Dislocations in search of equilibrium

April 3, 2020

–Some of the keys for improved market stability would be a weaker dollar, a decline in libor, a decline in vix, somewhat higher oil prices.  We’ve seen adjustments in some markets, but can’t seem to get the entire picture to mesh.  For example, the surge in oil yesterday on potential production cuts from Saudi Arabia and Russia is a positive sign, but the dollar is again strengthening, an indication that non-US dollar borrowers are having trouble in spite of the Fed’s swap lines to foreign CBs.  Treasury implied vol has come down and the VIX has generally declined since mid-March, but VIX still remains elevated at 52.  Libor has shown tentative signs of easing, setting at 1.373 yesterday, having backed off from a high of 1.45 at the end of March, but that’s still 130 bps above the Fed Effective rate which hit a record low 6 bps on Wednesday.  There’s a decent amount of press today about banks having balked at implementing the Treasury’s small business lending program because the rate was at only 0.5%, so now the treasury has adjusted the rate higher to 1%, but that’s still well below current libor which is supposedly for the best credits in the market.

–CLK0 settled yesterday at 25.32 and is more than a dollar higher this morning; a few days ago it was hovering around 20.  Gold also had a nice pop with GCM0 up to 1637, though it’s now 1630 with old highs at 1700 remaining the key resistance area.

–Rate futures were fairly quiet yesterday.  The euro$ curve steepened.  Reds-0.25, greens -2.0, blues -3.375 and golds -3.625.  The ten year yield eased slightly to 62.4%.  Implied vol in ten-year futures has been declining, now near recent lows at 5.7 to 5.8.  The week-2 139 TY straddle which settles this coming Thursday  traded 1’06 mid-session and settled 1’05.  Previously, the atm straddle with a month to go was around 1 point.  Currently 1 point in TY is worth approx 11.5 bps.   This morning EDJ0 trades 9886.5, a rate of 1.135%.  More than 20 bps of convergence left, which indicates the libor setting will decline further.  

–Today, the employment report is released, my guess is for NFP to be -200k.  Pretty difficult to attribute much importance to this number which will surely deteriorate appreciably given jobless claims of 10 million in the past two weeks.

–Money supply yesterday shows the annual growth at 9.4% for M2.  Previous peaks in annual growth were 12.5% in 1983, 10.5 in 2001 and 2009, 10.2% in 2012.  In each instance besides 2012, inflation rose with a lag.  M2 growth is certainly going to smash all previous highs.  The question is whether inflation will follow.  The long end of the curve doesn’t indicate that outcome so far; the ten year tip breakeven is only 101 bps.  

Pay as you go

April 2, 2020

–Shortly after the Saudi/Russia spat which led to a plunge in oil prices I wrote that the US would/should buy oil for the SPR.  Well it wasn’t the US, it’s China that is buying to boost reserves, leading to a pop in prices this morning with CLK0 above 22.  The other big news is that the Fed excluded treasuries from bank capital rules, which should free up balance sheet for greater lending.  This morning ESM0 has recovered about 1/3rd of yesterday’s 122 point plunge. 

–There was a somewhat informative note from Edmund’s about the length of new car loans in March 2020, now exceeding 70 months:  From March 2019 to March 2020 the length of the average loan went from 69.6 to 70.6 months.  The amount financed went from  $31962 to $34052.  However, the rate went from 6.4% to 5.8%, so the monthly payment only rose to $573/month from $553/month, even with a lower initial down payment.  Several things stand out.  First, the average SUV driver is probably saving the increase of $20 a month in gasoline.  Second, $570 is a pretty large monthly nut in any case.  Third, the US finance system of ‘pay-as-you-go’ displays its insidious side at a time like this…the vast majority of the population has no equity or wealth, just monthly payments for ‘things’, the debt servicing on which now can’t be paid, even at lower rates.  The Fed can’t fix that; lower rates simply perpetuate the illusion of wealth.

–Yesterday 3m libor was 1.436% and EDJ0 settled 98.785 or 1.215% a difference of 22 bps.  This morning EDJ is unch’d but EDM0 is up another bp to 99.46.  April/June spread continues to make new lows at -67 bps.  The fact that EDM is just 54 bps indicates market confidence that the Fed will get libor down.  Yields fell yesterday and the curve flattened, with twos up 1 bp at 23 bps and tens down 5.5 at 63.2 bps.  

–Jobless Claims this morning.  Can we get a double from last week’s 3.2 million?  Spain said its monthly unemployment increase was the greatest ever.

Q2 starts

April 1, 2020

–Not much net change in rates yesterday to end the quarter.  Curve steepened slightly with 2’s down nearly 1 bp at 21.8 and tens +1.2 to 68.8.  Block trades reveal illiquid conditions in treasuries.  For example, yesterday 4700 ultra bonds traded on block at 224-00 as futures were about a point lower just above 223.  One point in ultras is only a bit over 2 bps, but it just underlines lack of depth; WNM0 settled 221-28.  

–The window is quickly closing for convergence to occur between EDJ0 (which is trading 98.86 or 1.14%) and 3m libor which set yesterday at 1.45%.  30 bps.  As one client says, it feels like it’s rigged.  Well of course it does…because it’s April Fool’s day.  This basis is as clear a sign as anything of dysfunction in money markets. All asset values seem like they’re built on a bed of quicksand, why should the libor setting be any different?  Sort of makes me wonder how the atm EDZ0 9962.5 straddle can be just 20.5 bps.  Will it all get back to normal with permanently low rates? 

–In 1943 deficit to GDP peaked at 27%.  So, we’ve go that to shoot for.     –Stocks lower this morning.  An old friend who was a technical wizard in bonds told me that two equal highs separated by one day with a lower high is a sign of powerful resistance.  On Friday, ESM had a high of 2634.50.  A lower high ensued Monday, with Tuesday’s high at 2635.75.  I am not going to be comfortable with longs until we have a couple of closes above 2636. 

Here comes April

March 31, 2020

–A couple of levels: ESM0 current 2630 and NQM0 7942.  38% retrace from high to low, ESM0 2641 and NQM0 7833.  So ES is testing the first retrace, while Nasdaq is thru.  50% retrace levels are 2786 and 8204.  For some reason, it seems as if the futures trading limits act as support and resistance levels.  The initial down limit (trading halt) on 9-March when oil crashed $10/bbl was 2809 and in Nasdaq 8085.  I would anticipate strong resistance in ESM in the 2790 to 2810 area, which should be a mid-April target even as US COVID cases likely peak around the same time.

–At the futures settle I marked tens down 6 bps at 67.6%.  However, late in the day the long end sold off and treasury futures are somewhat lower this morning.  There have been some stories about mortgage players getting hurt by the Fed’s aggressive buys, as prices increases led to margin calls on short hedges.  I suspect that was part of the reason for yesterday’s price action.  Implied vol firmed significantly from Friday’s levels. In eurodollars the curve was marginally flatter.  Reds +0.625, greens +1.875 and blues +2.25.  Peak contract on the curve is EDH1 at 99.70 or 30 bps, which compares to the 2-yr treasury yield of 22.5 bps.  One notable trade was the exit of 100k EDU0 9887/9937 cs at 46.5 (settled 47.0 vs 9962.0).  If I recall these were originally purchased between 3 and 5.  EDJ0 currently up on the day at 9890.  Low settle was  9878 or 1.22%.

–Visa notes a sharp contraction in credit card purchases.  MS estimates a drop of 34% in Q2 GDP with a 2020 federal deficit of 18%.  

–Having pierced $20/bbl and settled just barely above that level, CLK0 is seeing a modest bounce today and is now 21.45.  

Waiting for the SPR purchase announcement

March 30, 2020
*strategic petroleum reserve

The May WTI crude contract traded below 20 this morning with a low of 19.92 and now prints 20.45.  On the Market Huddle podcast with Kevin Muir and Patrick Ceresna, one of them mentioned that a barrel of Western Canadian Select was about the same price as a Starbucks latte.  This morning, according to oilprice.com, W Canada price is $6.11/bbl.  Another client quipped, “How much is the barrel worth?”  Zerohedge has an article citing Bloomberg that the CFTC exempted Capital One from rules which would make it register as a “Major Swap Participant” in energy.  The article claims the CFTC “bailed out” COF by not making it meet margin calls.  If true, it’s a bombshell.  For all the Fed talk of ‘stress tests’, when actual stress hits the rules go out the window.  Not a confidence builder.  What’s in your wallet?  Nothing, nada, zilch.  https://www.zerohedge.com/markets/cftc-quietly-bails-out-capital-one

CFTC Quietly Bails Out Capital One | Zero HedgeLast Friday, around the time of the quad-witching collapse which sent the S&P to levels not seen since Trump’s inauguration, amid the flurry of headlines bombarding shell-shocked traders, was one that was particularly ominous if bizarrely incomplete.www.zerohedge.com

–Month and quarter end.  ESM0 hit a low of 2445.0 last night, nearly 200 lower than Friday afternoon’s late high of 2634.50.  It has now rebounded to 2527, +3.00 on the day.  Re-balancing should provide support.  Additionally, China cut its 7-day reverse repo 20 bps to 2.20%.  Rates are lower in the US amidst a flatter curve.  Reds +2.5, greens +4.0. blues +5.0.  EDJ0 is holding slightly positive at 98.80 (+2.0), so it’s likely that libor will finally set lower.  However, the ‘major bank in trouble’ rumors that have accompanied the persistent rise in libor may not be so far-fetched given COF. (3m libor has gone from 74 bps on 12 March to 145 bps on Friday).

–Given the libor pressure, it’s not too surprising that near ED calendars made new lows Friday.  EDM0/EDM1 settled -31.0, down 5.5 on the day.  However, EDH1/EDH2, the 4th quarterly one-year calendar, is positive at 4.5 and spreads rise from there forward to the mid-teens.  Almost all of the inversion is right up front.  EDM0/EDU0 settled -21.5.  Implied vol is coming out of treasuries, with TYM now 5.8, still high in a pre-COVID world, but well off the peak of over 11.4.

Libor rate to decline in order to converge to futures

March 29, 2020 – Weekly comment

On Sunday, 15 March, the Fed cut the FF target to 0-25 bps.  On the 16^th, the Fed Effective rate fell to 25 bps from 110 on Friday the 13^th.  Since then it has fallen further, to just 10 bps last Wednesday and Thursday.  On 12 March, 3-month libor set at a low of 74 bps; this is prior to the ease.  It has risen each and every day since then, reaching 145 bps on Friday, a surge of 71 bps.  On 12 March, EDJ0 settled at 99.43 and EDM0 99.535.  On Friday, EDJ0 was down to 98.78, a drop of 65 bps and EDM0 settled 99.38, a fall of 15.5 bps.  It’s worth noting that SOFR was 120 bps on 12-March and it is now 1 bp.

This is the crux of the Fed’s problem.  While libor is likely to be replaced as a benchmark, there are still trillions of instruments based on libor. In previous episodes of QE, the Fed encouraged participants to move out the risk curve, which, in a low rate environment, sparked the use of leverage to juice returns.  It was pretty clear in Q4 2018 that the reversal of Fed policies caused a significant asset re-evaluation, which the Fed answered by cutting rates and injecting liquidity.  Just like always. 

However, like the repo flare-up of last September, the plumbing is now clogged, but this time it’s going to take a lot more than the plunger.  Because now, credit concerns embedded in libor are laid bare. There are a couple of takeaways from the top paragraph prices.  First, EDJ0/EDM0 calendar spread is an astonishingly wide -60 bps.  Additionally, there are still 23 bps of convergence between the libor setting and EDJ0 and that’s with only 9 sessions to go.  The market is tacitly saying (or hoping), that the Fed will, one way or another, get the libor setting DOWN.  Obviously, if that were not the case, the simple trade is to buy puts on EDM0 and sit back to watch the contract sink to 98.55.  For example, EDM0 9900p settled 5.5. 

Some market prices have already begun to turn after extraordinary spikes, for example, IG and HY CDX (pictured below).  TY vol peaked in early March above 13 and is now less than half that level at 6.0.   Stocks had a bounce this week with SPX up 10%.  However, fragility is close to the surface, as evidenced by the late sell-off Friday in ESM0 (dropping over 80 points or 3.3% in about 20 minutes) when the Fed announced it was shaving treasury buying from $75 billion a day to just $60 billion a day starting April 1.  In my opinion, there are two keys for financial assets.  First, the Fed has to get libor down, and second, the Fed and Treasury have to further weaken the dollar.

The pricing on forward eurodollar contracts indicates a high confidence level that the Fed will eventually get the libor situation controlled.  One of the catalysts which contributed to the stock market sell off was the oil war sparked by the Russia/Saudi disagreement over production cuts.  Even there, the market perceives improvement over time, with CLK0 settling 21.51, but CLZ0 more than 55% higher at 33.45. However, oil in the 30’s still projects much weaker end-user demand.  The future is likely to be a very slow grind back to economic growth, augmented by monetary policy that might spark price inflation rather than financial engineering this time around.  Downgrades and bankruptcies will hopefully be drawn out over time.  The Fed isn’t likely to be able to strengthen growth with zero rates.  What it can do is arrest the plunge in financial assets, which will hopefully restore some measure of confidence. 

ISM numbers this week, along with the Employment report on Friday.  There’s an estimate of 45 for ISM Mfg.  Low in 2008 was 34.5.  I think the 3.28 million jobless claims number tells us all we need to know about the employment picture.   

OTHER MARKET/TRADE THOUGHTS

Treasury vol has come down fairly dramatically.  Here’s a picture of FV vol. Good sign for a return toward ‘normalcy’.

	3/20/2020	3/27/2020	chg
UST 2Y	33.3	25.5	-7.8
UST 5Y	54.3	42.0	-12.3
UST 10Y	93.4	73.6	-19.8
UST 30Y	157.2	132.5	-24.7
GERM 2Y	-67.7	-68.4	-0.7
GERM 10Y	-32.1	-47.4	-15.3
JPN 30Y	42.9	41.5	-1.4
EURO$ M0/M1	-15.5	-31.0	-15.5
EURO$ M1/M2	9.0	9.0	0.0
EUR	106.97	111.69	4.72
CRUDE (1st cont)	22.63	21.51	-1.12
SPX	2304.92	2541.47	236.55	10.3%
VIX	66.04	65.54	-0.50

Virtual reality

March 27, 2020

–Jobless claims hit 3.28 million, but stocks soared with SPX +6.24%.  In a way, the first sentence says it all: the Fed can provide unlimited paper liquidity to generate the illusion of financial healing, but the real physical and economic world will take time, and jobless claims signify the pain and changes to come.  That’s why they call it VIRTUAL reality.  The Fed’s balance sheet has ballooned over $5T, no surprise there, and the dollar index finally took notice, having dropped from a high of nearly 103 early in the week to below 99.5 yesterday.  As mentioned during the day, CDS had been sold on Wednesday (thanks WHM), treasury vol has consistently fallen (though it firmed a bit yesterday).  And while yesterday’s 3m libor setting surged over 10 bps to 1.37%, the 1, 6 and 12 month settings were all lower by about 1 bp.  Forward proxies for libor/ois are compressing somewhat.  For example, while FFQ0 to EDM0 remains elevated at 51.5 bps, the FFV0 to EDU0 spread settled at 31.5, down 1.5 on the day.  Demand for dollar liquidity will slowly be satisfied.  Stocks, which are a bit lower this morning, should find support.  However, it’s worth keeping an eye on REAL commodities.  For example, WTI crude slid yesterday with CLK0 -1.89 to 22.60.  Production cuts and slow work-off of bloated inventories will take time.

–Ten year yield fell 3.5 bps to 81.  Curve was mixed without much of a net change.  April treasury options expire today. 

–Consider pricing on ED December straddles, all of which expire 11-Dec 2020.  EDZ0 9962.5^ 23.0s vs 9964.5 (actually settles Monday 14-Dec).  0EZ 9962.5^ at 29.0 vs 9964.0, 2EZ 9950^ 40.0 vs 9946.0, and 3EZ 9937.5^ 54.5 vs 9932.5.  Pretty steep premium curve?  Actually, the upside straddle breakevens are all below the 100, zero-bound, with the midcurves between 9990 and 9992.  But consider the downside.  Is it difficult to imagine that in Dec 2021, for which 0EZ prices, that rates could somewhat ‘normalize’ to over 1% given gargantuan stimulus and liquidity?  Will look for ideas today…

–Chicago is closing the lakefront, its crown jewel where people can escape the grit of urban confinement.  You CAN still go to the beach, keep social distance and look good doing it:

JOB CLAIMS POOL

March 26, 2020

–If I were at the office today, I would have suggested a $5 pool on ‘closest to the JOBLESS CLAIMS number’.  I am going to guess 1.75 million.

–Yields yesterday were fairly well contained.  Curve steepened in dollar with red pack just barely positive at +0.125, greens -3.5, blues -5.625.  I marked 2’s down over 7 bps at 32.2 and 10’s up 1.4 bps at 84.5.   Senate passed $2.2T stimulus package, stocks have eased on the time-tested, ‘sell the fact, because the virus isn’t stopping…’

–Just a few notes highlighting continued dislocations: 1) treasury vol crushed again.  I guess you could say that a MONTH of time premium came out of the USM straddle in one DAY.   That is to say, on Wednesday, the MAY bond atm straddle settled 7’14, and JUNE atm straddle 9’58.  Yesterday USM straddle settled at 7’32, almost where May was on the previous settle!  The USK 178^ settled 5’16.  Is it a good sign that vol is coming out, suggesting ‘normalcy’?   Maybe….but consider 2) April ED contract settled 98.91 or 1.09% while EDM0 settled 99.415 or 58.5 bps, a spread of -50.5.  It was -10 two weeks ago.  3m libor has been around 1.25% while 3m bills are negative.  This ISN’T normal and indicates plenty more front end volatility and funding issues.  3) Ford cut to junk with a lot more in line.

–There were some large option trades: EDN0 9987c 1.25 paid 40k (new).  EDU0 9962/9975/9987c fly 4.5 paid 40k (appears to be roll up).  EDU0 settled 9961.5.  
In FV, there was a large profit taking sales of 35k FVM 125/125.5/126.25/126.75 c condor at 13, originally bought for 3 to 5 earlier in the month.  Also a new accumulating buyer of FVM 125/126/127 c fly for 19.  This settled 17 vs FVM0 124-24.  DV01 of the contract is around 54, so a move to the middle strike would suggest a yield of approx 23 bps, and I marked 5’s yesterday at 51 bps, so right around 28 bps for fives.  At least it’s positive. 

Nothing’s gonna touch you in these golden years

March 25, 2020

–DJIA jumped 11.4% and SPX +9.4% yesterday in anticipation of the $2T gov’t stimulus deal, which reportedly will be passed today.  As of this writing stocks have built on gains with ESM0 +58 at 2496.00.  Treasuries are lower with TYM0 177-20, down 1-07 and a cash yield of 85.5.  Curve is slightly steeper.  

–Implied vol in treasuries was crushed yesterday, with the TYM atm straddle going from 4’03 for the 138 line on Monday to 3’07 for the 137.5^ yesterday vs 137-145.   April options expire Friday and the TYJ 137.5^ settled 0’57.  Notable buyer yesterday of 40k TYJ 140/141cs for 1/64, exit trade.  Vol also lower in euro$’s but not as much on a relative basis, for example 3EM 9937^ settled 36.0 yesterday vs 37.5 for the 9950 strike on Monday.

–At one point gold was up over $100/oz yesterday with a high in GCJ of 1698.0.  The London Bullion Mkt Ass’n is urging the CME to change delivery rules so that gold bars in London can be used to satisfy delivery as physical transport is curtailed; huge spread opened up between futures and spot gold in London.  Not to mention that every governmental authority in the world is trying to debase cash so that debtors can continue to service payments.  You had your day palladium, now it’s gold’s turn.

–Near contracts on the dollar curve are still projecting cash crunch problems.  Yesterday EDJ settled at 98.99, down nearly 10 bps and printing 98.95 this morning or 1.05%.  Still about 20 bps of convergence between EDJ and 3-m libor with 13 trading sessions to go.   

By the way, it’s a little known fact that Soul Train was produced in Chicago on the 43rd floor of the Chicago Board of Trade Building at LaSalle and Jackson. (Thanks for info YZ)
https://www.chicagoreader.com/chicago/soul-train-local/Content?oid=1106014

Fed support now unlimited

March 24, 2020

–The Fed removed any guise of the illusion that it only would accept top-rated collateral, and has even taken the step to create a special purpose vehicle to support buying anything it feels the need to, while Congress remains on the verge of passing a $2 trillion stimulus bill.  This morning, markets are responding with ESM clawing higher and approaching the spike high after yesterday’s Fed announcements (unlimited buying of treasuries and CMBS, at least $75 billion in treasuries each day this week).   Yesterday’s high in ESM0 was 2386.00, there is clearly patient buying occurring around 2190 to 2210, and current level is 2333.  DXY appears to have left a double top around 103 and now trades around 101.50, another positive sign.  Gold has soared $150 in the past three sessions (GCJ0 now 1632) and silver has jumped $2 to current 14.10 (SIK0).  Ten year yield yesterday fell 18 bps to 0.75%, but the yield has rebounded to around 83 bps today with implied vol starting to soften.  Peak contract on the ED curve is EDH21 at yesterday’s settle of 9967.5, while the highest FF contracts, Aug, Sept and Oct are 9993.5 or 6.5 bps.  Curves flattened with 2yr down 6.4 bps and 10yr -18 bps.  It’s hard to hold a long-end short position when the Fed announces it will  buy everything.  On the other hand, there was noticeable buying of TY vs US in futures yesterday off the lows in that spread; 10/30 cash yesterday ended at 58 bps.  

–Obviously demand has been and will continue to be crushed (Eurozone Mfg PMI only 44.8), but CLK0 is up 1.60 this morning to near $25/bbl.  Markets have priced in a lot of pain; sellers should be nearly exhausted in the short term.  April treasury options expire Friday.  TYM0 settled 138-06+ yesterday and the TYJ0 138.25 straddle settled 1’21.  That’s just about equal to yesterday’s range in TYM which was 1-11.5/32’s.  It wasn’t too long ago that TY straddles would trade around 1 point with five weeks until expiration.  That was then, this is now.   

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