety of forces globally, such as the aging of the population in many large economies, some slowing in the rate of productivity growth, and increases in the demand for safe assets.”  Huh?  It’s equally plausible to say, ‘the unemployment rate is increasing because advances in technology and robotics are replacing jobs and holding down costs.’  Except that the unemployment rate is at a record low and all sorts of firms complain that skilled labor is in very short supply.  By the way, Brainard’s May 16 speech was titled ‘The Disconnect between Inflation and Employment in the New Normal.’ [link below] It seems to me that the Fed is now in the reactive position of trying to fit its analytical framework around market actions.  I think that some of these overwhelming market forces are a direct consequence of the zero-rate balance sheet expansion. 

However, before continuing, it’s clear that the most immediate impact on markets has recently become the geopolitical trade wars.  US equity markets bounce around with each and every ‘good cop/bad cop’ tweet out of the administration.  However, the Chinese side appears to have lost patience with this approach and has slowly moved in one direction: harder.  This past week, the state broadcaster CCTV anchor Kang Hui said, “If you want to negotiate, the door is open.  If you want a trade war, we’ll fight you to the end.  After 5000 years of wind and rain, what hasn’t the Chinese nation weathered?”  According to a few news reports, that video was viewed over 3 BILLION times.  Sounds like a little more than a squabble to me.  Over the weekend the South China Morning Post said China is ‘in no rush’ for another discussion with Mnuchin until the US becomes more realistic.  The yuan is close to testing the psychological 7 level.     

Now, back to our regularly scheduled programming.  This next chart isn’t really one for the Fed to ponder, it’s just a surprising item that was brought to my attention (thanks TW).  It shows a new high in the gold/silver ratio.  According to one article, 50% of silver’s demand is for industrial applications.  So maybe this chart simply portends a further slowdown in the global economy. Or perhaps it reflects a demand for ‘safe assets’ (by Russia) for gold and bitcoin, which, according to Brainard, feeds into a lower neutral rate.  Yeah.  That’s it.  In any case, I don’t care to think too much about the implications of this one.  Except that maybe we should be looking at buying silver!

I reviewed an article written by Zoltan Pozsar of Credit Suisse from mid-February.  At that time, he forecast that libor/ois spreads might tighten dramatically as funding costs relative to the treasury curve HAD to come down in order for the market to absorb significant increases in US supply.  The current forward OIS/libor prices as indicated by the futures markets reflect this tightening.  For example, EDM9/FFN9 has come down to 15.25 bps (9748.25 vs 9763.5).  EDU9/FFV9 is 16.5 (9759.5 vs 9776.0).  EDZ9/FFF0 is still 25.5 (9765.0 vs 9790.5).  The main point of Pozsar’s note was that the US curve had to steepen rather dramatically in order to maintain sufficient foreign and domestic demand for increased auctions.  The way that this adjustment has occurred is apparently through forward contracts (i.e. eurodollar futures) strongly inverting relative to the front end of the curve.  While the Fed has been talking about inflation expectations, the curve has signaled the adjustment that Pozsar forecast in February.  The market is telling the Fed that it has to continue down the 2019 path of more accommodative policy, and that rate cuts are a part of that equation.  With October Fed Funds settling at 9776.0, 15 bps lower in yield than the front May contract (FFK9 = 9761), there is a 60% chance of an ease by September. (EDM9/EDU9 at -11.25 isn’t quite as aggressive).  FFF0, the January contract, indicates certainty of at least one ease by the end of the year; at 9790.5 it is 29.5 bps below the front May contract. 

In the absence of a resolution of the trade impasse, will a more accommodative Fed reinvigorate the stock market?  Perhaps to some degree, but rate markets are already pricing this eventuality.  Is it the Fed’s job to cushion the economy from political decisions?  Maybe it is, in a reactive sense.  But clearly one of the Fed’s objectives is to make sure the financial gears don’t start to lock up, and this latter concern is likely to become much more important over the medium term.     

Note that on Monday, as part of the ‘Fed Listens’ program, NY Fed’s CEO and President, John Williams, is expected to give introductory remarks and Vice-Chair Clarida will give a speech on Monetary Policy Strategy, Tools and Communications. At 7:00 pm EST, Powell is slated to give a speech titled “Assessing Risks to our Financial System”.  I would expect the emphasis to be on global financial risks that might feed into the US economy.


June treasury options expire on Friday.  TYM9 settled Friday at 124-155.  Peak June call open interest levels are at the 124.5 and 125.0 strikes with 100k and 128k respectively.  I expect a test of the 125 strike sometime early in the week.  TYM9 125c settled 4/64’s.  A couple of weeks ago I suggested that TUM9 might re-visit 106-24 from late March.  Settled Friday at 106-18.75.  While there has been pressure on the June contract due to heavy selling in the M9/U9 roll, odds favor a further grind higher. 

Near Eurodollar one-year calendars posted new recent lows this past week with EDM9/EDM0 hitting -43.25.  Odds favor further inversion.  The reds have shown relative strength.  Although the red/green pack spread is slightly inverted at -1.125 bp, the 9800 midcurve straddles are nominally higher in reds as compared to greens.   For example, 0EU9 9800^ settled 35.5 with EDU20 at 9795.5, while 2EU9 9800^ settled 32.5 vs EDU21 9797.5. 

There was large buying of Oct 9800/9825 call spreads last week; total position around 80k.  Settled 2.25 ref EDZ19 9765.0.  A lot can happen in five months. When the Fed becomes forced to ease, it can occur quickly.  I don’t see any chance that the first move could be 50 bps, but I would not be surprised at all by two cuts of 25 at consecutive meetings.  I think it would take an ‘event’ but it feels like one is getting closer. 

5/10/2019 5/17/2019 chg
UST 2Y 225.0 220.0 -5.0
UST 5Y 224.7 217.8 -6.9
UST 10Y 245.3 239.3 -6.0
UST 30Y 287.4 282.4 -5.0
GERM 2Y -61.6 -64.6 -3.0
GERM 10Y -4.5 -10.4 -5.9
JPN 30Y 53.4 52.4 -1.0
EURO$ Z9/Z0 -26.5 -31.0 -4.5
EURO$ Z0/Z1 1.0 1.0 0.0
EUR 112.35 111.59 -0.76
CRUDE (1st cont) 61.80 62.92 1.12
SPX 2881.40 2859.53 -21.87
VIX 16.04 15.96 -0.08



Posted on May 19, 2019 at 1:49 pm by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

The reflation welcome mat

May 17, 2019

–Yields edged a bit higher yesterday with tens +2 bps to 2.398%.  Red pack was weakest on the dollar strip falling 5.0; greens through golds were -4.5 to -3.0.  Just a minor rise in yields causes USD strength which is in turn, deflationary, and should be a negative for US equities.  Maybe that narrative doesn’t quite hold, but stocks are a bit weaker this morning, supposedly due to souring trade talk.  Interestingly, Brainard and Kashkari both made comments yesterday regarding the idea of a ‘welcome’ overshoot in inflation.  Kashkari thought it might come through increased wages and Brainard, through increased import prices.  Brainard opined that the Fed might sit back during this “opportunistic reflation”.  At the same time, currencies are opportunistically adjusting to absorb potential price increases.  For example, the Korean won has weakened consistently from the end of April when trade talks broke down, from 1140 to 1196 this morning.  The Chinese yuan has also fallen this morning to a new recent low, now at 6.915.  A story on Reuters cites officials as saying China will use reserves to prevent CNY from piercing 7.0.  Know what that means?  It’s going straight to 7.  In the same way, Trump says he hopes the US can avoid war with Iran.  Know what that means?

–It’s true that import prices might go up due to tariffs and a decline in global trade. but strength in USD and possible faltering in US stocks is a major counterbalance.  And while the Atlanta Fed wage tracker has gently firmed over the past six years of so, it shows little sign of acceleration in spite of record low unemployment rates.  

–This morning brings Leading Indicators expected +0.2 and U of Mich sentiment numbers. 

Posted on May 17, 2019 at 5:19 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Pushing for an ease

May 16, 2019

–After weaker than expected Retail Sales and Industrial Prod data, the Atlanta Fed GDP Now forecast for Q2 was trimmed to 1.1% from 1.6.  Today’s news includes Housing Starts 1209k, Philly Fed expected 9.0 and Jobless Claims.  In a continuing escalation of the trade skirmish, the US blacklisted Huawei.  As the yuan is naturally pressured to partially absorb declines in trade, it becomes much less likely that a deal will come to a quick resolution as the US will accuse China of ‘manipulation’. Of course, the Korean won has also done nothing but decline since the trade talks fell apart.

–The bid for treasuries remains relentless with yesterday’s gains holding.  USM currently trading at a new high above 150.  Important levels from the end of March are being tested or surpassed. For example, 5/30 yesterday matched the March 27 high of  67 bps.  At that time. red/gold euro$ pack spread had settled 25.375, now 24.875.  The first three one-year calendars at end of March had posted lows of -42, -38.5 and -34.  Now -43.25, -37.5, -32.  Jan 2020 Fed Funds rose 2.5 bps yesterday to a new high of 9793.0, 32 bps lower in yield than the spot May contract (9761).    All near 3 month euro$ calendars posted new recent lows, with the lowest being EDZ9/EDH0 at -15.0. 

Posted on May 16, 2019 at 5:15 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Yields Press Lower

May 15, 2019

–In spite of a solid bounce in stocks yesterday, rate futures are at new highs this morning with TYM printing 124-20 (+9.5) and the highest contract on the euro$ curve, EDH21, just printing 9801 (+4.5).   EDH21 prints 50 bps lower in yield than the current libor setting.  Weaker than expected data out of China was a contributor.  Retail Sales +7.2% and Industrial Prod +5.4; nominally big numbers but both much lower than projected.  Quite different from the same data being released today in the US:  Retail Sales expected +0.2 and Ind Production +0.1.  

–Following Salvini’s threats yesterday to ignore the EU’s budget rules, Italian bank shares continue to fall, with the bank index 1.25% today and off 14% from last months high.   

–June treasury options expire a week from Friday.  On the call side, TYM 125 strike has the most open interest currently at 123k, soon to be the atm strike.  Implied vol declined in rates yesterday as stocks rallied, but rate futures and spreads reflected little confidence in a sustained boost in equities as prices barely changed.  EDM9/EDM0 closed right at the recent low of -37.75 and EDM9/EDU9 settled at a new low of -11.25. 

 –Treasury calendar rolls becoming more active in shorter maturities due to negative carry and delivery risks.  About 14% of 2’s and 8% of 5’s have rolled so far.

Posted on May 15, 2019 at 5:15 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Stuck in neutral (on the peak of a hill)

May 14, 2019

–When asked about the implications of a full blown trade war, Warren Buffet unequivocally said, “It would be bad for the whole world.”  US stocks are certainly following the script, with SPX falling 2.4% and Nasdaq 3.4%.  In spite of a threat by China to trim US Treasury holdings, the ten year yield fell 5 bps to 2.403%.  China is taking a negotiating tactic from Trump and lobbing outrageous claims to keep markets off-balance (while quietly letting CNY fall to a new low, 6.88 this morning).  However, treasuries remain the biggest and most liquid safe haven.  Bitcoin, on the other hand, is acting as an illiquid safe haven, having leapt from $5000 at the end of April to a new high of $8170 this morning.  Gold has also shown a spark, closing above 1300 and breaking a downward sloping 3 month trendline (GCM9).  Finally, Corn made a new low but had an outside day and closed higher, a sign of a short covering squeeze to come. 

–Williams joined a chorus of other Fed officials in noting that the neutral rate is low, and further added that the central bank should prepare for slow growth.  Nice cheerleading effort.  

–In terms of levels, some markets have pierced late March spikes and some have not.  For example, FFF0 settled at a new high of 9791.5, more than 25 bps lower in yield than the current Fed Effective (projecting at least one ease by year end).  Aug/Oct Fed fund spread closed -8.5, signifying about 1 in 3 chance of a hike AT the Sept meeting.  The spread between May and Oct is -15.75, so that indicates a chance of around 60% that the Fed eases BY Sept.  As mentioned over the weekend, when things start to get bad the Fed eases quickly; it’s a lot easier for reds to rally 10 than decline 10, and that’s what the call skew has been reflecting.  A large trade yesterday underscores that sentiment: new buyer of 50k EDV 9800/9825 c spreads up to 2.5 (settled 2.25 vs 9765.5 in EDZ9).  This trade needs 2 or 3 eases…but the Fed keeps talking down the neutral rate for a reason:  It’s because they are preparing to ease, or at least letting the markets know it’s probable.  Kashkari is the only one that didn’t get the memo, saying no cuts are necessary because the labor market is strong.

–One year ED calendars didn’t quite take out late March lows.  The cheapest is again EDM19/EDM20, the front spread, which settled -37.75 vs a low of -42 in March.  The peak contract is EDH21, which settled 9797. just shy of the 2% strike.   VIX well through March highs, now 19, but stock indexes haven’t quite taken out March lows.  Chance of reprieve with turnaround Tuesday…

Posted on May 14, 2019 at 5:21 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Hardening opposition

May 13, 2019

–The two sides are hardening in the US/China trade dispute, leading to a harsh reversal of Friday’s stock market rally.  Yuan has posted a significant new low at 6.874, having been around 6.71 through the early part of April.  While US stock indices have not taken out Friday’s early morning lows, US fixed income markets are making new highs with TYM having traded 124-10 as of this writing.  EDH21 is the highest ED contract on the strip, having settled at 97.88.  As of now, it trades 97.93, pushing closer to the 9800 strike which hasn’t been breached since late March.  Now it’s about how much pain each side can withstand.  I had watched Xi’s New Year address, and while I recall it as being generally upbeat and highlighting accomplishments, there were also somber warnings about working through upcoming challenges.  Trump points to new highs in the stock market. While China is the dominant concern, Turkey and Iran are possible flashpoints to keep in mind.

–Today, Clarida gives a speech relating to the Fed’s Policy Review.  Once again, we’ll hear about inflation targeting and allowing an overshoot to ‘catch-up’.  Last week Brainard floated the idea of yield targeting at the same venue and that’s sure to get a shout-out as well.  The rule of thumb that I am going with is that maximum pain for the Federal Reserve is right around a 20% decline off the high.  In SPX, that’s currently 2363 (High was 2954.  Friday’s close 2881).

–While oil is higher this morning copper is at a new recent low.  High open interest call strike in TYN is 124.5 with 90k open, which will probably act as a magnet on price.   

Posted on May 13, 2019 at 5:13 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Stay in your lane, bro

Weekly – May 12, 2019

“Relax amigo, it’s gonna look ok.”

There’s a fairly amusing recent AT&T commercial set in a tattoo parlor.  The tattoo artist is a big gruff guy, and the first-time client is nervously asking questions. “Just ok?”

The artist simply warns as he’s getting ready to ink, “Stay in your lane bro.”

The tattoo artist

I was going to write about the controversial Kentucky Derby last week, but I was out of town.  I watched the race in the friendly environment of the Dublin House on 79th Street in NYC, and while it was missing the extravagant atmosphere of  flouncy women’s hats and mint juleps, it was a jovial crowd. Although it’s a week old now, I can’t resist the political metaphor of what was an exciting race.  Maximum Security led wire to wire, but was disqualified for drifting out of his lane and impeding War of Will, leaving second place Country House to claim the roses. Trump’s core theme has been Maximum Security with respect to both borders and trade.  It’s a War of Wills between Trump and Xi.  Now China has more or less told the US to respect its sovereign dignity and “Stay in your lane” and Trump has appealed to the Country House: “Make products in the US and avoid tariffs.”

There’s another powerful figure fond of the “Stay in your lane, bro” analogy, and that’s Chairman Powell.  Many times he’s been asked about trade and fiscal matters with regard to monetary policy.  Here’s a typical response from July of last year, “Part of the independence that we have, is to stick to our lane, to our knitting, so really [ the Fed ] wouldn’t want to comment on fiscal policy… or trade policy.”

However, we’re now in a world where fewer and fewer players are inclined to respect the lanes, from China and the US in trade negotiations and South Sea differences, to Brexit, to Iran and N Korea testing missles, to Turkey calling an election ‘do-over’ because the results didn’t square with Erdogan’s objectives.  Trump (and Kudlow’s) incursion into the Fed’s independence is another instance.  The market has been prodding the Fed in the same direction as Trump, if not in magnitude.  For example, in mid December, nearby one-year eurodollar calendars all inverted, and they have stayed that way despite the stock market recovery into the end of April.  The first three 1-yr calendars are now all around -28.5 while the admin has called for cuts of 50 to 100 bps.  Below is a picture of the 2nd to 6th contract on a constant maturity basis.  The lower panel of the chart is the spread.  In December of course, stocks and commodities were falling hard.  The Fed hiked on December 19, and that was the switch that sent spreads from the light of a positive curve to the darkness of inversion, signifying a central bank that is too tight.  Ironically, pressure by the administration may prevent the Fed from taking out an insurance policy ease, even if some of the deflationary impulses we’ve recently encountered are indeed transitory.

2nd to 6th ED calendar spread. Red area denotes inversion

Both China and the US face domestic considerations with respect to indebted companies.  Bloomberg highlighted conditions in both countries.  One article from May 7, notes that missed bond payments in China quadrupled in 2018 from 2017, and are on pace to make 2019 a record default year.  I’ve repeatedly posted US corporate debt charts, but below is a good one from BBG, that clearly shows the increase as a percent of GDP.  Growth in corporate debt coincided with QE2 and QE3 and the explosion of the Fed’s balance sheet.  That’s exactly what the Fed was looking for: debt growth to finance productive capacity.  But share buybacks are not the same thing as productive capacity.

US Corp Debt as % of GDP (Bloomberg)

So we’re left with the prospect of large amounts of debt needing to be rolled in an environment which is getting a little more discriminating.  This is simply my own take, and not backed by any hard data, but it seems to me that venture capitalists are using this period to cash out of holdings and distribute shares of money-losing enterprises to the public.  There was an interesting late April interview on CNBC with Alan Patricof, legendary vc founder of Greycroft.  At least since March, he has been warning that because many of the upcoming IPOs are “household names”, like Lyft, Uber, WeWork, etc. that the public isn’t focused on metrics like profitability and sustainability of growth.  The public is focused on investing in companies that have permeated the economic landscape.   A clear red flag was seen in early January, when Softbank trimmed a planned investment of $12 billion in WeWork down to just $2 billion as Saudi backers balked at throwing more money into a huge cash burner.    

In the late 1990’s, Fed Chair Alan Greespan said that many tech companies in the Nasdaq frenzy would undoubtedly fail, leading to an inevitable shake-out, but that it wasn’t the Fed’s job to interfere with the decisions of multitudes of individual investors.  We now have venture capitalists who have essentially subsidized consumers in order to build market share and turn unicorns into “household names”.   They’re using this window of time to monetize their investments.  So far, it’s been an inauspicious start with Lyft, Uber and Beyond Meat.  Pinterest has fared well but its metrics are arguably better as losses have narrowed over time.  Beyond Meat’s S-1 spelled it out: “We have a history of losses, and we may be unable to achieve or sustain profitability.” [let me add… That’s because people don’t generally like fake meat].  So, these companies have subsidized consumers by pricing their products at levels which don’t generate profits.  Eventually, the public markets won’t be quite as forgiving as they are now.  Think TSLA.  And note that Illinois is thinking of taxing electric car owners $1000 per year because they don’t pay gasoline taxes but still use the infrastructure of roads.  If there’s a “transitory” aspect of inflation, this is a BIG one.  These companies will end up raising prices in an attempt to achieve profitability, or go out of business, allowing survivors the luxury of pricing power.  Of course, the new central banking ‘third mandate’ is to keep zombie companies on life support.     

On a related though separate note, Fed Governor Lael Brainard gave a speech on May 8.  It’s clear that the Fed is thinking an awful lot (one might almost say is pre-occupied with) the idea of a recession and related decline in inflation. 

For a variety of reasons, it seems likely that equilibrium interest rates will remain low in the future. Low interest rates present a challenge for the traditional ways of conducting monetary policy. That is especially true in recessions when, in the past, the Federal Reserve has typically cut interest rates by 4 to 5 percentage points in order to support household spending and business investment. But when equilibrium interest rates are low, we have less room to cut interest rates and thus less room to buffer the economy using our conventional tools.

She then touched upon the inflation “make-up” prescription which has been mentioned by a variety of Fed officials, but also floated a new balloon: Yield Targeting.  Many in the press latched onto her comments as suggestive of long-dated targeting – as the Japanese do with ten year yields.  However, this proposal begins with the idea of pinning shorter term yields:

Another idea I would like to hear more about involves targeting the yield on specific securities so that once the short-term interest rates we traditionally target have hit zero, we might turn to targeting slightly longer-term interest rates—initially one-year interest rates, for example, and if more stimulus is needed, perhaps moving out the curve to two-year rates.     

It’s still in its infancy, but imagine this sort of scenario unfolding.  VCs keep dumping supply on to the stock market at a time when capital is also being sucked into the treasury market to fund increased deficits.  At the same time, China and the US drag out negotiations because neither side feels that they have enough of a concession to claim a ‘win’.  Global trade flows and the stock market suffer.  Inflation remains below target.  The Fed is forced to start easing quickly as China lets its currency weaken to counteract tariffs and support exports, further pressuring US prices.  The Fed starts to target one year yields.  However, domestic prices bottom and start to rise given protectionism, and service companies that have gone public are forced to jack up prices to stop the cash-burn bleeding.  Yields at the long end rise.  The yield curve steepens dramatically. Cats sleeping with dogs.

Or, conversely, maybe it’s just simpler to look at the chart below and say that base metals prices lead the ten year yield by 3 to 6 months and have now almost completely reversed Q1’s rally and look poised to test last year’s lows, which in turn would forecast tens at 2.00-2.25% by Q3.    

BBG base metals index (amber) vs US 10y treasury yield (white)

In any event, what we’ve had over recent history is a “Relax amigo, it’s gonna be ok” attitude about market outcomes. Kick the can down the road and there will never be an ultimate price to pay.  Unexpected shocks never have follow-through, and are used as yield enhancement opportunities to sell premium. My thesis is that one of the next lane changes is going to end up causing a chain-reaction accident.  Or, said another way, that tail risks are increasing.  It’s worth keeping in mind, amigo.


The general structure of the market continues to suggest increasing odds of rate cuts.  Despite Friday’s stock market recovery from the depths of selling pressure, a continued cloud over global trade flows is negative for growth and for equity prices. 

As mentioned above, near one-year Eurodollar calendars remain inverted by a bit more than one-quarter pct. The lowest levels posted in late March were just under -40.  January Fed funds closed the week at 97.85 or 2.15%, vs IOER of 2.35%, indicating about 80% odds of a Fed ease by year-end.  This was the highest settle since late March which posted a high close of 97.91.  Libor/ois spreads have compressed, as indicated by EDM9 vs FFN9 which settled 16 bps and EDU9 vs FFV9 which settled 16.5.  It’s worth noting that euribor calendar spreads have also being declining.  For example, red/blue Dec (ERZ0/ERZ2) settled at a new low for the cycle of 36.0.  It had been over 60 at the start of the year.

I still favor a longer term theme of bull steepening as the long end of the US curve is held down by supply considerations.  Although odds of a market accident appear to be increasing, the Fed will likely be slow to react given criticism of the abrupt u-turn in policy at the beginning of the year.  However, when/if it becomes apparent that the economy has rolled over, the Fed will act swiftly. 

4/26/2019 5/10/2019 chg
UST 2Y 228.6 225.0 -3.6
UST 5Y 229.3 224.7 -4.6
UST 10Y 250.2 245.3 -4.9
UST 30Y 292.5 287.4 -5.1
GERM 2Y -59.5 -61.6 -2.1
GERM 10Y -2.2 -4.5 -2.3
JPN 30Y 55.8 53.4 -2.4
EURO$ Z9/Z0 -27.5 -26.5 1.0
EURO$ Z0/Z1 1.0 1.0 0.0
EUR 111.49 112.35 0.86
CRUDE (1st cont) 61.94 61.66 -0.28
SPX 2939.88 2881.40 -58.48
VIX 12.73 16.04 3.31

Note: Above are TWO week changes as I skipped marking last week’s data




Posted on May 12, 2019 at 1:27 pm by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options


May 10, 2019

At the end of March, yields took a dive.  German manufacturing PMI had come in at just 44.7.  Kudlow went on CNBC and called for a 50 bp rate cut.  The market was clearly positioned wrong, and the fixed income rally was vicious.  For example, EDM20 traded as high as 9797 and EDM21 as high as 9795.  Yesterday’s closes were 9776.5 and 9787.0.  At the time, stocks had a relatively small pullback, and VIX traded to around 17.5.  On the current pullback in stocks, VIX has spiked above 20. but the rally in fixed income has been much more measured as the Fed has tempered expectations of an immediate ease. Even with the escalation of the trade war with the imposition of new tariffs on China, rates are behaved.  In late March, near one-year ED calendars traded -38 to -42. now the first three one-yr spreads are -28 to -29.  The bias is clearly for rate cuts, but the market is more balanced.

–Yesterday the ten year fell  3.1 bps to 2.451% while reds through golds rose 3.0 to 3.5 bps.  Trump imposed new tariffs today, but the market appears to believe an 11th hour deal with China will still be struck.  SHCOMP rose 3%.  

–News today includes CPI expected +0.4 with Core +0.2, and yoy Core +2.1.  Bostic speaks about the economic outlook (he had previously expressed concerns over curve inversion. and we now have 3m bills around 2.38 and tens 2.45).  UBER IPO today.–May midcurve options expire with atm 0EK and 2EK straddles settling 6.0 yesterday, relatively high.  

Posted on May 10, 2019 at 5:23 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

Tipping points

May 9, 2019

–Stocks under renewed pressure this morning with Trump turning up the rhetoric saying China broke its deal.  Treasuries have reversed yesterday’s weakness going into today’s 30 year auction.  News today includes PPI expected +0.2, with yoy Core 2.5%.  Trade deficit $50.1b.  Jobless Claims 220k.

–Yesterday’s 3 month libor setting was 2.545, the lowest since last October and just shy of 29 bps below the high print set just after the December FOMC hike.  While this supported the very near contracts, reds through golds fell 3 to 4 bps.  After an initial push to new highs in TYM9 to 124-06, the market faded going into the ten year auction and declined further in its wake to settle 123-24.  The auction was poorly received with bid to cover of just 2.17, the lowest in a decade, with a tail of 1.4 bps to come in at 2.479 (3:00pm marked 2.482).  Most commentary surrounding this auction expressed concern with lack of foreign demand, with some suggesting that perhaps the prospect of increasing supply had reached a tipping point.  A BBG piece fretted about lack of Chinese participation.  Should that be a surprise?  After the 2008 crisis, the US/China relationship was often referred to as ‘vendor financing’ with China selling the US manufactured goods and recycling those dollars into treasuries.  From the start of 2008 to the middle of 2014, China’s reserves grew from $1.5T to a peak of $4T.  Since 2016 they’ve leveled off just above $3T.  But with less being shipped to the US, there are fewer dollars to recycle into UST.  Who is going to plug the gap?  You guessed it: The Fed. 

–Interesting to note that in this regard, BOJ’s Kuroda dismissed the idea that Japan was a real-life example of MMT.  It seems as if Kuroda equated MMT with the idea of hyper-inflation, but according to Stephanie Kelton, MMT’s main proponent, the point of MMT is to bring down employment and create/repair infrastructure, with an increase in inflation being the limiting factor, rather than a fixed dollar amount of debt.  That is precisely the Japanese story, and it hasn’t sparked inflation.  It’s also ironic that the Fed’s Lael Brainard in a speech yesterday brought up the (Japanese) idea of targeting yields slightly further out the curve.  Yes, the Fed will be on its way to monetizing the debt.https://www.federalreserve.gov/newsevents/speech/brainard20190508a.htm

–Some notable new sales yesterday of TYN 126c at 13 and 14; open interest +11k, settled 9.  Fears of a meltdown associated with a complete breakdown in trade talks just isn’t reflected in markets.  However, it’s also worth keeping an eye on TRY, new low today of 6.23.

Posted on May 9, 2019 at 5:03 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options

China, Iran and US banks altering agreements

May 8, 2019

–Yields fell as stocks declined.  Tens shaved 5 bps off to end at 2.446% in front of today’s 10y auction.  The red eurodollar pack closed +5.125, with greens, blues and golds +5.5.  SPX fell 1.65% with Nasdaq down 2% as the showdown on a US/China trade deal moved into a more precarious stage.  Vol up in both stocks and fixed income with the VIX nearing 20 and many eurodollar straddles adding 1-1.5 bps, but there seemed to be some call profit-taking in treasuries as well.

–Odds for Fed rate cuts increased slightly, but are not particularly close to more extreme measures seen at the end of March.  For example, the lowest one-year ED calendar spread is now EDU9/EDU0 at -29.5, while the lowest in March hit -42.0.  Aug/Oct Fed Fund spread is -6.0, indicating a 25% chance of ease in Sept (that had traded below -8.5 in March).  Jan 2020 funds settled 9781.5, which, given changes in IOER, is somewhere around 75-85% chance of a cut by year-end.  

–It’s not only about China.  The Turkish lira today is edging to a new low of 6.17 and apparently Iran is also stepping back from earlier agreements, leading to increased internat’l tension.  The Italy bank index has erased April’s gain and is nearing levels from late March.

–On a more mundane domestic note, Consumer Credit yesterday for March was up much less than expected at $10.4b vs $16b exp.  Revolving credit (credit cards) actually declined on the month.  In my mind, there are only two explanations: one, banks are tightening conditions as delinquencies edge up or two, households are trying to load up on student loan debt for the upcoming jubilee.  Non-revolving credit (student and car) increased nearly $12b from $2.983 to $2.995t.  A drop in revolving credit is a red flag. 

Posted on May 8, 2019 at 5:09 am by alexmanzara · Permalink · Leave a comment
In: Eurodollar Options