June 16. Austin Powers
Austin Powers: There are only two things in this world that scare me and one is nuclear war.
Basil: What’s the other?
Austin Powers: Huh?
Basil: What’s the other thing that scares you?
Austin Powers: Carnies. Circus folk. Nomads, you know. Smell like cabbage. Small hands.
Both prophecies are coming to pass. Carney dropped a bomb on the short term interest rate circus and the situation in Iraq threatens to draw the world closer to war.
June 16. Carney’s suggestion late Thursday that rates could rise faster than markets expect caused a huge sell off (and flattener) in short sterling, which spilled over into the US. Green euro$ pack was again the weakest part of the curve, closing -4.875. The 5 yr note rose 3.5 bps to 169, and tens were up 2 to 260. Near eurodollar calendar spreads were bid, as the market adjusted modestly to the idea of rates hikes in the US also moving forward. For example EDU4/EDU5 rose 3 to a new high of 52.5.
–Reds were the outperformer in terms of vol. For example, midcurve red Sept 9925^ settled 20 on Thursday and traded 22 Friday. 0EZ (Dec) 9900^ settled 36 on Thursday and was quoted 38 bid at one point on Friday, settled 37.5. Back end of the curve much more tame.
–One interesting trade that I noted from the week before last, buyer of 0EZ 9900^ at 36 vs sold 3EU 9737^ at 41. Settles Friday: 37.5 and 39.5, up 1.5 on both sides and actually a much bigger winner during the day Friday.
–The main event in the US this week will be the FOMC meeting on Wed, with new long term projections out to 2017. However, geopolitical events threaten to overshadow all else. There’s no way the US can sit back and watch Baghdad fall with Saudi Arabia next on the list. Iraq faces a brutal civil war with odds quickly increasing that oil revisits the $150 level from 2007; note that the surge in oil at that time was a precursor to the financial crisis. Priced in a weakening euro, pain for the EU would be even worse, compounding energy uncertainties which are already stoked by Russia/Ukraine. If implied volatility doesn’t come back in this environment, it never will.
