Dec 10. Long liquidation of front euro$ contracts; curve flatter in front of ten year auction
–US treasury auctions 10’s today and 30 yr bonds tomorrow, yet yields continue to press lower and the back end of the curve flattens. Ten year w/i fell 4 bps to 222.5. Red to green dollar pack spread closed at a new low just under 84 bps. There was huge selling volume in EDH5 early yesterday, though the contract only fell 0.5 bp to 9971.5. Later in the day there was another round of large clips of sales, which appeared to be long liquidation. Open interest fell 129k in March’15, 30k in June and 28k in Sept. All told euro$ open interest fell by 130.7k, around 1% of total OI. It appears that 2014 was the year that low volatility and large (and increasing) regulatory and exchange costs conspired to shutter many trading funds. I don’t know if yesterday’s large sales in dollars were associated with the end of any particular fund, but the trend has been evident.
–Stocks took a tumble early yesterday, only to bounce right back, as usual. DB notes in a research piece that something’s got to give between the plunging price of oil and its rippling negative effects (for example on high yield debt, and yes, I know there are positive effects as well), and large cap stocks which dance merrily higher. In my opinion, deterioration at the margin, in emerging market stocks and currencies, in high yield debt, and in europe, will eventually work its way inward and cause a hard pull back in US stocks. In 2007 Bear Stearns was forced to inject capital into its failing mortgage funds. It was mid-June and another crystal clear alarm bell. Actually, crude oil at that time was on an upside tear, and the Fed tightening cycle which had started in 2004 had inverted the US curve by 2007. In any event, after June the market had a sharp pullback, much like the one we just experienced in October. Then stocks made a new high into October 2007. By 2008 the market was falling, bounced in the spring and then accelerated lower. Perhaps the comparison isn’t valid because the US consumer at the time was beset by both higher energy prices and a mortgage refi spigot which had closed. Now the consumer is blessed by falling energy prices and relatively easy financing…but the rest of the world is getting shaky, and the asset values on which our economy depends are a bit more vulnerable. And, the flattening curve is giving a clear warning signal.
From DB: “These observations form the base underneath our view that something has to give here. Either the market is too negative on Energy, or it is not diligent enough in thinking about broader implications. The only argument that stands against this view is that the rest of the economy is supposed to benefit from lower oil, which as we have shown earlier, has its own limitations.”
