Contagion

February 24, 2020

–Markets have finally caught coronavirus, with ESH -81 at 3258.00 and mini-Nasdaq -283 at 9175.  The ten year yield is 1.42, just about 6 bps from the all-time low.  ESH should have initial support 3225 to 3250, while NQH should hold above 9000.  On Friday 0EH 9875 straddle settled 15.5 vs 9878 in EDH21.  This morning the contract is 9.5 higher at 9887.5.  On Friday FFG0/FFG1 settled -52.25, indicating two eases on the year.  Market action today suggests that may be an undershoot.  Several Fed papers and officials have suggested that the Fed shouldn’t ‘keep its powder dry’ in a crisis, but rather should move swiftly and aggressively.  Brainard echoed the point in her Thursday speech. “This finding leads the authors to conclude that these policies should be deployed quickly and aggressively in the future through a plan that is communicated in advance.”  I don’t know if we can say the ‘plan’ has been communicated precisely, but the message the market has relied on is: ‘the Fed has our backs’.

–Today’s news includes Chgo Fed Natl Activity Index, expected -0.90 from -0.35 and Dallas Fed Mfg, expected to pop up to +11 from -0.2.  We saw last week with Philly Fed (strong) and Markit PMI’s (weak) that the market doesn’t care about rear-view strong data, but is hand-wringingly concerned about signs of weakness.  On top of that, we have Bernie gaining strength just like the virus or a swarm of locusts.  In a fairly recent interview with Bloomberg news, Druckenmiller was asked about a hedge in case Bernie wins.  His response: “There’s no hedge, you just sell everything.” 

–When things get a bit crazy, it’s not uncommon to see ten year vol 5.5 to 5.8 and thirty-yr above 10.  On Friday I marked April 10y at 4.8 and USJ at 9.4.  The bold will be looking for places to sell treasury calls against record low yields and high vols, but it may still be early.

–Gold rocking this morning with GCJ up $35/oz to $1684.  By the way, from 1934, when Roosevelt devalued the dollar by raising the price of gold from $20.67 to $35, through the post-WWII Bretton Woods Agreement when $35 was again mandated as the price, through 1987, gold held at $35… today’s net change.  In August 2011 it exceeded $2000. 

Clean-up role

Weekly Comment – February 23, 2020

You all recall (or perhaps it’s just another anachronism) seeing kids in school who would use fat yellow highlighting markers on their textbooks.  I would buy used textbooks whenever I could, and sometimes huge swaths of text would be completely yellowed out. It often occurred to me that if you’re highlighting the entire book you’re not possibly distilling the material down to core concepts.

This weekend I read the FOMC minutes, Brainard’s speech and Clarida’s speech from Friday.  I found myself excerpting large amounts of text from each source (now using copy/paste instead of a yellow marker).  For my purposes, how the Fed considers data and the economic environment and its reaction to those inputs is extremely important.  From my reading, I would say these factors are most important in the interplay between financial CONDITIONS, financial STABILITY and inflation.  Clarida and Brainard are likely the two most influential board members.  However, there are a lot of conflicting thoughts between these speeches and the minutes.

My conclusion is that the Fed still has a credible voice, but that its message has been muddled and markets have now relegated the Fed to a much more reactive ‘clean-up’ role.  That conclusion has been reinforced by September’s repo squeeze, by the Fed’s $60B/month t-bill buying program, and by current market action.  So that’s my distillation.

The minutes reveal the Fed’s current concerns in one sentence:

At this meeting, the discussion focused on two topics: the potential interactions between monetary policy and financial stability and the potential use of inflation ranges around the Committee’s 2 percent inflation objective.

The first question is why the Fed is so obsessed with a small shortfall in inflation measures.  In my opinion, another excerpt later in the minutes obliquely provides the answer.

…several participants observed that equity, corporate debt, and CRE valuations were elevated and drew attention to high levels of corporate indebtedness and weak underwriting standards in leveraged loan markets. Some participants expressed the concern that financial imbalances—including overvaluation and excessive indebtedness— could amplify an adverse shock to the economy, that the current conditions of low interest rates and labor market tightness could increase risks to financial stability

Overvaluation and excessive indebtedness can be “cured” by higher inflation levels.  The implication is that firms will have more pricing power and can more easily service debt levels because of greater cash flow, therefore asset values can come into more justifiable ranges with respect to other macroeconomic variables.  Additionally, nominal wages increase which can support buying power.  Interest rates will naturally rise, pulling the Fed away from the zero-bound issue.  Disinflation puts the whole process into reverse and makes high nominal debt levels unserviceable. 

Now let’s consider a couple of comments by Clarida.  First he talks about monetary lags and says that policy decisions today have no effect on today’s inflation or unemployment rates.  Clearly, that makes some sense.  He continues:

Thus, central banks and financial markets are looking at the same data on macro fundamentals to make inferences about the future path of the economy, and, of course, any decisions on the policy path made by the central bank will influence asset prices through the discount factor. So optimal monetary policy will (almost) always be correlated with asset prices. Correlation is not evidence of causation, and the hall of mirrors problem at its essence is about inferring causation from correlation.

I would argue that the outsized importance of financial markets, in large part spurred by the Fed’s post-crisis expansion of the balance sheet has, in many ways, put the Fed in a box with respect to policy decisions; the only question now is when are we forced to do MORE.  As the long bond has plunged in yield I have heard a lot of people talking about refinancing mortgages.  Clearly this happens on the corporate side as well.  The market has lowered rates, influencing all asset prices, without as much of a lag as we might have had previously. The Fed might be trying to hold off on rate cuts because it doesn’t want to contribute to what might become larger indebtedness and future financial instability, but the market has taken the lead and forced the issue.  Furthermore, the policy change spurred by markets probably has less of a lag than actual Fed decisions.  The markets drag the Fed into trying to endorse stretched valuations, and indeed many Fed officials have done just that.  What appear to be supportive financial CONDITIONS presently can lead to financial INSTABILITY later.

Often, Fed officials talk about communication policy and credibility in outlining a course of action to the public.  A lot of this discussion has centered around inflation averaging, that is, letting inflation overshoot for a time to “make-up” for past shortfalls.  The problem here is addressed in all sources.  Clarida mentions data-dependence, and notes that estimates of inflation and rates in SEP dots have come down for years.  My interpretation: how can the Fed promise a course of action with respect to inflation averaging if its own estimates of conditions are continuously evolving?  The Fed has fallen short of its inflation target for years.

Brainard’s speech mainly concerns discussion of a paper written by Cecchitti et al.

The report assesses how unconventional tools—including forward guidance, balance sheet policies, negative nominal interest rates, yield curve control, and exchange rate policies—have performed over the past few decades.

The authors conclude that unconventional monetary policies worked during the crisis but did not fully offset a significant tightening in financial conditions. This finding leads the authors to conclude that these policies should be deployed quickly and aggressively in the future through a plan that is communicated in advance. This point is very important, so it will be the focus of my discussion.

To the extent that the public is uncertain about the conditions that might trigger asset purchases, the scale of purchases, and how long the purchases might be sustained, it could undercut the efficacy of the policy. Furthermore, the cessation of asset purchases and subsequent balance sheet normalization can present challenges in communications and implementation.

My conclusion here is that 1) the Fed has to identify and agree that a problem is occurring which requires unconventional policy.  2) if it’s unconventional, almost by definition you will have a hard time communicating intentions to the public in a credible way, especially in advance.  Again, how will the public know that temporarily offsetting tightened financial conditions won’t lead to future financial instability?  Brainard, or perhaps more appropriately the authors of the paper, are placing the Fed squarely in a reactive role.  Technical details about inflation averaging and yield curve targeting are almost irrelevant.  This final line is almost a joke:

It is important to emphasize that for monetary policy to be effective, it will be key for policymakers to communicate their strategy clearly in advance to the public, to act early and decisively, and to commit to providing the requisite accommodation until full employment and target inflation are sustainably achieved. This was one of the important conclusions of this year’s U.S. Monetary Policy Forum report.

Finally, from the minutes:

The staff noted that clear communications of the Committee’s ongoing assessments of the interactions between monetary policy and financial stability could help avoid large interest rate surprises that could otherwise contribute to financial vulnerabilities.

Some participants remarked, however, that keeping policy rates low to achieve both of the Committee’s dual-mandate objectives may contribute to a buildup of financial vulnerabilities, especially at times when the economy is at or above full employment, a development that could pose future risks to the economy and to the ability of the Committee to achieve its dual mandate.

And here’s the kicker:

…the possible use of financial instability escape clauses to help explain the rationale for policy actions when a buildup of financial vulnerabilities poses risks to the achievement of the Committee’s goals.

You had a cute kitten and now it’s a man-eating tiger.  So now the Fed wants to use “OUT” clauses to change policy when it realizes it has gotten behind the curve and perhaps communicated an incorrect message.  POP!  Now we have to clean up with whatever tools we can find. 

So let’s relate the Fed’s recent communications to current markets.  Stocks made all-time highs early in the week, but at the first signal of a pull-back implied vols in treasuries and VIX jumped.  Eurodollar futures and option markets have signaled that the Fed is going to have to ease, perhaps aggressively.  Spreads between corporate bonds and treasuries remain extremely tight, even though some high-profile downgrades to junk are occurring, for example Kraft-Heinz.  The long bond yield ended at 1.917%, an all-time low in spite of 50 year lows in unemployment. We have what seem to be very accommodative financial CONDITIONS, but the markets are indicating that VULNERBILITIES are lurking just around the corner.  The Fed will be forced into a clean-up role.

OTHER MARKET/TRADE THOUGHTS

The most notable changes week over week are the long bond yield, down 12.6 bps to a new low of 1.917% and the action in the front end of the curve.  EDM0 settled Friday at 9853.5 from 9845.0 the previous Friday.  EDU0 at 9862.5 from 9854.0 so both up 8.5 bps vs a change in the two year treasury yield of just 7.6 bps.  There has been an astonishing amount of activity in EDM0 calls, clearly betting on a forced Fed ease.

Here are open interest changes in selected EDM0 calls, along with Friday’s settlements and deltas. 

EDM0		2/14/20 OI	2/21/2020 OI	CHANGE	STL	DELTA
9850C		400k	468k	+68k	12.75	0.55
9862C		376k	567k	+191k	8.50	0.38
9875C		539k	600k	+41k	5.00	0.26
9887C		402k	717k	+315k	3.25	0.17
9900C		299k	341k	+42k	2.25	0.12

Friday’s settle of the atm 9850 straddle was 22.0, the previous Friday it settled 20 vs 9845.  These open int changes seem like whopping numbers and they are.  But in the grand scheme of things, an increase of 191000 EDM0 9862 calls, even at the settlement price of 8.5 is only $40.5 million.  A drop in the bucket for some large funds.  Should the Fed be influenced by such a paltry sum?  The full 717k of 9887 calls at 3.25 is only $58.25m of premium in total.  It almost seems as if a few large funds could use this fairly inexpensive signaling mechanism to help push the Fed along in its reactive function.

FFG0/FFG1 settled at a new low of -52.25.  I.e. the market has two eases priced for the year.  April FF vs EDH0 settled 7.0, FFN0 to EDM0 (9861.5/9853.5) settled 8.0, and January 21 FF (FFF1) vs EDZ0 settled 9890.0 vs 9866.5 or 23.5.  Nearer, lib/ois proxy has collapsed, while more deferred has remained bid.  Partially due to technical factors relating to near term bill supply.  Obviously many markets had wild moves this week, and are at or near the point when positions are forced.   

	2/14/2020	2/21/2020	chg
UST 2Y	142.2	134.6	-7.6
UST 5Y	141.1	131.6	-9.5
UST 10Y	158.7	147.0	-11.7
UST 30Y	204.3	191.7	-12.6
GERM 2Y	-65.5	-63.8	1.7
GERM 10Y	-40.1	-43.1	-3.0
JPN 30Y	38.7	34.5	-4.2
EURO$ H0/H1	-33.0	-41.5	-8.5
EURO$ H1/H2	-3.0	-4.0	-1.0
EUR	108.31	108.47	0.16
CRUDE (1st cont)	52.32	53.38	1.06
SPX	3380.16	3337.75	-42.41
VIX	13.68	17.08	3.40

The Fed balks at rate cuts that Trump and the markets want

February 21, 2020

–Buying of treasuries has been relentless, with 30’s closing below 2%, at 1.97.  Curve is flattening with the two year falling 3.3 bps to 1.391% and tens  down 4.8 bps to 1.522% (this morning at 1.48%).  2/10 ended at 13.1.  Red/gold pack in euro$’s fell another 0.5 bp to end at 16.375.   A big bounce in Philly Fed yesterday to 36.7 (vs expected 12) was ignored by the market.  It’s all about damage to supply chains and whether or not a post-virus bounce will occur in Q2.  Although virus focus is shifting a bit more to S Korea, the won has not yet taken out last year’s low.  USDKRW high last year 1224, now 1212.  However, gold has eclipsed last year’s high and appears poised for further gains, with GCJ0 up $16 this morning at 1637. 

–Clarida yesterday said he doesn’t really think the markets expect a cut, yet every treasury maturity except 30’s is below IOER.  FFG0/FFG1 closed -41.25, pricing nearly 2 eases this year.  The Fed’s refusal to endorse rate cuts is helping to flatten the curve.

–Equities are becoming a bit more volatile with VIX closing 16.81.  The high print at the end of Jan was 20.  Risk-off Friday likely.

Are safe havens safe?

February 20, 2020

–Minutes indicate the Fed would like to hold the line this year, saying rates are appropriate “for a time”.  The market disagrees, A LOT.  Buyers continue to pour into EDM0 calls, looking for forced rate cuts before summer.  Kashkari essentially endorsed the market’s outlook, saying policy was about right but risks were tilted toward ease.   EDM0 futures have a bit over 1.5 million in open interest, having settled -2.0 at 9845.5 or 1.545% with IOER at 1.60%.  EDM0 9862c settled 5.0, 28d, with OI of 567k, 9875c 3.0s, 17d, 598k and 9887c 1.75, 11d, 715k.  Obviously it doesn’t always work this way, but heavy amounts/increases of OI tend to act as a magnet for price.  Buying yesterday  of calls, call strips, etc.  See below.

–This morning Aussie is at a new low, with ADH0 printing 6628.  While there are specific issues there, a major factor is obviously China and the virus.  CNY prints 7.02 with yuan poised for further weakness.  Perhaps the most telling move is in JPY.  Safe-haven or new COVID-risk currency?  The market has emphatically chosen the latter with $/yen gaining 1% yesterday.  At the start of the month $/yen near 108, and it’s 112 this morning.  It’s not just Asia.  New lows in Brazilian real and Argentine peso as well. Etc.  So DXY is at a new high near 100, the highest since mid-2017.  I also saw a report on twitter that China M1 growth just fell to 0.0% yoy vs 4.5% expected (@BittelJulien).  It’s all flowing into the USA and TSLA for now… And into the long end, with 5/30 making a new recent low of 60.7 bps yesterday.  Red/gold euro$ pack spread also posted a new recent low at 16.875, down 1.25 on the day.

–Jobless claims and Philly Fed today, expected 12 from 17 last.

  A few players below, all buys: 

EDM 87/88 c strip 5.0, 20k
EDM 87c 3/30k
EDM 86/87cs v 46.5 10d 2.25 25k
EDM0 86/88cs v 46, 20d 3.5 30k
EDM0 86/88c 1×2 1.5 15k
EDM0 85/86/88/90 c condor 1.5 20k

Tiffany for Breakfast

February 19 2020

–In October, Tiffany’s share price was around $90.  In late November the company was acquired for just over $16 billion at a share price of 135 by LVMH.  In early February, LVMH issued bonds, in part to pay for the TIF acquisition.  Almost Daily Grants reports: “The deal, Europe’s largest corp bond sale [€7.5b] in nearly four years, saw two of the tranches priced to yield less than zero and the highest coupon at 0.45% for an 11 year tenor.”  The ECB was a buyer of those bonds. 

 –Let’s switch gears for a second.  Cass Transportation headline on its freight data: “North American freight shipments experience largest decline since 2009”

–Yellen last week suggested the Fed could buy equities and corporate bonds to help in a downtown.

–Why is Palladium up $200 an ounce this morning to 2700?  Why can’t stocks fall given coronavirus?  Given the negative real economic impact of the virus, one might think stocks would take a breather.  “Am I the only one who gives a sh-t about the rules?”  Hmm, the ECB is funding companies at zero rates to make acquisitions.  That’s why stocks can’t go down.  As Trump says, “Let’s have some of those negative rates.”  Let me get this straight.  ECB can fund LVMH to buy TIF at 45 bps or less, but the US govt has to pay 100 bps more to buy something really useful like cruise missiles?

–Well the eurodollar market is on board.  There was a buyer of well over 150k EDM0 9887.5 calls yesterday at 2.0 to 2.25.  Settled 2.25 vs 9847.5, with open int up an incredible 238k.  EDM0 contract added 33k.  There was a smattering of other call buying: +40k EDJ 9887c for 1.25, +10k EDZ0 9950c 2.5.  Also a buyer of 50k EDZ0 9825/9812/9800p fly for 1.5 covered 9859.  The ten year treasury yield yesterday fell 3.3 bps to 1.554%, while the thirty year bond is at 2% and Greek tens are sub-1%.  Dallas Fed’s Kaplan isn’t going with the flow.  He says he sees no change in rates this year.  

–I’ve attached a chart of the gold/silver ratio below.  Near all-time highs above 88.  Hasn’t really looked back since the Great Central Bank Liquidity Pump in 2011.  

–Speaking of gold, at least Illinois got its beloved former governor Rod Blagojevich back, as Trump commuted his sentence.  (Many former governors and other politicians in Illinois have had to serve out their full jail terms).  Here’s a quote by Blago referring to the Senate seat he wanted to sell: “I’ve got this thing and it’s (expletive) golden.  I’m not just giving it up for (expletive) nothing.”  (That was secretly recorded by Federal agents.  You know, when they actually cared about the sale of gov’t seats).  

–PPI today along with Housing data.  FOMC minutes this afternoon. 

–Mark it zero Smokey.

Conditions are Perfect. It’s Business Time

Feb 18, 2020

–Apparently no one could believe that COVID19 could have an impact on business until AAPL warned that it isn’t likely to meet March sales guidance laid out just three weeks ago.  AAPL down nearly 6% and HSBC also lower as it’s set to cut 35000 jobs in a major restructuring.  As of this writing ESH down 16 to 3366.  Flight to quality in USD with DXY making new highs for 2020, EUR at a new low 1.0829.  CNY back above 7.  Treasuries have seen inflows with tens falling about 4 bps from Friday’s close.  March treasury options expire Friday; TYH 131.25 calls were trading 5 yesterday vs 130-31 with the contract now just above breakeven at 131-11.  Precious metals also advancing, with Palladium starring, at a new high nearing $2450/oz.  

–Friday featured new lows in red/gold pack spread at 19.125 bps, down 1.125 on the day, and in 2/10 down nearly 3 bps to 14.5.  Today’s economic news includes Empire State report, expected 5.0 from 4.8 last.  Kashkari to speak at 2:00 EST.  The market has already priced the easing he’s sure to espouse, with FFG0/FFG1 spread printing -45 this morning, indicating nearly two cuts this year.  

–Last week former Fed Chair Yellen said it would help in a downturn for the Fed to buy corporate bonds and equities (even though it’s not currently allowed to do so).  Why even bring it up?  Japan has followed that script and just recorded a 6.3% drop in  Q4 GDP.   Brainard on Thursday is giving a speech titled Monetary Policy for the Next Recession.  They’re not talking about monetary policy for the next inflation spike.  Firmly Focused on the Downside which ironically supports stocks.  I saw a paper gushing about benefits to the bottom line as businesses are able to refinance at today’s rock bottom rates.  The assumption is that sales stay constant or improve.  Does that occur in ‘the next Recession’?

Disruptors

February 16, 2020 -Weekly comment

Disruptors.  In the cutting edge investment world, it’s not a pejorative word.  Disruptors are the creative destruction agents that tear down the old ways of business and force greater efficiencies and benefits.

My brother and I went to the Chicago Auto Show on Saturday morning.  First we had breakfast at Lou Mitchell’s, a Chicago institution on Jackson Blvd, near the starting point of Route 66.  This place was founded in 1923.  It’s not a disruptor.  The last ‘disruption’ was in 1958:

The fun part of Lou Mitchell’s magic formula was added one day in 1958 when the restaurant began offering breakfast diners donut holes. A tradition was set in place and since that day, millions of donut holes and boxes of milk duds have been given out to our fabulous customers.

So we walked in and got a donut hole, and fluffy eggs.  At the old Parthenon restaurant, a few blocks to the west, they used to give shots of ouzo to patrons walking in and standing in line. Young and old.  But that’s no longer there. That’s when the city used to work WITH local business, (for a little something on the side).

After breakfast we took an Uber to McCormick Place.  Uber, one of the great disruptors.  The bill was $15.44.  Of course I tipped in cash.  Here’s the breakdown:

Fare                                                                                       $7.36
Chicago Special Venue Surcharge                             $5.00
Chicago Ground Transport Surcharge                      $1.13
Chicago Accessibility Surcharge                                  $0.10
Tolls, Surcharges and fees                                            $1.85

On the way back there was a taxi stand, so we just took one.  $11.50 before tip.  Same distance.

Where’s the disruption?  It’s the government of the City of Chicago, County of Cook. Oh, it’s creative alright. “Ground transport surcharge?”  Maybe the cab didn’t have to add the $5.00 “special venue” charge.  So the fare would have been about the same.  The point is, the government has a way of smothering business.  Even big tech.  In this day of historic low unemployment, in part due to the gig economy, the disruptors can no longer be counted on as disinflationary forces.  Maybe the particular state of my residence, where there doesn’t seem to be any governmental unit that can run a balanced budget or come anywhere close to fully funding pension obligations, clouds my objectivity.  Oh, by the way, I had driven downtown and parked in a public lot near Lou Mitchell’s. $10.00.  The Chicago tax on public parking lots is 20% on weekdays, but there’s a break on the weekend, just 18%.

The US national election is this November.  A choice between tax-and-spend or tax-cut-and-spend.  Mayor Bloomberg is reportedly considering asking Hillary to be his running mate.  Way to tie a quarantined-cruise-ship anchor to your leg Mike.  Either way, the gov’t is coming for wealth creators.

Obviously the election can be a disruptor. Like COVAD-19, locust swarms, and an escalation in Turkey/Syria hostilities that draw in US and Russia. 

On a more mundane level look at the downgrade of Kraft Heinz to junk on Friday (by Fitch and S&P)..  Almost Daily Grants had a great quote from Christian Hoffmann, portfolio manager at Thornburg: “Kraft is to investment grade as Velveeta is to cheese.”  Grant’s noted that KHC’s sales in the fourth quarter fell 5.2% from a year ago.  You know what happens when sales start to decline?  Can’t pay the interest on massive debts.  There’s a lot of Velveeta in the IG world.  Or maybe it’s Cheese Whiz.  “Now, he discovered, not only was cheese no longer prominently listed as an ingredient, it wasn’t listed at all.  Not surprisingly, Kraft kept this change to itself.” (from 2013).  ADG notes that just over 50% of Investment Grade bonds are BBB, the last notch above junk.  Another article from 2019 said that 58% of IG was BBB rated.  In any case, the BBB spread to treasuries is incredulously near its absolute low at around 125 bps (recent low in Feb 2018 was 116 bps; recent high at end of 2018 was 210 bps).  Many have warned about the “triple-B cliff”, including Gundlach.  Or maybe it all just oozes down like melting Velveeta.  But when Powell says the Fed will aggressively use QE in a downturn as he did last week, it’s hard to stop dancing.

Another rather interesting article I read noted the circular support of stocks, bonds and USD.  “Even though risk is bid, bonds actually go up in price because they have to price the second derivative, strengthening USD and the negative effect that has on growth, [particularly in EM].

http://jonturek.blogspot.com/2020/02/imperial-circle-part-2-long-us.html

Let me just circle back to the auto show for a minute.  There are a LOT of $55 to $75k aspirational pick-ups and SUVs on the floor.  The State of Illinois collects a 7.25% sales tax on the purchase of all vehicles.  “There is also between 0.25% and 0.75% when it comes to county tax. In addition…the City of Chicago has a 1.25% sales tax.”  https://www.salestaxhandbook.com/illinois/sales-tax-vehicles

Let me add another change made with the turn of the decade.  In Illinois, before 2020, when one traded in a used vehicle to buy new, the buyer only paid tax on the difference in value.  So, trade in the old SUV for $20k, buy new for $55k, and pay tax on $35k.  The new law doesn’t give a tax break on the trade-in.  Tax is on the full $55k.  So that’s an extra $1450 (at minimum) in tax.  How does that filter into inflation and growth data?  I don’t know. The only way to keep those plates spinning is with low, low financing and lease rates.

An interesting NY Fed Liberty Economics publication last week notes that among auto purchasers:   

Borrowers with credit scores less than 620 saw their transitions into delinquency exceed 8 percent in the fourth quarter (annualized as a moving sum), a development that is surprising during a strong economy and labor market. Meanwhile, the delinquency transitions among those with the highest credit scores have remained stable and very low. In aggregate, the increasing share of prime loans has partially offset the deteriorating performance of the subprime sector.

The note concludes:

Although rising overall delinquency rates remain below 2010 peak levels, there were over 7 million Americans with auto loans that were 90 or more days delinquent at the end of 2018. That is more than a million more troubled borrowers than there had been at the end of 2010 when the overall delinquency rates were at their worst since auto loans are now more prevalent. The substantial and growing number of distressed borrowers suggests that not all Americans have benefitted from the strong labor market and warrants continued monitoring and analysis of this sector. 

The Fed’s Consumer Credit release cites only $1.19 trillion of auto loans.  Not really enough to wring one’s hands over.  But in the UBER, Lyft and WeWork gig economy where treasury and corporate borrowing rates are already near record lows, there doesn’t seem to be much wiggle room.

Lest one think it’s all dour, on Saturday afternoon I met a few friends at Sketchbook, a relatively new brewpub in Evanston that was full at 4:30 pm.  No tvs.  Few cell phones out. Just good beer in a great setting…almost like an old public house gathering spot.  YZ unveiled one of his business plans that I am not currently authorized to share, and I think I never laughed as hard at the conversation in general. 

OTHER MARKET/TRADE THOUGHTS

Week over week changes weren’t particularly large.  SPX was up, VIX was down to 13.68, DXY at 99.16 closed at the high for 2020, and near last year’s 2 ½ year high just over 99.50.  I don’t think COVAD-19 is being properly priced, but markets are convinced the Fed has our backs.  In euro$’s, EDU0 settled 9854.0 or 1.46% and EDZ0 settled 9858.0 or 1.42%.  Both contracts have about 1.26 million in open interest.  Both have developed large long call open interest.  In EDU0 there are 1 million combined open 9875 and 9887 calls.  In EDZ0 there are 432k open in the 9900 call strike.  If the Fed changes from “the economy is in a good place” narrative to “we might have to ease” then positioning in strong hands will be a more important factor than fundamentals in driving price.

Bank stocks don’t seem to be too enthusiastic about the prospect of ever lower rates and a flat curve.  Charlie Bilello on twitter put out the following interesting chart.  Banks are relatively underperforming to the point of the lows in 2009.

The CPI inflation data was released last week, +2.5% yoy.  Several Fed officials have noted that low readings in the beginning of last year will begin to fall out of the yoy calculations, bringing the level up.  I’m not sure the market will respond to higher inflation data, but it’s also worth noting that 20-year bonds will start being auctioned in May.  June treasury options expire May 22.  At these low vol levels, it might be worth owning some put spreads in TYM or USM. 

	2/7/2020	2/14/2020	chg
UST 2Y	140.1	142.2	2.1
UST 5Y	140.3	141.1	0.8
UST 10Y	157.7	158.7	1.0
UST 30Y	204.7	204.3	-0.4
GERM 2Y	-64.3	-65.5	-1.2
GERM 10Y	-38.6	-40.1	-1.5
JPN 30Y	39.1	38.7	-0.4
EURO$ H0/H1	-34.0	-33.0	1.0
EURO$ H1/H2	-2.5	-3.0	-0.5
EUR	109.46	108.31	-1.15
CRUDE (1st cont)	50.32	52.05	1.73
SPX	3327.71	3380.16	52.45
VIX	15.47	13.68	-1.79

https://www.uber.com/blog/chicago/new-surcharges-mandated-by-the-city-of-chicago/

https://www.chicago.gov/city/en/depts/bacp/sbc/tax_information.html

https://www.al-monitor.com/pulse/originals/2020/02/the-takeaway-february-12-2020.html

Michael Moss: The day they took the Cheese out of Cheez Whiz

https://libertystreeteconomics.newyorkfed.org/2019/02/just-released-auto-loans-in-high-gear.html

https://www.federalreserve.gov/releases/g19/current/default.htm

All good

February 14, 2020

–Yields edged slightly lower as the treasury wrapped up the 30-yr bond auction at a rate of just 2.061%.  Tens fell 1.3 bps to 1.617% and euro$ contracts had similar moves, closing flat to +1.5.  A week ago Ken Griffin said markets are “utterly and completely unprepared for a jump in inflation.”  Probably because they don’t need to be… however, CPI yesterday was 2.5% yoy with Core 2.3%, and the NY Fed’s Underlying Inflation Gauge is now 2.3 for the full data set and 2.2% for prices.  

–Today’s news includes Retail Sales expected +0.3% and Industrial Production -0.2%.  

–Money continues to flow into US markets.  The dollar index has risen about 2.6% since the start of the year, accelerating with the virus.  –Turkey/Syria conflict looks set to further accelerate in Idlib, bringing the risk of US/Russia hostilities by proxy.  COVID-19, locust swarms and proxy wars with hundreds of thousands of refuges.  All to benefit US homebuyers that can get cheap mortgages. 

–Some senators are thinking twice about Judy Shelton’s Fed nomination, worried about her views regarding the gold standard and the Fed’s independence.  The latter issue is likely the larger risk.  Senator Richard Shelby voiced concerns about Shelton not being ‘a mainstream economist’.  I’m not sure that ‘mainstream’ is the credential by which judgment should be made in these times of unconventional policy, but I certainly think the Fed’s independence is more important than ever.  Another nomination defeat, partially as a soft rebuke after the impeachment circus?   

–Treasury vol remains compressed, near the lower end of the range.  TYM 130.5 straddle settled 2’11 or 4.0%.  Expiration of Feb midcurves today.  3EG 9862.5^  settled 5.0 vs 9859.0.  Looking for a relatively quiet Friday.

They lied?!?!

February 13, 2020

–In a stunning development that no one could have possibly predicted, official news outlets under-reported the cases of coronavirus, and are now correcting the error with a multiple of original estimates.  China is changing personnel in affected areas.  Forward looking markets are unsettled by the change, with reports yesterday having claimed that the rate of pace of infection was slowing.  ESH is working on an outside range day, having edged to new highs after yesterday’s close, and currently down 26.  Data barely matters at this point, but CPI is released this morning, with Core prices expected +2.3 yoy.  Treasury wraps up auctions with the 30 year; yesterday’s 10 yr saw solid demand with 2.58 bid to cover and a yield of 1.622%.

–Although rate futures pressed lower in yesterday’s session, there was heavy call buying in EDZ0 and EDH0.  The day started with a buyer of about 50k EDZ0 9950c for 2.0 (settled 1.75 vs 9855.0).  As the day progressed both Z0 and H1 9900/9950 call spreads bought in new size of ~50k each.  EDZ0 9900c settled 7.25, open int +37k.  9950c 1.75, OI +82k.  EDH0 9900c 12.0s +63k, EDH0 9950c 3.25, +58k.  Several people mentioned that these strikes are not likely to be seen, especially with the Fed rejecting the idea of negative rates.  Now imagine an infected US with Bernie at the helm.  Maybe the odds of a zero FF target are low, but they aren’t, well… zero.  In treasuries there was a notable buyer of over 20k TYH 130.5/131.5 call spread for 20.  Settled 22 ref 130-22.

–In euro$’s reds through golds (2nd year through the 5th year) were down 4 to 5.5 bps.  This morning those losses have been erased.  EDH0/EDH1 is still the lowest one-year calendar on the board, having settled -30.5.  The recent low is -41.5  which came on the last day of January, as virus fears swirled.  I wouldn’t be surprised to see that level re-visited by tomorrow afternoon.  

What the Fed says, What the market hears

February 11, 2020

–Starting this morning with another Far Side cartoon, as Powell gets ready to testify in front of the House today.

–I would simply re-caption: ‘What the Fed says to markets’ followed by ‘What the market hears

‘”Monetary policy is in a good place.  Consumer spending and employment are solid, capex is soft.  We must acknowledge possible risks due to the coronavirus. If the effects were to spill over into the US economy, the Fed would take appropriate steps to loosen financial conditions.”

What the market hears: Blah, blah, POLICY blah blah blah blah blah MUST blah blah blah LOOSEN blah blah.   

 –Price action shows that real economic commodities like oil and copper, and the Baltic Dry Freight Index are reflecting big problems while stocks float to new highs.  Stocks are responding to liquidity prospects, not to a rebound in economic activity.  The chart below shows SPX divided by the Bloomberg Commodity Index.  Up 14% in a month!  The longer term chart shows SPX/BCOM is up 9x since 2009!  That’s a lot of airpods and cloud computing.  We can’t keep buying physical inventories that we’ve already accumulated, let’s buy back our own stock!

–One analyst suggested that all government announcements regarding the virus should be ignored, rather one should watch what steps private firms are taking.  British Airways cancelled all mainland China flights until the end of March.

–Rates fell yesterday with tens down another 3.3 bps to 1.547%.  Most euro$ contracts rose 3.5 to 4.5, but it was again a December contract that was the star performer: EDZ21 +5.0. Year-end turns are no longer considered much of a risk post-Quarles.  There was a new buyer of 40k 0EU 9837.5 puts for 5.0 covered EDU21 9875.  Settled 4.25 vs 9877.5.  The 9825 strike continues to be hammered in near contracts: EDM0 9837/9825p 1×2 bought for 2.5 in 40k. (settled 3.0 vs 9848.5).

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.