Sept 20. This is what it sounds like, when doves cry…
This is what it sounds like, when doves cry…
Prince/The Revolution
Prince wasn’t singing about Central Bank Economists, but it’s clearer than ever that they are addicted to monetary drugs to keep asset prices aloft, in an attempt to force forward progress in the global economy, and it’s no longer working. The equity markets are beginning to see things more like the lyrics in a Pink song…”And I swear you’re just like a pill / Instead of makin’ me better, you keep makin’ me ill”. Well, it worked for a while anyway.
From Reuters Saturday (links below): “Peter Praet chief economist at the ECB “What’s important is to emphasize our readiness and our decisiveness, should the need for action arise”
“That’s premature, at this time, but the risks in the world economy have increased significantly. We have had to correct our economic forecasts downward and we want to be ready to act, should the conditions demand it.”
And from the Guardian Friday: “Interest rates in the UK may have to be cut further from their record low level, the Bank of England’s chief economist has warned, as he highlighted signs that the global financial crisis is entering a third phase of turmoil.”
Andy Haldane cited evidence of a slowdown on the domestic front and risks to the global economy from China, where an economic downturn has coincided with a stock market rout that has sent shockwaves through the world’s markets.
From Janet Yellen’s press conference: “Given the significant economic and financial interconnections between the United States and the rest of the world, the situation bears close watching.”
It’s likely we can thank Kocherlakota for the negative year-end dots for 2015 and 2016. In US markets, we occasionally see trades in ED 100 calls that translate into negative rates, now common in Europe. But the US Federal Reserve, with its sincere communication policy, is opening up this idea to a much wider audience. I don’t know how that can possibly instill economic confidence.
So that’s the ECB, the BoE and the Fed. The doves that study this stuff are clearly worried. Oh, and France was downgraded by Moody’s.
I expected no hike but thought the press conference would provide a strong hint for a near term move. I was wrong. I thought on ‘no hike’ there would be a relief rally in stocks. Correct, for all of about 5 minutes. Global equity markets appear quite vulnerable, with the DAX closing out the week on the lows (new low for September on huge volume, down 3% on Friday). Japan’s Nikkei was down 2% Friday. SPX closed near the low of the week, and appears to have broken out to the downside of a rising wedge pattern which started with the August low. Again, huge volume. Target 1860.
Despite Friday’s sell off, VIX closed only marginally higher on Friday, and was lower on the week. The real vol smack down occurred in interest rates after the Fed decision. For example the atm TYZ straddle on Wednesday (which was the 126.5 strike) settled at 2’21 or 5.5 vol. On Friday the 128 straddle was 2’08 or 5.1. During the day on Friday TYX straddle was as low as 4.8. According to Bloomberg, 60-day historical is 6.1, a fairly large gap. One interesting note is that in previous cycles there had been consistent BUYING of out of the money calls, but at the end of the week there was a large SELLER of TYX 128 calls in size of about 35k, new position. These calls were sold all the way up from 24/64 to 44/64 Thursday and Friday (settled 0’48); open interest in the strike is 57.5k.
In any case, Friday was the highest settle price for both FVZ5 and TYZ5 since August 24, which was the big stock market sell off day. This week brings auctions of 2’s, 5’s and 7’s, so the front end of the curve may take a bit of a breather after the powerful end of week rally. From Wednesday to Friday close, the five year yield plunged 18 bps, and on Friday FVZ added 69k in open interest.
Despite the run up I would look to buy FV call spreads on any pull back; perhaps there will be a small concession in front of the auction. Having closed at 143.6 in cash fives, with a futures price of 120-035, I think a target of 1.25% yield is attainable over the next month, which is around the 121 strike (121-02). FVX 120.5/121 call spread settled 9/64s and the 120.5/121/121.5 c fly settled 5/64.
Below are net weekly changes in selected markets.
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| 9/11/2015 | 9/18/2015 | chg | |
| UST 2Y | 70.5 | 67.4 | -3.1 |
| UST 5Y | 150.5 | 143.6 | -6.9 |
| UST 10Y | 218.1 | 212.8 | -5.3 |
| UST 30Y | 294.3 | 292.8 | -1.5 |
| GERM 2Y | -23.2 | -23.6 | -0.4 |
| GERM 10Y | 65.3 | 66.3 | 1.0 |
| EURO$ H6/H7 | 64.0 | 63.5 | -0.5 |
| EURO$ H7/H8 | 54.0 | 53.5 | -0.5 |
| EUR | 113.38 | 113.03 | -0.35 |
| CRUDE (1st cont) | 44.39 | 45.02 | 0.63 |
| SPX | 1961.05 | 1958.03 | -3.02 |
| VIX | 23.20 | 22.28 | -0.92 |
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Links
http://www.reuters.com/article/2015/09/19/us-ecb-economist-idUSKCN0RJ0CW20150919
