Aug 2. Weekly review, Low wages, high (junk) yields

THEMES:

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7/24/2015 7/31/2015 chg
UST 2Y 67.8 67.2 -0.6
UST 5Y 162.0 154.7 -7.3
UST 10Y 227.1 220.5 -6.6
UST 30Y 297.4 292.9 -4.5
GERM 2Y -22.5 -23.2 -0.7
GERM 10Y 69.1 64.4 -4.7
EURO$ Z5/Z6 ** 80.0 76.5 -3.5
EURO$ Z6/Z7 64.0 61.0 -3.0
** peak one-yr spd
EUR 109.85 109.84 -0.01
CRUDE (1st cont) 48.14 47.12 -1.02
SPX 2079.65 2103.84 24.19
VIX 13.74 12.12 -1.62
 
   
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Review of the week: Concerns about China’s stock market and economic growth pushed US stocks lower and caused a bid in fixed income at the start of the week. On Thursday, Q2 GDP was stronger than expected with positive revisions to Q1, and the FOMC announcement enhanced perceptions that a hike was still in the cards for this year, most likely in September. But then Friday’s extraordinarily weak Employment Cost Index of just 0.2% (lowest on record) put the entire picture into a tailspin. On top of that, pressure on emerging market currencies is intensifying, and crude oil closed at a new low. I have to think the ECI data is an outlier, which could easily be contradicted in the employment data coming out this week. In any case, for the week, fixed income futures closed at the highs, with the cash 5 yr treasury yield having dropped 7.3 bps on the week; the strongest part of the curve.

There was an interesting Bloomberg article on Friday, ‘Exit From Leveraged-Credit Funds Seen as Sign of Things to Come’ http://www.bloomberg.com/news/articles/2015-07-31/exit-from-leveraged-credit-funds-seen-as-sign-of-things-to-come

The article quotes a report by Credit Suisse, ‘The steep decline in credit closed-end fund shares is “a signal both of underlying credit market illiquidity and also of end investor risk aversion.”’

I often mention the high yield ETF’s HYG and JNK, which have been under pressure but had bounces this week. Both have thus far held the lows from last December. However, some of the closed ends funds are WELL below their December levels, for example HYT*, HPF**, HYI. The latter is Western Asset Hi Yield Defined Opportunities Fund, with a yield of 8.80% according to bigcharts.com.

The point is that one man’s debt is another man’s asset, and the latter counts it as a part of his ‘wealth’.

It’s all coming down to debt. Here are some of the Financial Times headlines from Sunday: –Brazilian Households Struggling with Debt   –US Equity Margin Debt Flags Top   –Outflows from EM Funds Accelerate. And from the Telegraph: –Dubai Debt Crunch Looms as Oil Slump Hits Gulf

Here’s a quote from an article by Ambrose Evans Pritchard last week: “David Cui, from Bank of America, said $1.2 trillion of stock holdings are being carried on margin debt. This is 34pc of the free float of the Shanghai and Shenzhen stock markets.”

And an article on Reuters cites a Chinese central bank official: “Sheng warned about the risks of local government debt, saying that 2 trillion yuan ($322.08 billion) in bond swaps may not be able to fully cover maturing debt, according to the report.” http://www.reuters.com/article/2015/08/02/us-china-economy-idUSKCN0Q702Y20150802

Puerto Rico apparently missed a bond payment over the weekend.   But nearer and dearer to my heart is Chicago, which is considering issuing debt that Puerto Rico considers “TOO RISKY” hahahahahah. Capital Appreciation Bonds, or CABs, (as in taxicabs). As we used to say on the floor, “Sell a cab, drive a cab…” Anyway, quoting form the article: “Chicago may allow the use of a type of debt that’s fallen out of favor in other municipalities because it saddles taxpayers with higher costs by delaying payments. Mayor Rahm Emanuel proposed issuing $500m of bonds this week in an ordinance that would permit the use of capital appreciation bonds, where borrowers postpone interest and principal payments into one sum at the end of the term.” http://www.bloomberg.com/news/articles/2015-07-31/chicago-mulls-borrowing-that-puerto-rico-rejected-as-too-risky

Just to bring it to full circle, (in a roundabout way), a few years ago, perhaps about five, I went into Chicago’s City Hall to appeal a traffic violation and request a hearing. I got off the elevator, entered a room with a big metal fan sitting atop the filing cabinets (hi-tech fan, the oscillating kind). The woman at the counter handed me four duplicate forms with CARBON PAPER and told me to press down hard when I wrote so that the last form would be legible.   Want to lend these guys your money?   Well maybe you do, because the final outcome was a $500 fine that I paid.

Contrast that to UBER, the biggest CAB company in the world. Flexible pricing. Flexible workforce. Knows where the cars are and where the customer is. The ultimate “just in time” model which fully harnesses new technology. In fact between UBER, FB, and debit/credit cards there is more information on the current crop of consumers than ever before. A complete picture of location, finances and consumer tastes at all times. But policy makers can’t quite figure out why the consumer isn’t spending as much as is necessary to ultimately service the amount of debt in the system.

So, is there going to be a Fed hike in September? Maybe. Depends on the next couple of employment reports.

But take a clue from the back end of the dollar curve. It is getting a bit flatter, not steeper. Given the positive slope of the curve there should be a natural roll carry. However, a spread like EDZ6/EDZ7 actually declined 3 bps on the week to just 61 bps. I continue to think there’s a risk that long curve trades are squeezed out, thus leading to a further painful rally in green and blue Eurodollars (3rd and 4th years). However, implied vol is still low enough that it’s relatively inexpensive to put on downside for protection.

 

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*HYT is Blackrock Corp High Yield

**HPF is Hancock Preferred Income Fund II

Posted on August 3, 2015 at 5:13 am by alexmanzara · Permalink
In: Eurodollar Options

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