A few notes on levels

February 2, 2020 – Weekly comment

The five year yield fell 18 bps this week, while tens fell 16. On the euro$ curve, the biggest week-to-week changes were in EDU21 through EDM22, all up 19.5 bps (last two reds, first two greens).  On a two week change, from Friday, January 17, the 2-yr fell 24 bps, 5-yr 31, 10-yr 32 and 30-yr 29.  The two-week changes for the leading euro$ contracts, EDM22 and EDU22 (middle two greens) were even more dramatic, both up 36.5 bps in price.

Low yields in fives and tens were made in mid-2016, at 94 and 137 bps, but of course that’s when the Fed effective rate was between 37 and 40 bps.  At the end of August last year, the 30-yr bond made a new low at 1.95%, fives reached 1.32% and tens 1.47%.  So, currently, fives at 1.321% are 38 bps higher than the low in 2016, tens at 1.517% are 15 bps off the low in 2016 and just 5 higher than last year’s low, while 30’s are 6 bps higher than all-time lows.  The new IOER rate of 1.60% is above the entire treasury curve except 30’s which are only 40 bps higher.

1/17/2020 1/24/2020 1/31/2020 2wk chg
2-YR 156.2 147.7 132.5 -23.7
5-YR 162.9 150.2 132.1 -30.8
10-YR 183.4 167.9 151.7 -31.7
30-YR 229.4 212.8 200.8 -28.6
EDH20 98.255 98.290 98.360 10.5
EDH21 98.465 98.600 98.775 31.0
EDH22 98.445 98.610 98.805 36.0
EDH23 98.360 98.535 98.720 36.0

The interest rate option markets have been leaning heavily toward the idea of continued ease, and the last couple of coronavirus-inspired weeks have further accentuated that pricing.  In terms of timing, we can take our cues from short term curves.  There are FOMC meetings March 18, April 29, June 10 and July 29.  February FF settled Friday at 98.41 or 1.59%, essentially at the new IOER.  The first contract that indicates ‘certainty’ of an ease is FFQ20 at 98.68, 27 bps above Feb.  This sort of timing is corroborated by EDH0/EDU0 spread, which had been around -11 in the beginning of the year, but settled Friday -26.0. 

One-year calendars are as follow: FFG20/FFG21 is -52.0 and EDH20/EDH21 is -41.5.  Both are pointing to 50 bps of ease over the coming year.  The difference between the spreads is due to the next FOMC on March 18, which has no chance to impact FFG20 but can, of course, impact EDH20.   The peak contract on the ED curve is currently EDU21 at 98.825 or 1.175%, which is consistent with a Fed Effective of around 1% vs the 1.50/1.75% target range currently. This contract is in the 7th quarterly slot.  The high settles were made at 98.945 on September 4th of last year, at that time the 8th quarterly contract.

The rally in FI has been dazzling, driven primarily by safety concerns.  In a two-week period the market has eased for the Fed.  What’s not clear is whether easing can mitigate the effects of the virus. 

In 2001, after 9/11 had grounded US air travel for a few days, the Federal Gov’t rushed to pass a bill to provide financial assistance to the airlines, “$5 billion in direct aid and $10 billion in loan guarantees.” Here’s a quote from the same CNN article of Sept 23, 2001, “Why am I up here supporting this bill? Because I think we are in a new era… where every one of us has to give a little bit.” Charles Schumer D-NY.  In the current era of highly levered corporations and a rancorous political environment, if things really do downhill, it will again leave the Fed as last resort.  There’s not likely to be bipartisan support for what may become necessary ‘bailouts’.  

The US economic prognosticators appear to place strong confidence in the US consumer, as capex has been weak.  From the FOMC statement: “Although household spending has been rising at a moderate pace, business fixed investment and exports remain weak.”  Certainly the consumer and the federal gov’t have been the biggest props for the economy.  This week the Treasury releases Q1 financing estimates on Monday and the refunding statement on Wednesday.  It seems likely to me that gov’t spending is about to worsen rather than improve given the virus.  And by “worsen” I mean that deficit spending will kick into even higher gear.  Corporate supply-chains are already being heavily impacted and the movement of goods and people are likely to become further curtailed. 

While actual activity might slow, it’s not clear that prices will come down.  In fact, this pandemic could lead to rising prices as the costs of new safety measures are passed to the consumer, and the cheapest, most efficient supply chains are replaced, (at least temporarily) by more expensive alternatives.

Obviously I have no insight as to the spread of the Wuhan virus.  What I do know (or at least think I know) is that markets tend to follow technical signals a lot more closely during periods of greater uncertainty.  That means that trendlines which are tested are likely to hold the first time, that retracement levels and old highs and lows take on increased importance. 

Gains in rate contracts from here should be more difficult to come by as the safety seekers have probably already piled in.  Pricing, as noted above, is already fairly aggressive with respect to future Fed policy.  There is plenty of news out this week, though it’s likely to be of less importance than usual unless particularly weak.  The Fed’s Quarles gives a speech on the economic outlook on Thursday.  The Employment report is Friday, followed by the Fed’s semi-annual report to Congress.  Iowa caucuses tomorrow evening.


Two weeks ago I compared the late 2017 into January of 2018 SPX rally (associated with the tax package) to the current market, which has also posted a similar percentage magnitude rally essentially beginning with the Fed’s $60/billion per month t-bill purchases.  I noted that in 2018, the top was on Jan 26 and a sharp pullback ensued, along with a spike in VIX that blew up a few funds.  This year, I thought there was a chance the Jan 29 FOMC meeting might provide an excuse to turn the market lower, as I thought the Fed might signal that eventual removal of liquidity would be more appropriate in the future as asset prices appear stretched.  As it turns out, the high close in January in SPX was the 23rd, and the virus is the dominant factor.  However, it’s worth noting that in 2018, SPX fell around 11.8% from late Jan to early February.  Additionally, an 11.8% pullback from the high in Jan would put SPX around 2990 vs the current 3225.  I am not forecasting that level, just tucking it into my memory.  I actually think that late July and September highs last year of just above 3000 will provide great support; I look at the 2950 to 3050 area as a strong buy zone.

In Eurodollars there are hefty longs IN EDU0 9875 and 9887 calls, with open interest in those strikes of 451k and 442k.  Last week showed no signs of exits, settled 12.0 and 9.0 ref 9862.0 in EDU0.  The 9900c settled 6.5.  Tempted to outright sell these calls.  THIS IS NOT A RECOMMENDATION

1/24/2020 1/31/2020 chg
UST 2Y 147.7 132.5 -15.2
UST 5Y 150.2 132.1 -18.1
UST 10Y 167.9 151.7 -16.2
UST 30Y 212.8 200.8 -12.0
GERM 2Y -61.1 -67.0 -5.9
GERM 10Y -33.5 -43.4 -9.9
JPN 30Y 40.3 36.5 -3.8
EURO$ H0/H1 -31.0 -41.5 -10.5
EURO$ H1/H2 -1.0 -3.0 -2.0
EUR 110.26 110.97 0.71
CRUDE (1st cont) 54.19 51.56 -2.63
SPX 3295.47 3225.52 -69.95
VIX 14.56 18.84 4.28


Posted on February 2, 2020 at 12:58 pm by alexmanzara · Permalink
In: Eurodollar Options

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