Dec 9, 2018. Overkill

I watched a fascinating documentary last week on bodies that had been excavated from peat bogs in Ireland and Denmark from the Iron Age (2000 BC).  These bogs preserve the tissue and it remains pliable thousands of years later.  This show specifically dealt with Cashel Man, found in a bog near Cashel in County Laois, Ireland.  The forensic science is astounding, but to cut to the chase, many of these bog bodies appear to have been ritualistic killings of kings due to conditions having gone badly under their reigns.  The program refers to ‘triple killing’, noting bodies that have had throats cut, been stabbed by sword through the heart, and axed in the head. In short, ‘overkill’.


“The killings tend to be excessive,”  Kelly, said “in that more is done to the bodies than would be required to bring about their deaths. Bog bodies may have their throats cut, been stabbed in the heart and have other cut marks. However, it is absolutely not torture, but a form of ritual sacrifice.”  “By using a range of methods to kill the victim, the ancient Irish sacrificed to the goddess in all her forms. This manner of death is peculiar to the ritual killing of kings. It means that a king was being decommissioned.”


When Trump was elected in November 2016, the Corporate BBB option-adjusted spread to treasuries was 179 bps.  It was already in a rapid decline from the energy inspired surge in late 2015, which peaked in February 2016.  In the two years that Trump has been in office the spread never exceeded the election-day level of 175 bps – until this week.  I sent the image below on Tuesday as the spread was just about to make new highs for Trump’s reign.  On Thursday the St Louis Fed marked the spread at 191 bps, and it was obviously higher on Friday.


In late November of 2016, the two-year treasury was around 110 bps and the five-year was around 180 bps.  As of Friday both the 2 and 5 yr were around 270 bps.  Even with the decline in rates seen this week, the record level of corporate debt to GDP means that a crunch of sorts is coming for companies that need to roll debts, especially those that cleverly borrowed in order to buy back shares.


Of course, it’s not just companies that need to borrow.  The Federal Gov’t has become voracious, and this week will auction 3, 10 and 30 year paper in the amount of $78 billion, which will raise $54 billion in new cash.  ‘Crowding out’ of the corporate sector may become a real concern.  Although still relatively low in recent history, FT notes “The US distress ratio [for US junk] – defined as…’the number of distressed credits divided by the total number of speculative-grade issues’ – rose to 7.2% as of Nov 15, up from 5.6% as of mid-October.  S&P cautions that a rising ratio suggests an increased need for capital and signals that defaults could rise.”


Last week the Fed released the Z.1 report for Q3.  None of the borrowing ratios by sector look particularly worrisome, although business borrowing slowed appreciably in Q3 from Q2 from a rate of 6.94% to 3.87%.  The deterioration is longer term in nature and concerns borrowing by the Fed’l Gov’t.  I used to think of Households, Business and Fed’l Gov’t as having comprised about 1/3rd each of total non-financial domestic debt.  Pre-crisis in 2006 the amounts outstanding were $13.3T for HH (43% of total), $9.0T for business (29%) and $5.8T for the Fed’l Gov’t (19%).  By 2015 it was $14.2T HH (31%), $12.8 business (28%) and $15.2T for the Fed’l Gov’t (36%).  Sure, the Federal Government had to expand to heal the damage and the HH sector was either shut out or self-disciplined with respect to borrowing. The latest figures for Q3 2018 show HH at $15.5T (30% of total), business at 15.0T (29%) and the Fed’l Gov’t $17.8T (35%).  Although the economy has ‘recovered’ and the Fed has withdrawn stimulus, growth is still being heavily supported by the Fed’l Gov’t, which is one reason that fiscal programs enacted earlier in the year were forecast by some as a “sugar-high” temporary boost to growth.


On the week, whatever positive feelings came out of the G20 meeting quickly evaporated, with SPX down 4.6%. On Tuesday the NFIB small business optimism data is released, which has been closely correlated to the Russell, which was down 5.5% this week for a new low close on the year.  We’ll see if NFIB follows suit.  Treasury yields plummeted with a decline of 15 bps in the 5y to 2.69% and 16 bps in tens to 2.845%.  The German bund ended at 25 bps, below important support at 30/31.  China’s ten year also finished at a new low of 3.31%.


The Eurodollar curve saw a massive re-pricing.  The one-year spread between the 3rd and 7th quarterly contracts inverted after having been as high as +42 in February.  This is now June’19/June’20 which settled -3.5 (9716 and 9719.5).  Some forecasters had been predicting recession in late 2019 and the euro$ curve generally had been on the same page, with EDZ19/EDZ20 hovering between +5 and -2 since summer.  However this spread, Z19/Z20, plunged to a new low of -12 on Friday, and the inversion of nearer spreads like EDM9/EDM0 puts the timetable for recession much closer.  What a difference a week makes.  EDZ19 was up 12 bps on the week on huge volume, while the middle 2 greens, EDH21 and EDM21 were up a whopping 22.5 bps (strongest part of the curve).  No matter how the ‘dots’ come out at next week’s Dec 19 Fed meeting, the ED curve is currently looking at a terminal rate of around 2.5%.  In Fed Funds, the Jan’19/Jan’20 spread went from 31 to 19.5 on the week…over/under on the prospects of just one hike over next year.  EDZ19 has the most open interest of any contract on the board, but 49K were liquidated on this week’s rally, from just over 2 million to 1.954m.    On the other hand, EDZ20 rose in OI from 1.189m to 1.246m.  Note that midcurve December options expire Friday so there will be quite a bit more adjustment this week.  On Friday Nov 30, 2EZ 9700 straddle settled 10.5 with a settlement right on strike at 9700 in EDZ0.  With just 5 trading days until expiry, 2EZ 9725^ settled 10.0 vs 9721.5 (and needless to say, the 9700 straddle doubled).


The other powerful move was inversion in the very front part of the ED curve, with EDZ18/EDH19 closing at negative 1.  Partially this is due to year-end funding concerns, as libor/ois widens.  The December Eurodollar to January’19 FF spread closed at a new high of 43 bps.  EDZ8/EDH9 was as high as +15 in early November.  A nice trade that occurred to play the inversion was a buyer of EDZ/EDF 9725 call calendar for 1.0.  Settled 2.25 on Friday, 0.5 in Dec and 2.75 in January.


The interest rate market is sending SOS flares for relief from the Fed’s austerity campaign, and stocks are now also begging for help, but problems are geopolitical rather than simply financial.  In some cases there are regulatory issues.  For example, DB closed at a new low.  GS closed at a new low, off a third from the year’s high.  In fact, in the past month, the market cap of GS declined by the same amount as the total current market cap of DB (about $18B).  XLF, the financial etf, closed at a new low, down 17% from the high of the year.  Tensions with China went from a brief sigh of relief on Monday to a white-knuckle grip with the arrest of Huawei Technologies CFO.  The rioting in France seems to be expanding outward.  Conditions under the leadership of Trump, Macron and May are deteriorating.  Are markets warning of a glancing blow without lasting damage, or are we marching down to the bog for ritual overkill? CNBC commentators will obviously echo the Black Knight, “Tis but a scratch”.  On the other hand, with problems piling up globally, we might close out the year with, “Alright, we’ll call it a draw.”  Which would be a bloodbath, a combination of under-statement, and over-kill.


Besides the auctions, this week includes inflation data, PPI Tuesday and CPI Wednesday.  Retail Sales on Friday.



Feb/April FF spread settled 6.0, down another 5.0 on the week and effectively taking down the odds of a March hike to 1 in 4.  May/July settled 4.5, down 1.5.  Fed fund spreads have chopped odds of further hikes, but in the front end, funding libor/ois is front and center with EDZ8/EDH9 INVERTED at minus 1.0, down 6.25 on the week, and EDZ8/FFF9 at 43.0.


11/30/2018 12/7/2018 chg
UST 2Y 280.9 271.1 -9.8
UST 5Y 284.1 268.9 -15.2
UST 10Y 301.0 284.5 -16.5
UST 30Y 330.9 314.0 -16.9
GERM 2Y -59.6 -59.9 -0.3
GERM 10Y 31.3 24.9 -6.4
JPN 30Y 80.0 80.6 0.6
EURO$ Z8/Z9 22.8 10.0 -12.8
EURO$ Z9/Z0 -2.5 -12.0 -9.5
EUR 113.20 113.87 0.67
CRUDE (1st cont) 50.93 52.61 1.68
SPX 2760.17 2633.08 -127.09
VIX 18.07 23.23 5.16

Posted on December 9, 2018 at 5:44 pm by alexmanzara · Permalink
In: Eurodollar Options

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