Atonal Music

August 30, 2020 – Weekly Comment

There’s a comedy from 1979 called The In-Laws.  Peter Falk plays rogue CIA agent Vince Ricardo, who is trying to thwart a Central American dictator’s plans to set off a panic in the western world by printing off trillions of dollars of major currencies (having stolen the necessary engravings), thus upending the global financial system.  Alan Arkin plays NY dentist Sheldon Kornpett whose daughter is engaged to marry Ricardo’s son.  Vince explains the situation to Sheldon in a cafeteria…

Vince Ricardo What do you think will happen when they run off this dough… and there’s trillions of extra dollars, francs, and marks floating around? You’ve got a collapse of confidence in the currency. People are gonna panic. There’s gonna be gold riots, atonal music… political chaos, mass suicide. Right? It’s Germany before Hitler. You can see that. Jesus, I don’t know what people are gonna do… when a six-pack of Budweisers costs $1,200. That’ll be awful.

Prescient.  Except this time it’s not a lovable dictator who is trying to destroy the value of the US currency, it’s the Fed. 

From a paper on Atonal Music:  “We further argue that neural correlates of uncertainty estimation could represent a central mechanism for engaging with Atonal Music and that such contexts engender a comparatively weak predictive model in the listener.”  Hard to argue with that… because I have no idea what the hell it means.  But I have come up with some thoughts relating to a predictive model having watched Powell’s pirouette to inflation averaging.  And for those I rely heavily on Vince Ricardo.  Gold riots, collapse in confidence, political chaos.  I just hope we can avoid atonal music.

In terms of the dollar, it has recently been weakening but is nowhere near the low set in 2008.  As shown below the low in DXY during the GFC was 70.70 vs 92.37 now.  The halfway back level from the 2008 low to the high just after Trump’s election is 87.25 which would likely correspond to EUR around 1.30 vs 1.19 now.  In 2017, after a similar sell-off there was a bounce off the 91.00 area which could easily occur again.  However, the Fed is overtly providing wind at the back of dollar shorts as it seeks to create inflation, that is, to diminish the purchasing power of dollars. They’ve been fairly successful with this strategy when it has come to Nasdaq, and have recently chalked up some success in the gold market.    

However, they’re looking for a broader inflation, one that seeps into wages and services and lessens the burden of crushing debt.  Liz Ann Sonders of Schwab notes, “Debt keeps piling up…total-debt-to-EBITDA ratio for investment grade companies climbed to 3.53 in Q2 (5.42 for high-yield) which is the highest since 1998 (inception of data).”  Needless to say, government debt-to-GDP is off the charts.  Currently Congress and the administration are bickering about new stimulus measures.  But vocal protests have now taken a turn towards outright threats, especially in transportation.  American Airlines publicized the need for more government money or it will cleave 19k employees.  Delta has joined the chorus.  From BBG regarding NY’s public transit service, “The MTA says it is now preparing for a ‘doomsday scenario’ that could include a 40% cut in service for both commuter trains and busses, resulting in longer wait times, lane closures, fare hikes and massive job cuts.”  This agency is reportedly losing $200 million PER WEEK and wants $12 billion to see it through year end.  From an official, “Without question there is no economic recovery without a healthy MTA and there is no national recovery without a healthy New York,” Foye said during the meeting. “That is why investment in the MTA is in the national interest.”

Wow!  That is an amazing stretch of logic.  However, it also points to a change in mindset.  There currently must be great incentive to signal price increases to competitors in a bid for collaboration.  ‘We don’t have ridership but the Feds are forced to save jobs so let’s take this opportunity to jack prices.’  The Fed and the Federal gov’t are concerned about jobs.  When focused on a primary goal, price becomes less of a restraint.  The private sector needs the flow of government funds, both to consumers and in the form of outright grants or low interest loans to specific businesses.  My perception is that the long end of the bond market is starting to transmit potential ramifications.  USZ implied vol closed at the high of the month on Friday in spite of a bounce in price off new lows set in the early morning.

When I was  kid on the old Chicago Board of Trade floor, I worked in “the financials”, the old room located directly behind the limestone façade that anchors the base of LaSalle Street.  The grain floor was ironically moved to the modern south annex, and was a state-of-the-art facility.  In the old room, the price chalkboards were still visible around the perimeter of the catwalk.  The grain room had none of that, just some sleepy pits surrounded by FCM booths and massive walls of glowing price boards, and Jay Homan there early every day with impeccably combed hair, single-handedly representing the Oat pit with his massive deck of orders, wearing saddle shoes.  Yes.  Saddle shoes.  And never a scuff on them.  Nothing, it seemed to me, happened in the grain markets.  Until, that is, the drought of 1988.  This set off a bid for grains and provided a tractor beam draw for retired grain traders.  The grains opened at 9:30. I recall going for coffee around 9 and seeing old guys, some with canes, marching to the grain pits with their bright yellow full membership badges, going back to re-live the glory days of a bull market.  Well friends, dust off your Commodore Amiga 1000s and make sure the floppy drive still works so you can log into Globex.  “Beans in the teens!!  Orders bid for 5 million!”  (Because in those days they traded in bushels and not contracts). But remember, you can’t yell at the box, you still have to click the mouse.

Could this be the time and place where we determine if the Fed is really finding success with inflation averaging?  I mean, look…if I were running the Fed, having taken in junk bonds and flailing municipal debt, I would throw a bone to the farmers and start buying bushels of corn.  And bushels of wheat.  Support farmland prices.  Support ADM and Bunge and Cargill and Deere…A, B. C. D right through the alphabet.  Isn’t the American farmer the symbolic heart of the country?  Forget the atonal music and crank up some John Cougar Mellancamp, Rain on the Scarecrow, at full volume.  I did, and my neighbors love me for it.  Or maybe they don’t.  But they should.  Anyway, here’s a picture of the Bloomberg grain index.  Corn, beans, wheat.  “Hey Esther.  The KC Fed couldn’t properly sponsor Jackson Hole because of Covid, but we’d like to put you in charge of the new Fed facility, Grain Order Department, GOD.  Don’t stop until you catch up with Bullard, who we’ve put in charge of lumber.”

I’ve already sort of gone off the tracks with this note, so below are some specifics relating to rates.


Here’s something you don’t see too often:  EDH1 settled 9979.5.  EDF 9987c settled 1.25.  EDH 9987c settled 1.50.  There is no open interest in Feb calls yet but they are listed, so Bloomberg provides a modeled settlement of 2.0.  They have crushed the March 9987c due to the 9975/9987c 1×2 such that its price according to model is ridiculously cheap.  And no, you can’t buy the Feb/March call calendar for a credit, but it’s a nice thought.

The EDZ0 9975 straddle traded some 7.75’s last week before settling at 8.0 vs 9971.  Three and a half months to go.  I know the Fed’s not in play, but selling that straddle doesn’t strike me as an ideal financing vehicle.

The trade of the week was a buyer of 125k 2EZ 9962/9950 put spread for 2.5 on Friday.  Open interest rose 111k in 2EZ 9962p and fell 30k in the 9950p so it appears to be a roll-up.  Expiration is 11-Dec and underlying is EDZ’22 at 9973.5.  Dec FOMC is 16-Dec, not that it matters.  Settles in options were 4.25 and 2.25.  On 9-July there was a buyer of around 35k 2EZ 9950p for 4.25 (synthetically) vs 9974.  So in less than two months, the next strike up is now the same price at the same futures level.  There was also a sizable buy of some 30k EDZ1/EDZ2 calendar spreads at 3.5.  This spread settled 4.5.  There are now no FF contracts above 100 (that is, at negative rates).  Steepeners are becoming more popular, although expressing that bias within 3 years on the ED curve may not be the best bet.  But it’s a pretty cheap way to wager on a total loss of confidence in the Fed.  How ya left on the Paul Volcker/Murat Uysal spectrum? 

5/30 treasury spread made a new high on the year at 123 bps.  2/10 has a double top this year just above 68 bps (March and June), it finished the week just above 59, highest since mid-June. 

Clarida speaks Monday and Brainard on Tuesday, both on the topic of the Fed’s New Monetary Policy Framework.  Just in case the markets did not get the point with Powell last week.  Fed officials often talk about Financial Conditions and Financial Stability.  They’re not the same thing.  The former represents the degree of looseness of policy as telegraphed by rates, the stock market, the dollar, credit spreads.  The latter is almost a third mandate.  The trick is being as generous as possible on the first without endangering the second.  It’s a hard enough job without the uncertainty of fiscal policy, but I think they’ve rounded the bend this time.

UST 2Y14.313.3-1.0
UST 5Y26.827.40.6
UST 10Y63.372.69.3
UST 30Y134.8150.816.0
GERM 2Y-63.3-66.5-3.2
GERM 10Y-50.7-40.99.8
JPN 30Y61.361.70.4
EURO$ U0/U1-3.25-3.50-0.3
EURO$ U1/U24.03.5-0.5
EURO$ U2/U310.011.51.5
CRUDE (active)42.3442.970.63

Posted on August 30, 2020 at 12:10 pm by alexmanzara · Permalink
In: Eurodollar Options

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