It was a heck of a January, punctuated by the FOMC meeting of January 30, where the Fed confirmed that hikes in the FF target are over for now.  Not, as I pointed out last week, that there weren’t plenty of hints from Fed officials beforehand.  The guy who got it EXACTLY right, though often maligned for getting it exactly wrong, was Dennis Gartman.  Below is his call, made after Powell’s appearance on January 4 (this quote is lifted from ZeroHedge on Jan 7). 

Stock markets everywhere are materially stronger following the “about face” that Mr. Powell made on Friday which we think has changed the game of investment sharply… violently… dramatically… in the opposite direction from where it had been. We are now of the mind… after having been manifestly and loudly bearish of the global stock markets and most particularly of the US stock market because the Fed had been removing the fuel from the markets and from the economy via its continued and material running off of its balance sheet… that stocks are headed a good deal higher; that the dollar is headed a good deal lower; that commodities… and especially gold… are headed demonstrably higher and that the great game has changed. We do not make this statement often, but Friday was a WATERSHED shift on the part of the Fed and a WATERSHED shift on our part.

NICE CALL!  (but how long does a ‘watershed’ last?)

All assets rose in the month of January.  From US stocks to DAX, Kospi to the Hang Seng, crude oil to gold, EEM to HYG.  Not lost on Gartman is the Druckenmiller rule: ‘For me it’s never been about earnings, it’s never about politics, it’s always about liquidity.’ That quote is from a Real Vision interview with Druckenmiller (short youtube link below), from Sept 2018, where he’s actually warning about the Fed’s REMOVAL of liquidity spilling into the possibility of a hard sell off in Q4.  Also correct. 

Gartman nailed it.  If the Fed is changing its posture on the removal of accommodation, then markets will react positively from depressed levels. But let’s take a closer look.  Gartman mentions the balance sheet run-off as a primary culprit, but the Fed did NOT announce a change in the tapering schedule (they’ve dangled that carrot for the March meeting).  Also, the dollar is only slightly weaker than it was at the start of the year.  What should we sell the dollar against?  The euro? I don’t think so…  Italy has fallen into recession, and the Italy Bank Index is the only thing that hasn’t rallied but is actually right at the low from the end of the year.  The euribor curve has flattened; Eurozone growth has slowed.  Sell USD against the yen?  The 10y JGB closed the week back at a negative yield (-2.2 bps) while the 30yr ended at 60 bps, the lowest since late 2016.  (If you recall, global yields all made their lows in mid-2016, following the EM and energy rout of late 2015 into 2016).  Perhaps DXY will soften from here, but maybe the better call is to sell USD against commodities.  I.e. buy gold.  Another one of Gartman’s recommendations.  I would note however, that gold was rallying even in December on global financial stress, and was much more adept at picking up on hints being dropped in December by Fed officials that policy might change.  GLD ended November just below 116 and ended December above 121, and is now 124.50. 

I think the Fed has laid the groundwork to trim the balance sheet run-off schedule at the March 20 FOMC which is 6 ½ weeks away.  Details will, of course, be dribbled out beforehand.  Will this shift be enough to keep January’s trends intact?  I doubt it.  Negative global issues remain.  Perhaps a US/China agreement before the March deadline will provide another shot of adrenaline to stocks, but liquidity will be key, globally.   

While the Fed may slow the balance sheet run-off, the treasury is, over the longer term, increasing supply.  That is, siphoning off investment dollars from other places in order to increase gov’t borrowing.  Consider this paragraph from the TBAC (Treasury Borrowing Advisory Committee) minutes released last week:      

The Committee then turned to a presentation on the potential for innovation in Treasury’s suite of products and debt management tools. The presenting member outlined the potential for a significant financing gap over the next 10 years in the context of the potential need for domestic investors to participate more if foreign reserves were to grow at a slower pace. In a high level “blue sky” presentation, the committee discussed a list of potential products that might generate additional demand from untapped savings pools, widening Treasury’s investor base, including: additional floating rate notes, inflation indexes, nominal coupon maturities, zero-coupon securities, and other structures. It was emphasized that any of these potential ideas would require additional review and analysis before the Committee would be prepared to make a recommendation.

Hahahhahahahahha.  I LOVE this paragraph.  When I was a clerk on the old trading floor, my ‘colleagues’ and I would engage in what we called “High-level executive conference meetings” which was to say,  drinking beer and playing liar’s poker.  That’s what this sounds like.  “Suite of products”.  “Blue sky”.  “Untapped savings pools”.  I hope the guy that wrote this isn’t still paying off the loans for his MBA.  I had to look up “blue sky” on google. Here’s a result: “Thinking creatively.  Creative thinking is the process by which individuals come up with new ideas or new approaches to business.”  Honest. 


And here’s the blue-sky approach:  Let’s give them free toasters if they buy up to $250 million in floating rate notes.  Great idea!  Let’s take a break for lunch.  What exactly are “Untapped savings”??  If you widen the Treasury investor base, you’re taking market share from someone else.  The cash isn’t just hiding under a rock. 

This is how it worked for me in liar’s poker:  Someone had called four sevens.  Then 4 nines, then 5 deuces.  My turn.  “Five sevens.” (I had none; a masterful bluff). Without hesitation: CALL.  CALL. CALL. And finally, Tony Bria, “I call you, VE-HEE-A-MENTLY”.  No sevens on ANY of the bills.  That, my friends, is known as a “financing gap.”

It was also around this time that I worked for a major US bank.  They brought in sales consultants for a seminar which dragged on interminably.  At one point, the presenters suggested, “Try to engage your customers on a personal basis.  Ask them what they’re doing on the weekend.  Ask them about their families…”  My friend Tom S had enough and interrupted, “How about showing them a good TRADE IDEA?  If you want a friend, GET A DOG.”  As hard as I was laughing I could still see that the presenters were deer-in-the-headlights dumb-founded.  You need to sell more treasury bonds?  Sweeten up the yield a little bit.  Or…better yet, have the Federal Reserve (code word for ‘untapped savings’) buy them. 

Here is where we can see a little bit of a problem.  On the chart below, I have the 2 and 5 year note yield plotted against the Fed Effective rate.  Carry has lessened significantly.  Longer dated assets are within 10 bps of funding costs.  Need to sell more?  Either drop the financing rate or get the yield up on the long dated stuff.    

2y and 5y treasury yield and Fed Effective

In terms of rates, the ten year yield rose Friday, partly due to a big NFP of 304k.  On the week, the curve bull flattened, exactly as expected with the Fed shift: 2’s fell 10.4 bps, 5’s 8.0, 10’s 6.3 and 30’s 3.1.  The ten year yield closed 2.686%,  essentially the midpoint of the range I mentioned the last two weeks, between 250/55 and 282/87.  The Eurodollar curve still projects an easing bias, with the lowest one-year euro$ calendar spreads being EDU9/EDU0 and EDZ9/EDZ0 at -14.5.  Over the nearer time frame, the Fed Fund curve is worth a look, and that look, in a word, is BORING.  Every contract from February 2019 to October 2019 settled exactly on the current Fed Effective of 2.40%, that is, 97.60.  January 2020 settled 97.63, a modest nod to the chance of an end-of-the-year cut. 

The interest rate market was knocked off course by a seismic disturbance, which caused shockwaves that have now lessened in amplitude, oscillating around the final resting spot of “we’re done”.  (Hey, maybe I can work for TBAC).  So I guess it should be no surprise that implied volatility in treasuries is right back down to the lower end of the range near historic lows.

This week brings auctions of 3’s, 10’s and 30’s.  So far there has been no problem at all in absorbing supply.  Trump’s State of the Union address will be on Tuesday.  


Given Fed dots projecting 2 hikes in 2019 vs the market projecting none, it’s reasonable that low risk shots are being taken to the downside.  Ironically, if the Fed DOES announce a tapering of the run-off schedule, an increase in the FF target may again be in play.

There was a large buyer of 150k EDU9 9725/9712ps on Thursday for 2.5 bps. Settled 3.0 on Friday vs 9735.5. This theme continued Friday with buying of EDZ9 9725/9712ps for 3.5 covered 9740-40.5.  Settled 4.25 vs 9734.0.  Further back on the curve there was also put spread buying, for example 3EH 9712/9687ps bought for 0.5 25k; EDH22 settled 9748.5.  I like the idea of cheap long put spreads in blues or golds. As mentioned, the treasury curve steepened this week, and while I highlighted the historic flatness of the red/green pack spread last week, it’s worth noting that red/gold is perking up a little bit, and, with a change in the Fed’s outlook, may have found a long term bottom. 

In this context consider the futures spread between EDM22 and EDM23 (Blue/Gold June).  The near one-year calendars are all negative, but EDM22/EDM23 is +12.5.  The green/blue pack spread (year 2021 to 2022), is +6.625 and blue/gold (2022 to 2023, is +12.25).  Relative steepness in the back part of the curve could be sending a signal about forward expectations of inflation and term premium. 

1/25/2019 2/1/2019 chg
UST 2Y 259.8 249.4 -10.4
UST 5Y 258.7 250.7 -8.0
UST 10Y 274.9 268.6 -6.3
UST 30Y 305.9 302.8 -3.1
GERM 2Y -58.0 -58.1 -0.1
GERM 10Y 19.3 16.6 -2.7
JPN 30Y 65.2 60.2 -5.0
EURO$ H9/H0 1.0 -7.5 -8.5
EURO$ H0/H1 -12.5 -10.0 2.5
EUR 114.13 114.59 0.46
CRUDE (1st cont) 53.69 55.26 1.57
SPX 2664.76 2706.53 41.77
VIX 17.42 16.14 -1.28
Posted on February 3, 2019 at 8:19 am by alexmanzara · Permalink
In: Eurodollar Options

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