Bizarro Markets

June 9, 2019 – Weekly Comment

Last week I started with this line, “This week, the markets eased.”  In the week just ended, the trend continued, but the ease was pulled forward in time.  The most glaring example can be seen in the July’19/August’19 Fed Fund spread which closed at -20 on Friday from -10 on the previous Friday.  The settle indicates 80% odds of a 25 bp cut at the July 31 FOMC meeting, up from 40%.  August FF alone settled 97.88 or 2.12%, versus Fed Effective of 2.37 to 2.40%.  In other words, by August the market is pricing CERTAINTY of at least a 25 bp cut.  By my calculations, an ease at next week’s FOMC is being priced at about 1 in 3 (FFM9 settled 97.6425).

The week before last JP Morgan revised their call from balanced odds between a hike and ease to a forecast of cuts in September and December.  Last week Barclay’s vaulted ahead, calling for a 50 bp ease in July, followed by another quarter in September.  Citi is looking for a cut of 50 in September.  Kashkari is now thinking a HIKE is in order (just kidding).  The change in sentiment over the past couple of weeks is simply astounding.  This week, inflation data in the form of PPI and CPI are released on Tuesday and Wednesday.  Below is a chart of yoy Core data.  Do the modest drops in inflation, consistently referred to as “transitory” by Fed officials, warrant full-on monetary easing with conventional and unconventional tools?

Let me just note a couple of other prices.  EDM9/EDU9 settled at a new low of -33.25 with June expiration just one week away.  The German bund yield closed at -25.7, a new historic low.  EDZ9/EDZ0 actually rallied 13.5 bps on the week to -27.0, as the market moved up the timing for aggressive easing by the Fed.  In short sterling, Dec’19/Dec’20 settled at a new low of NEGATIVE 8, while Dec’19/Dec’20 euribor settled 0 (with ERU9/ERU0 -4.5).  The dollar index fell to a two month low, closing on the 200 day moving average at 96.56.  The US two year note fell nearly 10 bps on the week, but 30’s shaved only 1 bp.  Stocks soared, with SPX just 2.7% from all time highs.  Except in China, where the Shanghai Comp eked out its lowest close since late February, even though the PBOC said there’s “tremendous room” to adjust monetary policy.  Gold has rallied eight sessions in a row.  The world demands lower rates.

This is bizarro price action. 

From Wikipedia:

The Bizarro World (also known as Htrae, which is “Earth” spelled backwards) is a fictional planet appearing in American comic books published by DC Comics. Introduced in the early 1960s, htraE is a cube-shaped planet, home to Bizarro and companions, all of whom were initially Bizarro versions of Superman, Lois Lane and their children…

In the Bizarro world of “Htrae”, society is ruled by the Bizarro Code which states “Us do opposite of all Earthly things! Us hate beauty! Us love ugliness! Is big crime to make anything perfect on Bizarro World!” In one episode, for example, a salesman is doing a brisk trade selling Bizarro bonds: “Guaranteed to lose money for you”.

Of course, Bizarro World was more recently made famous by a Seinfeld episode citing Bizarro Superman, the exact opposite of Superman, who lives in the backwards bizarro world. “Up is down, down is up. He says hello when he leaves and good-bye when he arrives”.  This episode also  featured “Man hands”.  Back in the day, there was a striking clerk working for (of course) FO, who was known as man-hands.  But that’s a different bizarre story for a different time.    

In today’s environment, “Us buy stocks when yields are forecasting an economic catastrophe.”  “Us cut rates when data strong.” “Us buy bonds that are guaranteed to lose value”.  The ten year bund at -25 bps?  By the way, the US Treasury is raising $54 billion of new cash this week by selling $38Bb in 3 year notes, $24b in tens and $16b in thirties.   With the ten year yield having fallen over 70 bps from this year’s high, of which 30 bps was in the past three weeks, what kind of demand will there be for fresh supply?  Especially when considering that a slowing economy will make deficits even WORSE, leading to greater supply.  “Smithers, how in the world could you bid for 30’s at these yields?!?  You’ve blown up our portfolio.” Smithers’ reply “Well, I was able to get a 20 bp yield pick-up over Italian tens.” 

The question becomes, why is the market pushing so aggressively for an ease in policy, even with relatively buoyant asset prices and economic data which feature the lowest unemployment rate in fifty years?  Is it because of the slowdown in global trade, as Powell alluded to on Monday?  Or is it something much more pernicious indicating risks in global financial stability?  If it’s the latter it’s not showing up in corporate spreads.  HYG and JNK hi-yield ETFs are right back where they were last fall prior to the 4th quarter sell-off. 

The question becomes whether the central bank should accommodate what has been a political decision on trade made by the President.  According to the dual mandates of full employment and steady inflation, the Fed has done a pretty good job, as Fed officials constantly remind us.  On Wednesday, El-Erian published an article with the following question: “Would such [rate] cuts even lead to sustainably and substantially higher consumption and investment; and, if not, how long can markets maintain increasingly elevated asset prices that are decoupled from the underlying economic and corporate fundamentals?” (emphasis added).  If the markets successfully push the Fed into aggressive accommodation, Powell will be seen as completely folding to Trump.  I simply can’t see how that would be anything but a huge curve steepener.     

European bank shares are generally at or below the lows seen at the end of last year. China’s financial system is coming under further scrutiny with the recent state takeover of Baoshang Bank and weakness in yuan, which increasingly looks like a test of 7 is nearing.  The old CME floor local lament, whenever big trades came in that turned the flow of the market is:  “What do these guys know?  They know SOMETHING.”  Maybe it’s not the domestic situation, perhaps markets are sensing that it’s the global financial architecture that is nearing a breaking point, exacerbated in part by a strong dollar.  In that case, this week’s decline in DXY is welcomed. 

Just as a historical sidenote, in August of 1987 SPX was at a new all time high.  It pulled back into September, but made a new run at the highs in early October, getting within 2% of the top.  On Saturday, October 17, Treasury Sec’y James Baker III told the Germans to “either inflate your mark, or we’ll devalue the dollar.”  On October 19, SPX lost 20.5%.

Sometimes trade tensions lead to a breaking point. In that light, the month end G20 meeting takes on added importance.


5/31/2019 6/7/2019 chg
UST 2Y 194.4 184.7 -9.7
UST 5Y 192.9 185.0 -7.9
UST 10Y 214.2 208.4 -5.8
UST 30Y 258.2 257.2 -1.0
GERM 2Y -65.9 -67.0 -1.1
GERM 10Y -20.2 -25.7 -5.5
JPN 30Y 45.4 37.9 -7.5
EURO$ Z9/Z0 -40.5 -27.0 13.5
EURO$ Z0/Z1 8.5 7.5 -1.0
EUR 111.71 113.35 1.64
CRUDE (1st cont) 53.50 53.99 0.49
SPX 2752.06 2873.34 121.28
VIX 18.71 16.30 -2.41

Posted on June 9, 2019 at 8:13 am by alexmanzara · Permalink
In: Eurodollar Options

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