Feb 5, Testing for weakness

Janet Yellen:  Yes, yes, yes. That’s why we’re taking extreme precautions.

Markets:  That’s right, but they never attack the same place twice. They were testing the fences for weaknesses, systematically. They remember.

Actually, the quote above is NOT from Janet Yellen, though it might as well have been as she seems always inclined to err on the side of caution.  It’s actually this exchange from the movie Jurassic Park:

John Hammond: Yes, yes, yes. That’s why we’re taking extreme precautions.
Dr. Alan Grant: Do they show intelligence? With their brain cavity…
Muldoon: They show extreme intelligence, even problem-solving intelligence. Especially the big one. We bred eight originally, but when she came in she took over the pride and killed all but two of the others. That one… when she looks at you, you can see she’s working things out. That’s why we have to feed them like this. She had them all attacking the fences when the feeders came.
Dr. Ellie Sattler: But the fences are electrified though, right?
Muldoon: That’s right, but they never attack the same place twice. They were testing the fences for weaknesses, systematically. They remember.


Yellen and Central Bankers in general, are a little like John Hammond, the brainchild of QE… Jurassic Park.  If you are unaware of the movie, Jurassic Park was created as an attraction with live dinosaurs and raptors reincarnated from old economics textbooks  DNA suspended in amber.  OK, maybe the analogy is a bit over the top, but if we’re going to go overboard with manufactured drama, might as well do it on SuperBowl Sunday.  Consider this:

February 2 – Bloomberg (Chikako Mogi and Masaki Kondo): “The Bank of Japan whipsawed markets as it fought to assert control over rising bond yields. The Japanese central bank first disappointed with a smaller-than-expected increase in bond purchases Friday morning, which spurred the 10-year yield and the yen to advance. Its unscheduled offer later to buy an unlimited amount of debt for some maturities sent rates and the currency falling.” [Just ask the Swiss National Bank how to gracefully withdraw a peg].

It’s worth noting that the 30 year JGB closed at a new high rate of 86.7 bps, a fairly impressive move from last summer’s low near zero, and up 4 bps on the week.

In the US, the markets have been testing the idea of a series of rate hikes in 2017.  After the FOMC announcement Wednesday, odds for a move in March were lessened.  Some trades were adjusted as a result, for example, the large long position in EDM7 9862/9850 put spread was rolled higher into the 9875/9862 put spread.  However, the Friday to Friday changes in almost all Eurodollar contracts were essentially zero:  Friday to Friday change EDZ7 9847.5 to 9847.5.  EDZ8 9800.0 to 9799.5, EDZ9 9766.0 to 9766.5.  The very near contracts did edge up a couple of bps in price, as the employment data , while showing an impressive increase in payrolls (NFP +227), didn’t do much to provide the last piece of the puzzle in terms of wage growth, which was only +0.1.   However, it’s worth mention that the Prices Paid categories in both Mfg and Service ISM were at new highs last week, with Mfg 69.0, highest since late 2011 and Service 59.0, highest since early 2014.  So, while the FOMC didn’t guide the markets to more certainty of a March move, it is by no means off the table.  That point was driven home by SF Fed’s John Williams in an interview late on Friday.  The quote that captured the market’s attention was, “Williams can see arguments for a rate hike in March.”  While that line was taken slightly out of context, he indicated that he preferred to move sooner rather than later, and said if the economy runs “…too hot too long, we could see imbalances develop.” [Link of this short interview is below]  Fairly aggressive selling ensued.

While near one-year Eurodollar calendar spreads remain pegged around 50**, indicating only two hikes in a year, Friday’s price action saw most Eurodollar contracts with outside days and lower closes.  Treasury supply comes this week in the form of 3’s, 10’s and 30’s in an otherwise fairly quiet week.  Near treasuries, like Eurodollars, had marginal changes on the week, but it’s worth noting that the 30-year bond was up 5.2 bps to 311.2, and 5/30 closed at a new high on the week just over 118 bps.  Astonishingly, March bond vol (US) is still just under 10%, with March treasury option expiration on Feb 24th, AFTER Yellen’s semi-annual testimony on Feb 14 and 15.  While traders have been systematically testing the front end for rate hike resolve, they now might target the long end of the fence.

While I’m on the analogy, I’d tend to extend it further and say it’s not just the central banking fence, it’s the geopolitical world order that’s getting an electrified jolt from our new President’s haphazard tweets.  There are all sorts of fissures globally, widening like the crack in Arizona. [“A gaping, 2-mile-long crack has opened in the barren earth in Arizona, and it will likely continue to grow, geologists say.”]  http://www.livescience.com/57663-giant-crack-opens-in-arizona-desert.html

Nations and voters are going to continue to poke and prod other nations and their own leaders.

One last little note on stress testing…  It’s well known that hedge funds have been lining up against the Bank of China and the yuan, and the following snippet reflects defensive moves by that central bank.  February 3 – Wall Street Journal (Shen Hong): “China’s central bank raised key interest rates in the money market Friday, reinforcing a shift toward tighter monetary policy aimed at deflating asset bubbles and reducing long-term financial risk. The latest effort by the People’s Bank of China follows a similar decision shortly before the weeklong Lunar New Year holiday to increase the borrowing cost on special loans to a select group of commercial lenders, a move widely interpreted as an effective policy interest-rate increase.”

To conclude, here’s a final thought from Jurassic Park.

John Hammond: When we have control again…
Dr. Ellie Sattler: You never had control, that’s the illusion! I was overwhelmed by the power of this place. But I made a mistake, too, I didn’t have enough respect for that power and it’s out now.

Or, as the Bank of England’s Mark Carney said, “‘In many respects we’re coming to the last seconds of central bankers’ fifteen minutes of fame which is a good thing.”

It might be a good thing, but it might get messy.



1/27/2017 2/3/2017 chg
UST 2Y 120.8 120.9 0.1
UST 5Y 194.1 193.1 -1.0
UST 10Y 248.1 248.9 0.8
UST 30Y 306.0 311.2 5.2
GERM 2Y -66.6 -74.2 -7.6
GERM 10Y 46.2 41.2 -5.0
EURO$ H7/H8 55.5 57.5 2.0
EURO$ H8/H9 44.0 44.5 0.5
EUR 106.99 107.86 0.87
CRUDE (1st cont) 53.17 53.85 0.68
SPX 2294.69 2297.42 2.73
VIX 10.58 10.97 0.39



**EDM7/8 settled 53.0, EDU7/8 51.0 and EDZ7/8 48.0

Posted on February 5, 2017 at 2:13 pm by alexmanzara · Permalink
In: Eurodollar Options

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