Feb 18. Veisalgia – ‘Uneasiness following debauchery’

My web surfing research was freewheeling for this note.  First, I thought I would delve into the Chinese New Year, Year of the Dog.  Somehow, this morphed into Hair of the Dog, which turned out to be a much more productive and useful thread of inquiry, and led to this week’s title, “Veisalgia” which was apparently coined as a medical term in the year 2000 to describe a hangover.  This scientific word is formed from Norwegian ‘kveis’ (uneasiness after debauchery) and Greek ‘algia’ (pain). I don’t know why some pompous jackass had to come up with a ‘medical name’ for a hangover, but I knew I was going to use it when one site also referenced Vikings.

In any case, the term sort of fits with market action last week, subsequent to the Viking debauchery of vix, stocks and bonds in the previous week. This week stocks rallied, the dollar had a small bounce, vix fell.  It all feels a little better.  On the trading floor after a big night it would be comparable to working through the 7:30 data, followed by a trip to the Merc Club, and an omelet made by Carmen with her homemade salsa, served by the charming Idolina, while Onecimo or Alfredo set you up with a 7 oz Budweiser (or two), all the while with a view through the west windows of office workers streaming out of the Northwestern train station for their day’s 9 o’clock start.  Hair of the dog, all better.  The business was a bit more fun back then.  So…let’s try to recall some details from last week.

The big piece of data was CPI, which came out stronger than expected at +0.5.  Yields surged to new highs.  However, the curve flattened, and sensing the worst of the damage was over, vol on longer maturities was crushed going into the holiday weekend. I marked the USM straddle at just 8.2 vol, astonishingly low in my opinion. On the week, 5/30 dropped over 11 bps, from 62.3 to 51.1.

On Friday, the dollar index posted a slight new low, but then reversed with an outside day and closed higher.  EURUSD was a mirror image, new high and a reversal.  Everyone has now become a dollar bear, but I think it’s due for a good tradable bounce with more or less of a triple bottom set Jan 26, and then Jan 31, followed by Friday’s test which was slightly lower.  Stop out below Friday’s low, or above Friday’s high if shorting EUR.

What I keep reading now are references to old topics that have had new life breathed into them:  twin deficits, crowding out, trade wars.  So I used google trends on the first two phrases, expecting to see a surge in interest.  I didn’t.  But even though they’re not on google, doesn’t mean they haven’t crept back into the markets’ consciousness.

The big issues for fixed income remain, and are quite clear.  Increased supply in the context of increased inflation.  While the BoJ re-affirms its monetary stimulus with Kuroda’s reappointment and a new deputy who favors more monetary largesse, elsewhere things are tightening up just a little.  This is obvious in the front end of the Eurodollar curve, where both EDH8 and EDM8 settled at new lows.  The fall has been stunning.  EDM8 has surged over 75 bps in yield since September, from 9852.5 to Friday’s settle of 9777.5.  Friday to Friday change in EDH8 was 9804.5 to 9795.5 and in EDM9 9786.0 to 9777.5.  In contrast, the ten year note yield rose just under 5 bps on the week to 287.5 and the 30 yr bond was essentially unchanged at 313.5. By the way, weakest parts of the curve were the 2y (+13 bps) and red euro$ pack, -14.875.  Here’s a picture of fra/ois…looks like it wants to revisit highs made during the money market reform surge to nearly 50 bps in October of 2016.

In terms of ‘crowding out’ I would note that HYG spiked to a new low on Friday 09-Feb, but has been grinding higher over the past week.  I would mention once again, that corporate debt at $8.84T and total business debt at $14.06T are at record levels….not such a big deal given low rates and tight spreads, but debt servicing costs are going to chew up a bigger part of the budget going forward, for both gov’t and business, and with gov’t debt becoming more plentiful, the business sector may need to pay more of a premium for financing.

On the topic of trade wars, Commerce Sec’y Wilbur Ross suggested imposing hefty tariffs on steel and aluminum for national security purposes.  Trump has until April to decide, but China has already responded, and I wouldn’t be surprised if the threat of trimming reserves of US treasuries isn’t inferred as a possible response.

The point is, we’ve addressed the worst part of the hangover with a big greasy breakfast and hair of the dog, but now the market may be rested well enough for another foray into debauchery. Like Vikings.


This next section is redundant for some, as I put out a note late Friday regarding EDZ8 and EDZ9 positioning.  However, I am repeating some of the highlights here with updates.

There has been heavy accumulation of EDZ8/EDZ9 calendar spreads since the start of the year, including a block buy of 40k at 34.5 on Friday.  According to CME data, open interest in EDZ9 vaulted up by 93k contracts Friday to 1.822m, which is now the highest open interest on the curve, followed by EDZ8 at 1.750m (down by 21k Friday).  The next highest contract is EDM8 with 1.54m, so people are extrapolating position size of 400+k for the Z8/Z9 buyer.  I’ve previously noted Fed ‘dot’ projections for Fed Funds at year end of 2018 and 2019 at 2.1% and 2.7%, and with EDZ8 settling at 9753.5 or 2.465% and EDZ9 settling at 9719.5, or 2.805%, the market is pretty much accepting the Fed’s forecast (for the first time ever).

As a reminder, on January 5, there was a seller of >100k EDZ8/Z9/Z0 butterfly at 14.5.  On that day, EDZ8/9 settled 20 and EDZ9/0 at 5.5.  Over the next couple of days the low in the fly was 13, but on Friday it settled at a new high for the year at 24.0, and traded as high as 25.5.  In the interim, associated with the Feb 5 stock sell off, the fly touched 14.5 again.  On Friday, EDZ8/9 settled 34.0 and EDZ9/0 10.0.

There’s obviously a pretty good roll up the curve.  For example, EDH8/9 is 51.0, M8/M9 43.0, U8/U9 39.0.  However, the forward roll has become slightly less compelling recently, especially as fra/ois spread has blown out and near contracts came under heavy selling pressure.  For example, the high settle on 2-Feb in EDH8/EDH9 was 60.5, and it’s now 51.0. EDZ8/EDZ9 on 2-Feb was 36.0s.  So, at that point, the roll was 60.5-36.0 or 24.5 bps; call it 2.7 bps per month. But now that’s been cut back to a difference of 51 vs 34, or 17 bps over 9 months; 1.9 per month.  This is obviously simplistic, but provides a bit of context.  On 2-Feb the one year butterflies were as follow: March 29.5, June 24.5, Sept 24.0 and Dec 22.0.  Now they are 24.0, 24.0, 25.0 and 24.0.

In a more technical picture, the weakness of EDZ9 is ‘distorting’ markets.  For example, consider EDM9/EDU9/EDZ9 fly vs EDU9/EDZ9/EDH0 fly (3 month double butterfly).  It traded -7.0 Friday.  The doubles on either side are +4.0 (EDH9 start) and +6.0 (EDU9 start).  That’s quite a disparity, and indicates “cheapness” of EDZ9 contract.  Or consider plain 6 month butterflies: EDM9/EDZ9/EDM0 is 11.0/11.5 (11.0s).  The one in front, EDH9/EDU9/EDH0 is 7.0 and the one after, EDU8/EDH9/EDU0 is 6.0.

There are sev’l reasons that this situation might persist, (or might not).  First, perhaps the EDZ8/Z9 buyer begins to exit.  That doesn’t appear so likely.  Second, rel val players could come in and start buying EDZ9 in various fly configurations, which might rub the rough edge off of this curve ‘kink’.  That obviously is occurring, but may not be large enough to have much impact yet.  However, given the decline in front butterflies, players might be more emboldened to fade Z9 weakness.  For example, selling Z/Z/Z no longer appears to entail much in the way of negative carry.


2/9/2017 2/16/2018 chg
UST 2Y 205.7 218.7 13.0
UST 5Y 251.3 262.4 11.1
UST 10Y 282.6 287.5 4.9
UST 30Y 313.3 313.5 0.2
GERM 2Y -56.7 -56.8 -0.1
GERM 10Y 74.5 70.6 -3.9
JPN 30Y 80.5 78.5 -2.0
EURO$ H8/H9 46.0 51.0 5.0
EURO$ H9/H0 26.0 27.0 1.0
EUR 122.52 124.09 1.57
CRUDE (1st cont) 58.99 61.55 2.56
SPX 2619.55 2732.22 112.67
VIX 29.06 19.46 -9.60




Posted on February 18, 2018 at 1:45 pm by alexmanzara · Permalink
In: Eurodollar Options

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