All Prices Will Be Met

Sept 15, 2019

Weekly Comment

The reach for yield in August was astounding, culminating in the Sept 1 tariff implementation, followed on September 4, by the sub-50 print in Manufacturing ISM of 49.1.  Yields hit their lows in the beginning of September, with 5’s down to 1.32%, 10’s to 1.46% and 30’s to 1.95%.  The total protonic bond market reversal seen so far in the month of September has been just as dramatic.  Fives rose 43 bps to 1.75%, 10’s 44 bps to 1.896% and 30’s 42 bps to 2.37%.  Moves in the German bond market were similar, with the schatz yield surging to -71 bp from -93 bps and 10-y bunds from -71 to -45 bps.

This Wednesday of course, we’ll get the FOMC announcement followed by a press conference.  The last meeting was on July 31, where the Fed began the process of lowering the FF target and kicked off August’s rally.  As the chart below shows, the five year treasury yield at 1.75% is almost exactly back to the same level as it was at the July FOMC (denoted by the horizontal line).  Longer dated yields have fallen a bit shorter of a full retrace as the curve flattened.  For example, 5/30 on July 31 was 68, peaked on Aug 1 at 76, and is now 62. 

US 5y treasury yield

At the Fed’s quarterly Summary of Economic Projections in June, Core PCE prices were forecast at 2.0% in March for both the end of 2019 and end of 2020.  These projections were dropped to 1.8% and 1.9% in June.  The Fed Funds Median projection was much more volatile.  For the end of 2019, the forecast was 2.4%, both in March and June.  But for year-end 2020, the projection in March was for a rate increase to 2.6%, while in June it was for a rate decrease to 2.1%.  In hindsight we know the schedule for an ease was moved aggressively forward, from the end of 2020 to July 31, 2019 as the FF midpoint target was dropped to 2.125% from 2.375% at the last FOMC.  SEP is only released on quarterly meetings; there will be no dot plot or tables of forecasts at this FOMC.

The Fed’s problems have mostly come as the result of risks to global growth due to trade tariffs, but the slowdown in global manufacturing was already occurring.  This has led to subdued price pressures which the Fed and other central banks remain fixated on.  However, the latest price data released last week in the US suggest that such concerns could be overblown as Core PPI yoy was 2.3% and Core CPI yoy was 2.4%.   U of M’s current inflation expectations index was 2.8%, though the 5 year horizon was only 2.3%.  In any case, inflation might go in the “be careful of what you wish for” category because the drone attacks on Saudi processing plants over the weekend threaten to cause a jolt in the price of oil.  Coincidentally, on Friday I ran the chart below, which shows SPX and the rolling price of the first WTI Crude contract.  On the CME website a price limit of 7% is indicated on the front CL contract.  That indicates a move of $3.84 off the October contract settle of 54.85.  That is, 58.69.  I suspect the market will be at least $10 higher than that. 

The gap which opened up since the end of last year is something I thought would likely begin to close, though I imagined a scenario of oil continuing to ease lower with stocks correcting a bit more rapidly.  With Saudi supplies questionable in the near term, crude is expected to gap higher and stocks, I would assume, ease lower.

In any case, I wouldn’t be surprised if, during the press conference, Powell said something like, “While geopolitical and trade risks to growth remain tilted to the downside, inflation data appears to moving closer to our symmetric target.”  This sort of a non-dovish meeting outcome would likely not sit well with the bond market.  Clearly, the easing steps taken by the ECB last week (10 bp cut and €20 billion per month in QE) didn’t stem the recent rate rise. 

However, a change in market sentiment is not only affecting the direction of rates, but is also apparent in liquidity conditions across markets.  Tad Rivelle, CIO of TCW, presciently summarized this change in a note released Sept 5, nearly pegging the exact low in yields.

Key lines: But, “free money” not only makes loans cheap, it also erodes the capacity of lenders to ask for such reasonable terms as traditional loan covenants and basic financial disclosure.

Hence, not only have the debt markets ballooned in size, but the growth has come disproportionately from those segments of the debt market where financial disclosure is poor.

Importantly, this isn’t only the case in leveraged loans and corporate bonds.  It is also apparent in IPOs.  Recent issues like UBER and LYFT have been pasted, and the much anticipated WeWork IPO is now supposedly sporting a potential value of just 1/3rd the level of its last funding round at $15 billion vs $47 billion. Additionally, the depth in futures markets has dwindled significantly; perhaps not too surprising given delivered price volatility. 

Almost certainly after this FOMC there will be articles written questioning the credibility of the Fed.  I don’t know how many articles I have seen  over the years somberly concluding that the Fed had lost its way and thus, the market’s confidence.  I am sure I have been guilty of writing along those lines on past occasions.  However, what appears to be different now is a more widespread, and growing, perception that negative rates are doing more harm than good and have led to global overcapacity.  I.e. maybe it’s not a lack of final demand, maybe there are just too many widgets being produced.


I had mentioned during the week that if accounts needed a specific hedge against the Fed holding rates steady at this week’s FOMC, consider FFV9 9806.25 puts (which had been sold at 1.0 early in the week) or FFV9 9800 puts which I thought might even trade 0.5.  While I personally am 99% sure of a 25 bp cut, I can understand spending a little insurance money in this environment.  As it turned out, the 9806.25 p traded 10k on Friday, 1.5 to 2.0, and settled 2.0 ref FFV9 9810.5.  There is no open interest in FF options aside from these puts and a tiny bit in Oct 9800 and 9787.5p.  Fed Fund options ONLY trade for the binary FOMC event.  What is amazing is that FFV9 traded to 9810.5, having been as high as 9824.5 settle on 15-Aug.  I think 2.0 is too high to pay for the 9806.25p, but selling at 9810.5 is arguably a worse risk/reward than simple long puts.

Dec’19 eurodollars have broken hard with everything else and settled 9794.5, down 18 on the week and 31.5 from the high settle on Aug 15.  The spread to the expiring EDU9 contract is only -9.25 bps.  EDZ9 to FFF0 settled at a new high of 38.5 bps.  Two factors are at play: the risk that the Fed signals that this week’s ease is the last one, and the risk that year-end funding pressures are accentuated. 

While I thought the ten year cash yield would test just over 2% in the near term, the attacks on Saudi oil infrastructure can change the picture in a hurry.  With just 5 trading days to go, the Oct TY atm straddle (128.5^ vs 128-18.5) settled 59/64’s.  That’s amazing given that atm TY straddles have recently traded that level with 5 WEEKS to go.  A bid for the safety of US treasuries is only a drone attack away…

9/6/2019 9/13/2019 chg
UST 2Y 152.6 180.0 27.4
UST 5Y 141.8 174.9 33.1
UST 10Y 155.0 189.6 34.6
UST 30Y 202.1 237.0 34.9
GERM 2Y -87.0 -70.7 16.3
GERM 10Y -63.8 -44.9 18.9
JPN 30Y 20.9 33.5 12.6
EURO$ Z9/Z0 -59.0 -40.5 18.5
EURO$ Z0/Z1 -8.0 -6.5 1.5
EUR 110.31 111.57 1.26
CRUDE (1st cont) 56.52 54.85 -1.67
SPX 2978.71 3007.39 28.68
VIX 15.00 13.74 -1.26
Posted on September 15, 2019 at 1:22 pm by alexmanzara · Permalink
In: Eurodollar Options

Leave a Reply