The People’s Economy

May 14, 2021

–Yesterday PPI was released at +6.2% with Core 4.1.  The thirty year bond auction went off at 2.395.  Fortunately, the two have nothing to do with each other.  Today we get Retail Sales expected +1.0% and U of Mich inflation expectations survey with the one-year rate expected 3.4% and longer term 2.7%.  Yields actually fell across the curve yesterday, with tens down 2.8 bps to 1.67%.  The eurodollar curve flattened with reds up a modest 1.875, but greens, blues and golds were +4, +5.5 and +5.75 even though there continues to be net buying of blue midcurve puts.  The only thing that matters is that the Fed continues to monetize the administration’s stimulus plans, and if those plans are slightly trimmed, then it means that the deficit won’t be quite as bad.  We’re all under Stephanie Kelton’s spell now.  It’s the Birth of the PEOPLE’S Economy. 

–The Colonial pipeline hackers were apparently paid $5 million in ransom.  Now they can buy a shack in the Bay area and live as communal roommates eating Cheetos while continuing their side gigs as Uber Eats drivers and still have a little money left over for blue hair dye.  The governor of Ohio is paying $5 million for people to get vaccine shots.  Patrick Mahomes contract extension was over $500 million.  Concepts of value and money seem to have taken a twisted turn.  Why do tens present a good buying opportunity at a yield of 1.67?  Because they are going up, that’s why.  

You WANTED inflation, well here it is

May 13, 2021

–They said there was going to be a temporary surge in inflation, and it’s here.  CPI yesterday was 4.2% yoy with Core 3.0.  Don’t expect much help from PPI today, expected +5.8% yoy with Core 3.8.  Just for good measure, the NY Fed released its Underlying Inflation Guide at 2.7% for the full data set, up 0.5 from the previous month, and 2.9% for the “prices only” measure, up 0.3.  The ten year tip breakeven ended at 261 bps, a new high.  2/10 and 5/30 both made new recent highs, but are below the highs from late March.  Same with the red/gold pack spread in eurodollars (2nd to 5th year forward spread).  It settled at a new recent high of 165 bps, but the peak close for the year was on March 31 at 182.  All eurodollar straddles rose 0.5 to 2 bps.  With the shift to a lower strike, the last long-dated green straddle closed over 100 bps; that would be EDH’24 9875 strike at 101 vs EDH’24 9880.5.  There are 1040 days until expiration.

–SPX was down 2.1% and Nasdaq down 2.7%, but the ten year yield was still up 6.8 bps to 1.682%.  It’s somewhat hard to justify a deeply negative ten-year yield with these inflation data.  Today the treasury auctions thirties, with the when-issued just over 240 bps at the futures settlement. 

–The recent buyer of 2EM 9937.5/9918.75 p 1×2 saw his upper strike move into the money with a futures settle of 9935 in EDM’23.  The Fed may have to re-think the “taper before tighten” plan as the curve steepens. We’re probably only one bad auction away from a deviation in plan.  Makes sense to cut the MBS buying with the red-hot housing market, but keep the bulk of treasury purchases going given gargantuan deficits.  A rise in FF off zero would likely be more effective in tamping down inflationary expectations by flattening the curve.

–May Bitcoin contract currently under 50000 as Musk is scrapping the payment system due to environmental concerns.  Currently 49525, down 4920 or just over 9%. 

“Accommodation” strategies are running out of room

May 12, 2021

–Tens rose 2 bps to 162.4 in front of today’s auction, with CPI looming this morning.  On the eurodollar strip, greens through golds settled down 2.5.  New recent high in 5/30 just over 155, which is still about 10 away from the high of the year.  Ten year tip breakeven made another new high at 254 bps.  FT notes that China’s Producer prices leaped in data released yesterday, “the price of raw materials and goods leaving its factories rose 6.8% yoy”.  Brainard’s speech yesterday suggested patience and uncertainty about the path forward, though she added this reassuring remark: “I will be carefully monitoring measures of longer-term inflation expectations to ensure they are well anchored at 2%.  To date, various measures suggest inflation expectations remain well anchored and broadly consistent with our new framework.”  What does that even mean?  “Broadly consistent” leaves a lot of room for markets to test the Fed’s reluctance to withdraw accommodation.  The June FOMC is one month away (16 June) and will undoubtedly feature a contentious press conference.   

–There were a couple of notable trades in dollars, a new buy of 35k EDM2 9962/9937 put spread for 2.25 to 2.5, which settled 2.25 vs 9976.0 in underlying EDM2.  Also a block sale of 25k EDZ2 at 9961.5 which appears to have been an exit judging from the decline in open interest.  

–The news media has latched on to the inflation story as the main woe confronting equity markets.  Although stock futures are again lower this morning, treasury prices are barely positive. ESM currently -16 at 4130.25 while TYM is +2.5 at 132-17.  However, grains are continuing a sizzling rally with July Beans up nearly 30 cents to a new high 1644.  One month ago the contract was 1375.  

–While news reports are glossing over the bombing of Israel, it appears as though serious escalation is brewing in the mideast, likely a net negative for stocks. In many ways, geopolitical events are threatening to overwhelm the administration at the same time that markets overwhelm the Fed. Accommodation strategies are at the end of the runway.  

Inflation gets real

May 11, 2021

–Stocks are pushing a bit lower this morning, with inflation concerns popping up all of a sudden as an excuse.  CPI is released this morning, expected 3.6% yoy with Core +2.3%.  Auctions kick off with $58 billion in 3-year notes.  I saw a clip this morning that put the inflation story into stark reality: McDonald’s may have to raise the price of a Big Mac.  The Big Mac index is well known across the world for comparing currency levels, but I never realized how much variation there was in the US.  I ran across this story from March, noting that a Big Mac costs $3.75 in Austin and $6.39 in Seattle, noting “one big [factor] is labor”.  So perhaps we need a US BigMac index to measure labor price differences across the states.  https://www.restaurantbusinessonline.com/financing/why-big-mac-costs-more-seattle-austin

–The curve continued to steepen yesterday with the five year note up 1.5 bps to 78.4, while tens rose 2.8 to 160.4 and thirties 4.7 to 232.1.  The ten year tip breakeven hit a new high is 253.8.  

–Large trade yesterday was a new buyer of 40k 2EM 9937.5/9918.75p 1×2 for 2.0.  Settled 2.25 vs EDM3 9944.5.  Midcurve May options expire Friday, but this was for June, and expires 11-June, in 31 days.  Is one month enough to solidify expectations for two hikes by June of 2023?  I think so.  We get inflation data today and tomorrow, and a gaggle of Fed speakers that are going to play down price fears.  All speaking on the topic of the Economic Outlook, we have Brainard at 12:00, Bostic at 1:15,  Harker at 2:00 and Kashkari at 2:30. 

Basic commodities to cyberhacks

May 10, 2021

–Friday’s miss in payrolls of 266k vs 1 million expected caught the rate market leaning and sparked an instant rally in eurodollars.  Greens, the third year forward, were the strongest on the board, closing +6.625, (pack price of 9917, or 83 bps).  Near one-year calendars out to Dec’22/Dec’23 made new recent lows, with Sept’21/Sept’22 back to single digits, settling at just 9.5.  Sept’22/Sept’23 also made a new recent low at 49.5, but the 40 bp difference between the two is another indication that the market doesn’t see much chance of rate hikes until late next year.  

–While the 5 year treasury fell 2.7 to 77 bps, the 30 year bond yield rose 3.8 bps to 2.274%.  5/30 closed at a new recent high of 150.5, but has been in a range since February of 139 to 166.  The ten year treasury to inflation-indexed note breakeven closed at a new high of 250 bps.  Relative weakness in the long end is due to increased inflationary concerns, weakness in the dollar, and a concession for this week’s auction schedule, which includes $41 billion in tens on Wednesday and $27 billion long bonds on Thursday.  Apart from the dollar depreciating against nearly every commodity, China’s yuan has taken out the year’s high and is now just above 6.41… seems likely to rally right through until the 100th anniversary of China’s Communist Party on July 1 to highlight China’s ascent. 

–Several news sources have blurbs this morning about the sharp increase in iron ore prices (FT, BBG), and of course the cyber attack on the Colonial pipeline is at the top of the news cycle.  From the most mundane commodity building blocks to cracking encrypted code for ransom, the risk of transitory price pressures seems to be on the rise.  CPI on Tuesday with yoy headline expected 3.6, Core 2.3.  PPI on Wednesday expected 5.8% with Core 3.7.  

Missing the biggest threat to stability

May 9, 2021 – Weekly comment

You know that women never really faint
And that villains always blink their eyes
-Lou Reed, Sweet Jane

What they depict in the movies, and in political theater isn’t always true, no matter how many times it is repeated.  Inflation expectations aren’t anchored.

The Fed released its Financial Stability report last week.  It covers four topics: Asset Valuations, Borrowing by Businesses and Households, Financial Sector Leverage and Funding Risk.  A link is at the bottom; a summary is on page 13 of the pdf.  Throughout the report “significant government support” is cited.  Valuations on assets are termed “generally high”.  In the list of asset markets, the outstanding amount of equities has risen 22% in the past year, eclipsed only by the growth of treasury securities at 26%. (pg 16).  “Valuations continue to be supported by low interest rates.”  “Business debt vulnerabilities remain elevated.”

On page 66 there is this interesting passage:

Despite China’s relatively strong economic rebound from the pandemic, it continues to have elevated corporate and local government debt, a vulnerable financial sector, and stretched real estate valuations. Although government policy is still supportive of the broader economy, Chinese authorities have introduced measures to cool down property markets. If these measures fail to limit speculation, financial vulnerabilities will continue to rise. Under such a scenario, a sudden correction in domestic property markets could put pressure on Chinese property developers and other firms and substantially stress the financial sector. Given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could further strain global financial markets and negatively affect the United States.

I can’t help but think the pot is calling the kettle black.  Everything said about China is applicable to the US, EXCEPT that the US authorities have done nothing to cool down residential property or asset markets.  I suppose the US banking system is more robust as well.  But by holding down funding rates, the Fed has introduced a risk to the currency… it was already apparent by surging crypto and commodity markets, and with Friday’s lower than expected NFP, it spilled over into DXY and the gold market.

As we face another round of auctions, my question becomes whether the US could find itself under funding stress.  This week $126 billion in 3’s, 10’s and 30’s raises $78 billion in new cash. 

The ‘government support’ which is so frequently mentioned in the Fed’s Stability Report is never questioned in terms of a risk to stability in and of itself.  Maybe THAT’S the really big risk.  Paycheck protection, loss mitigation and other government support mechanisms run the risk of blunting market signals that used to impose discipline on economic agents. Currently the only signals are soaring commodity, crypto and stock prices.  The USD is declining in value against all of them, yet there is official denial in terms of inflationary implications.  On Friday DXY fell, breaking a minor trendline off the low set in January.  On a long term chart, it looks vulnerable to a break below the 2018 low of 8825, a move which might have the fury (in the opposite direction) of the 2014 rise when the taper tantrum highs of 2013 were exceeded.

Of course, the dollar declining against other fiat currency is just a sideshow.  The dollar is declining against THINGS and everybody sees it.  A Morgan Stanley report noted that 21% of all US dollars ever in existence were created in 2020. 

The ransomware hackers that shut down the major Colonial Pipeline this weekend aren’t asking for dollars.  Reports on this cyber-attack are saying that the price of gasoline could skyrocket in response.  Vulnerabilities to cyber disruptions are increasing across all economic segments, perhaps representing more of a threat than military conflict.

As Del Preston said, “I learned it from Keith Richards when I toured with the Stones.  This may be the reason Keith cannot be killed by conventional weapons.”

It’s not the conventional that we have to worry about, like elevated business debt.  It’s the unconventional, unprecedented US government intervention both through fiscal and monetary measures, and it’s the rise of cyber weaponry, through both state-sponsored and private actors, (as foretold by the 1997 book The Sovereign Individual).

CPI and PPI on Wed and Thursday with yoy Core expected 2.3 and 3.7.  Retail Sales Friday.

OTHER MARKET THOUGHTS/ TRADES

Jackson Hole in late August is looming large in the market’s consciousness due to a possible change in policy by the Fed.  I would also bear in mind July 1, the date which will mark the celebration of the Chinese Communist Party’s 100 year anniversary.  It will highlight nationalistic fervor and the dramatic gains made by China.  No doubt there are agents that would like to cause disruptions around these celebrations, especially given tensions with Taiwan that the US is fanning.

Three month libor set at an all-time low last week.  Friday’s setting was 0.15988.  From the Financial Stability Report:   

Several respondents noted that bank reserves were expected to continue to increase dramatically, potentially pressuring some short-term interest rates into negative territory and amplifying rate volatility. In particular, some contacts noted the unpredictable trajectory of balances in the Treasury General Account. Several respondents suggested that the outcome of the impending debt ceiling negotiations has contributed to this uncertainty, as a delay in an extension of the debt ceiling suspension could result in a rapid drawdown of the Treasury’s account balances, thereby increasing reserve levels. Some worried that a surge in reserves would increase froth in markets, heightening future risks of a disruptive correction.

The trade of the week concerns the purchase of 3EU 9800 puts, which were bought outright in huge size for 6.0 and 6.5, mostly ref EDU4 trading 9851.5 to 9855.  On Friday this put settled 5.25 with 16 delta vs 9960.5.  The change in open interest on the week was 259,000 contracts, from 190k on April 30 to 449k on Friday.  Yes, this expiration covers the Jackson Hole Conference.  As a comparison, note that 4EU 9750 puts settled 5.75 vs 9815 settle in EDU5.  A bit further out of the money, and slightly more expensive; there are 115k open. There’s more open interest in the 3EU 9800p at 449k than there is in the underlying EDU4 future at 397k.

The curve steepened Friday with the NFP miss (266k vs 1 million expected) causing some analysts to say the Fed is “right” to be holding funding rates at zero.  2/10 rose 2.5 bps to 143.2, while 5/30 rose 6.5 to 150.5.  The latter spread has been in a range from 140 to 165 since February and is likely to stay within those parameters for the time being.  However, an eventual upside breakout would be supported by the ten year inflation breakeven closing at a new high of 250 bps Friday; it hasn’t been this high since 2013.

	4/30/2021	5/7/2021	chg
UST 2Y	16.0	14.3	-1.7
UST 5Y	85.4	76.9	-8.5
UST 10Y	162.8	157.5	-5.3	w/I 158.5
UST 30Y	229.7	227.4	-2.3	w/I 226.8
GERM 2Y	-68.2	-68.5	-0.3
GERM 10Y	-20.2	-21.5	-1.3
JPN 30Y	65.7	65.2	-0.5
CHINA 10Y	315.6	315.2	-0.4
EURO$ M1/M2	7.5	6.0	-1.5
EURO$ M2/M3	40.0	32.5	-7.5
EURO$ M3/M4	72.5	68.5	-4.0
EUR	120.20	121.63	1.43
CRUDE (active)	63.58	64.90	1.32
SPX	4181.17	4232.60	51.43	1.2%
VIX	18.61	16.69	-1.92

https://www.federalreserve.gov/publications/files/financial-stability-report-20210506.pdf

https://home.treasury.gov/system/files/221/TBACRecommendedFinancingTableQ22021-05052021.pdf

SuRpriSe!! Let’s throw some confetti in the street!

May 7, 2021

–Congrats to Bolingbroke and Spratt for being the lead article on Bloomberg this morning, highlighting the massive buying of 3EU 9800 puts, in the context of a “Jackson Hole surprise”.  This strike was bought again yesterday for 6 to 6.5, with open interest jumping another 137k to 421k.  The underlying EDU’24 contract only has 382k of open interest.  The put has delta of 18, underlying EDU’24 settled 9854.5, expiration is 10 September 2021, and the put settled 6.25.  It’s true that the expiration falls just beyond the Jackson Hole confab, but it is also the case that yesterday, in spite of this massive buying, the ten year treasury yield eased a couple of bps to 1.56%, and EDU4 itself was up 0.5.

–Perhaps there is no “surprise” aspect to the trade at all.  Julia Chatterly of CNN had a Morgan Stanley guest on yesterday who noted that “21% of all dollars were printed in 2020.”  People like to say that bitcoin isn’t backed by anything…but at least we know the supply is limited.  They’re printing dollars like confetti.  Speaking of limited supplies, a friend said to me yesterday, “OK, you can sell one thing: Corn, Lumber, or Copper.  Which one?”  How about Nope.  July Corn is at a new high this morning 725.  July Copper is at a new high this morning 469.  And July Lumber is in a class of its own, new high 1607.  The “Surprise” is happening right in front of our (and the Fed’s) eyes.  Kaplan seems to be the only one noticing it, saying yesterday that the Fed should think about tapering sooner rather than later.  And that a hike FROM ZERO should be on next year’s timetable.  July Lumber up 4 times from October, Corn has doubled since last summer.  How is the ten year justified at one and a half percent?
  
–The Fed released its semiannual Stability report yesterday afternoon.  On the pillar of ‘asset valuations’ the report notes: “However, valuations for some assets are elevated relative to historical norms even when using measures that account for [low] treasury yields.  In this setting, asset prices may be vulnerable to significant declines should risk appetite fall.”  Phew, they’re ON IT.  We can all relax now.

–Almost forgot that it is Payrolls day, expecting a gain of nearly one million.  SURPRISE!

Inflation…in fed speakers

May 6, 2021

–Fed comments yesterday from Evans, Bowman, Rosengren, Mester and Clarida downplayed inflation even as commodities tell a different story.  Below are a couple of news bullets: 

*EVANS: RISK OF AN OUTBREAK OF ACCELERATING INFLATION IS REMOTE
*EVANS: MONETARY POLICY WILL BE ACCOMMODATIVE FOR SOME TIME

– FED’S BOWMAN SAYS STILL SEES ‘SMALL’ RISK OF PERSISTENT INFLATION OUTBREAK DESPITE INCREASES ANTICIPATED THIS YEAR
– FED’S BOWMAN SAYS EXPECTS ‘UNUSUALLY STRONG’ JOB GROWTH THROUGH THE SUMMER

–ROSENGREN SAYS OIL PRICES, PENT UP DEMAND FOR GOODS AND SHIPPING DELAYS WILL TEMPORARILY DISTORT INFLATION NUMBERS THIS SPRING
– ROSENGREN SAYS THE MOST LIKELY OUTCOME REMAINS THAT INFLATION WILL NORMALIZE CLOSE TO 2 PERCENT

– MESTER SAYS SHE NEEDS TO SEE MORE LABOR MARKET IMPROVEMENT BEFORE ‘I WOULD CONSIDER THE CONDITIONS OF OUR FORWARD GUIDANCE ON ASSET PURCHASES AS BEING MET’
– MESTER: FACTORS THAT HAVE KEPT INFLATION LOW HAVEN’T GONE AWAY IN THE PANDEMIC

–A judge voided the CDC’s eviction moratorium, which some associated with a jump in tip breakevens to new highs.  Ten year treasury to tip spread ended at 247 bps.  However, yields drifted slightly lower on the day, with tens down 1 bp to 158.  

–The big trade of the day was a new buyer of 100k 3EU 9800 put for 6.5. This put settled 6.0 with the underlying Sept’24 future 9854.0.  Open interest was +80k.  Expiry is September 10, beyond the late August Jackson Hole symposium.  Eurodollar option flows are consistent in blues:  buying puts/ selling calls.  

–ADP yesterday was +742k, with Claims today expected 538k.  Tomorrow’s payrolls expected +998k.  Today’s Unit Labor Costs expected -1.0% vs +6.0% last, and tomorrow’s yoy Average hourly earnings expected to be down slightly as well, though ‘help wanted’ signs are everywhere. 

Short rates tied to zero as critical input prices surge

May 5, 2021

–Crude oil is near new highs this morning at 66.35 (June WTI contract) as API data showed a large draw.  Yellen yesterday said rate increases might be needed to prevent overheating, but was forced to walk back those comments later in the day by saying she’s not expecting inflation or rate hikes.  Other commodities like soybeans, corn, and copper are on a tear, at or near new highs.  It’s astonishing that the mere suggestion of a move off the zero bound is met by resistance.  A little over a year ago crude prices tumbled into negative territory, but now the surge in the cost of this systemically critical input is being shaken off as irrelevant.    

–Early yesterday morning there was a wave of buying in TY and selling in stocks, perhaps associated with Chinese military aircraft entering Taiwan space, but others suggested a program trade.  Open interest in TY rose 36k yesterday and was also up 26k on Monday, so there appears to be new buying in front of Friday’s employment data.  Cash tens fell 1.5 bps in yield to 1.59%.  Eurodollars rose 0.5 to 2.5 across the strip, with a slight flattening bias.  Flows continue to favor put buying and call spread selling in blue midcurves.  However, the red/blue September calendar spread declined 1.5 bps, with the red Sept’22 contract up 0.5 to 9968.5, while blue Sept’24 rose 2 to 9851.5.  So that two-year calendar is 117 bps.  Recall that in the 2004 to 2006 hiking cycle, the fed raised by 25 at every meeting, or 200 bps per twelve month period.  Just over 100 bps over two years doesn’t seem like much by comparison.

–News today includes ADP expected 860k from 516k.  ISM Services expected 64.1 from 63.7.  

No inflation…if you pay in etherium

May 4, 2021

–Yields eased Monday with tens down 2.2 bps to 1.606%. Mfg ISM was lower than expected at 60.7 vs 65, but Prices Paid at 89.6 was near an all-time high.  A headline from WSJ proclaims ‘Auto Makers Retreat from Just-In-Time Manufacturing’.   I don’t know the details of the story, but I do know that just-in-time was pioneered by Japanese makers to enhance efficiency and keep prices low.  With supply bottlenecks, holding inventory as insurance becomes more important than price efficiencies.  At the margin, it’s a non-transitory change in behavior that supports inflation. 

–Although EDU’24, blue Sept, was +4 on the day to 9848.5, there continues to be buyers of put spreads vs call spreads on the contract.  The downside piece is the 9837.5/9812.5 put spread which settled 7.25, while the call spread yesterday was 9887/9925 which settled 4.75.  This package only traded about 12k, but the flow remains consistent.  

–Today’s news includes Durables, and Mary Daly of the SF Fed speaks at 1:00 at the Economic Club of Minnesota. She has previously indicated that an increase in asset values is irrelevant if an offshoot of policies that help employment.  Etherium was 1700 at the end of March, and is now 3350 into the first couple of days of May.

–Treasury released financing estimates, expecting to borrow $463 billion in the current April to June quarter.  That borrowing estimate is $368 billion higher than estimated in February, because… COVID.  A fudge factor of over $350B in two month’s time!  And in the July to Sept quarter the estimate is $821 billion.  (But it will only be half that much in etherium).
https://home.treasury.gov/news/press-releases/jy0158

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