August 20. Eclipsed

It’s slicing the US in half. Bannon’s dismissal? The sudden flare-up in race relations and stark divide in political dogma? No. It’s the path of Monday’s eclipse, which begins in Oregon, passes over the heart of the country in Lincoln, NE, and exits in Charleston, NC.





All of our ancestors had myths about eclipses.The ancient Greeks believed eclipses occurred when the gods were angry with humans, and the Babylonians believed it signified the death of a ruler.” “The indigenous Pomo of N. California envisioned a cranky bear ambling through the heaven and biting the sun when it refused to move out of the way.”

The Babylonians, as usual, might have been on to something. From Bannon, “…that presidency is over.”

It’s interesting to note that Bannon’s world view is informed in part by The Fourth Turning, the fascinating 1997 book by Strauss and Howe. It’s not a political manifesto, it’s a work that suggests history isn’t linear, but rather is a repetition of seasonal patterns led by similar generational archetypes. We’re currently in winter. From the authors’ prophecy in Chapter 10:

Sometime around the year 2005, perhaps a few years before or after, America will enter the Fourth Turning.

One of their scenarios (and remember, this is 1997) is: A global terrorist group blows up an aircraft and announces it possesses portable nuclear weapons.

Another is this:

An impasse over the federal budget reaches a stalemate. The president and Congress both refuse to back down, triggering a near total government shutdown. The president declares emergency powers. Congress rescinds his authority. Dollar and bond prices plummet. The president threatens to stop Social Security checks. Congress refuses to raise the debt ceiling. Default looms. Wall Street panics.

Not so far-fetched in our current political climate. Treasury Sec’y Mnuchin has consistently stayed on message -unlike others – warning that the debt ceiling must be quickly and cleanly passed, and has decided to continue in the administration. “As long as I am Treasury secretary I will do the best job I can for the American people and provide the best advice I can to the president.” Admirable. However, the t-bill curve still has its kink reflecting concerns about the debt ceiling, with 9/28/17 bills at 95.3 bps, 10/12 at 108.5 and 11/2 back down to 101.0.

The new mood and its jarring new problems will provide a natural end point for the Unraveling-era decline in civic confidence. In the pre-Crisis years, fears about the flimsiness of the social contract will have been subliminal but rising. As the crisis catalyzes, these fears will rush to the surface, jagged and exposed. Distrustful of some things, individuals will feel that their survival requires them to distrust more things. This behavior could cascade into a sudden downward spiral, an implosion of societal trust. If so, this implosion will strike financial markets – and, with that, the economy.

The Chicago superstition could run along these lines: The eclipse goes over Lincoln, Nebraska. Pete Ricketts is the governor of NE. His brother is Tom Ricketts, who owns the Cubs. The Cubs won the World Series. Everyone knows there’s gotta be an equal and opposite reaction. Something bad’s gonna happen. Let’s play some Buddy Guy.

Enough of the broad strokes of societal decline. The main economic event this week is the Central Banking Symposium held at Jackson Hole, amusingly titled ‘Fostering a Dynamic Global Economy.’ Yellen is slated to give her address on Friday, at 10:00 EST. According to an article on Reuters (linked below) her topic will be financial stability. Dudley has probably been the most prominent voice on the Fed regarding financial conditions, and has expressed concerns they’ve been too easy in spite of increases in the fed funds target.

From a speech by Dudley in March, 2017, “…financial conditions can be broadly summarized by five key measures: short and long term treasury rates, credit spreads, the foreign exchange value of the dollar, and equity prices.”

While there have been minor adjustments in the past couple of weeks, overall financial conditions remain, well, uneasily easy. Taking them in the order of Dudley’s list, short term rates have increased, but the average one-year Eurodollar calendar spread over the next two years is only 21 bps. That is, the market expects MAYBE one hike per year. When the first hike occurred in December 2015, the ten year treasury was 2.29%, now it’s 10 bps lower at 219.4, (within one bp of the close on the previous Friday). The dollar index was 98.40. Though it traded close to 104.00 in the euphoria related to Trump’s election, it’s now 93.40, near a new low for the year. While junk bond spreads have widened slightly (with superb timing by Tesla and Amazon in terms of bond offerings), spreads are still tight.  Equities as expressed by the SPX, are obviously up. Before the first hike in December of 2015, the SPX was around 2100, it is now 2425, just 2.6% off the high set a few weeks ago.  Ten year treasury to tip spread in Dec 2015 was around 150 bps, it’s now 177, so inflation expectations have just slightly firmed (the intervening high was close to 210). I have included below a chart of the Chicago Fed’s Financial Conditions Index. No red flags waving there….it looks like any old volatility chart.

Over 100 financial indicators. Released weekly. Chicago Fed National Financial Conditions.

We know that some on the Fed are rather concerned that loose financial conditions are bolstering increased risk taking, and that asset prices in real estate and equities, having seen strong increases, can create instability if the air comes out too quickly. The unexpected risk for Yellen’s speech, who always seems to fall back to the dovish idea of weak wage growth, is bearish, i.e that the Fed must continue to remove accommodation. Is it crazy to suggest that turning up the heat with monetary warnings might also serve as a catalyst and enter into calculations regarding the political situation? Well there, I’ve just suggested it.

‘What I’ve gotten a greater appreciation for is how everything is so orchestrated by the authorities,’ she said. ‘The upside is that it creates stability. The downside is that it can create a problem of proportions that people would think is never possible. We’re moving into that territory.’

That’s not a US reference, but the appearance of stability is of paramount importance everywhere. It’s from a WSJ article quoting Charlene Chu. ‘In her latest report, Ms Chu estimates that bad debt in China’s financial system will reach as much as Rmb51tn ($7.6tn) by the end of this year, more than five times the value of bank loans officially classified as either non-performing or one notch above.’ (3)

It’s likely no coincidence that bitcoin is exploding higher as the Chinese monetary foundation appears ever more suspect. I mentioned a few things about China in last week’s piece, but it’s unlikely to unravel prior to the National Communist Conference this autumn.

Maybe it’s the Pomo tribe that has had it right all along. A bear’s about to take a bite out of this market.


Posted on August 20, 2017 at 11:27 am by alexmanzara · Permalink
In: Eurodollar Options

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