May 12. WARNING. Faith in central banks beginning to crumble
–I guess the guy who paid a record price for Picasso’s “Les Femmes d’Alger”had to liquidate the bond portfolio to pay for it, sending global bond markets into a tailspin. The thirty year bond yield surged 13 bps to close over 3% (302.4). The ten year yield also jumped 11.5 to 226, taking out the high yield mark from March. Curve steepened to new highs with 5/30 up 3.7 bps to 144.2. In dollars, the red/gold pack spread rose a whopping 9.75 bps to 142.125 (also a new high).
–Just as implied vol was crushed on Friday’s brief rally associated with weaker than expected employment data, it rebounded Monday with TY vol back to 5.6. Still probably cheap at these levels. Speaking of employment, the Fed yesterday released its Labor Market Conditions indicator, which came out at -1.9, the lowest since June 2012. Should have been bullish for rate futures, but….no.
–Some analysts are suggesting that the prospect of Fed hikes is sending long end rates higher around the world. Yet the odds for hiking in 2015 are little changed between Friday and Monday, with only 1 hike of 25 bps being priced in. I would suggest something much more insidious: THE MARKET’S FAITH IN CENTRAL BANKS IS BEGINNING TO CRACK. Many people have warned that blind faith in policy makers would fray, but are having a hard time seeing it when it actually happens right before their eyes. It’s not that the Fed is going to be more aggressive in terms of tightening, it’s that they’re data dependent and their own Labor Mkt Conditions data is weak. So the Fed will be behind the curve, to use an overused cliche. And what happens? The curve steepens. IF this is the correct interpretation, and it might not be but is worth keeping in mind, then we are on the verge of some real fireworks…it could be a game changer for many asset markets.
–One other technical note on liquidity. Yesterday as the bond rout was getting started, there was a buyer of about 7k USM 153 put (36 delt at the time). He initially paid 62 when the bond contract was 154-08, but only bought a few thousand at that price and ended up paying to 1’01. The bond contract was driven down to 154-01 as market makers sold their hedges. The point is that an order equivalent to less than 3k futures contracts was able to move the market 7/32’s. Short gamma is NOT the way forward.
