Hey Jerome, look at my new dress. It was a steal!

June 16, 2019- Weekly Comment

It’s pretty clear what is driving expectations for a Fed rate cut:  Women’s apparel prices.  On a year over year basis they fell 5.7% in May.  The St Louis Fed chart below starts in 1992. The decline is greater than seen even in the depths of the Great Financial Crisis.  The next chart is the University of Michigan Survey of 5-10 year Inflation Expectations, which also hit a new historic low of 2.2%.  Obviously, I’m stretching the case like a pair of yoga pants with the women’s apparel thing.  (By the way, lululemon LULU made an all time high this week).  On the other hand, Powell has gone out of his way to emphasize the importance of inflation expectations in setting policy, and both survey and market measures have declined.

Yoy change in women’s apparel prices
U of Michigan 5-10 year inflation expectations

On the week, prices didn’t change all that much.  The ten year note was up less than one bp at 2.09% and thirties added 2 bps to end at 2.59%.  Auctions were well received with respectable bid-to-cover ratios in spite of the low yields.  Stocks ended a touch higher, VIX edged lower.   The critical event this week of course, is the FOMC meeting.  Though some analysts have called for an insurance rate cut on Wednesday, the market clearly signaled on Friday that it’s NOT going to happen.  For example, gold, which was up $15 early on Friday closed nearly unchanged.  The dollar index surged, having successfully held the 200 DMA.  Fed fund and ED futures downticked.  However, odds for an ease at the July FOMC are still quite high.  August FF (FFQ9) settled 97.87, 23 bps above FFM9 at 97.64.  The July/Aug FF spread settled -19.5, indicating around 80% odds of an ease at that meeting. It’s worth remembering that the Fed taper program ends at the end of September, and it was the increase in asset sales to $50 billion a month in October that coincided with the market turmoil of Q4.   

After solid retail sales and industrial production data, the Atlanta Fed marked up its Q2 GDP Now forecast to 2.1% from 1.4%.  The NY Fed also increased its Q2 estimate, which now sits at 1.4%.  The Fed has already judged recent soft inflation readings as transitory.  On the other hand, the constant repetition by various officials  that the neutral rate is declining and that another visit to the ELB (Effective Lower Bound) in rates is likely in a downturn, is a clear message the Fed is now in an easing stance.  When you have to change the acronym from ZIRP to ELB, thereby removing the reference to ZERO as a boundary, it’s not exactly a reflection of confidence in the broader economic narrative, regardless of the new and improved Fed communication initiative.

The economic signals are conflicting.  From msn, “Morgan Stanley’s Business Conditions Index, which captures turning points in the economy, fell by 32 points in June to a level of 13 from a level of 45 in May.  This drop is the largest one-month decline on record and the lowest since December 2008 during the financial crisis, according to the firm.”

The Credit Bubble Bulletin cites the rise in Household Net Worth (the equity rebound) as the catalyst for retail sales and notes these stats from the last quarterly report of the Fed’s Z.1:

Household Assets surged $4.697 TN during Q1 to a record $124.694 TN. And with Liabilities expanding just $5.9 billion, Household Net Worth surged $4.691 TN – the strongest ever quarterly increase in Net Worth (2nd place Q4 ‘99’s $3.114 TN). Household Net Worth jumped to 516% of GDP, just below the record 522% from Q3 2018. This compares to peak ratios of 484% in Q1 2007 and 444% during Q1 2000. CBB

It’s not the Fed’s place to handicap the outcome of the possible G20 meeting between Trump and Xi.  While stock investors (and treasury shorts) want to believe that resolution could occur as quickly as it did with the withdrawal of the Mexico threat, that’s not a likely outcome.  The outgoing Chairman of Economic Advisors, Kevin Hassett, was interviewed Friday and said that a deal had been so close with China before it fell apart at the last minute, that it’s not at all unreasonable to think that a few modifications could quickly lead to a sealed agreement now.  It’s a compelling argument.  Except for the fact that in the meantime, Trump has issued ultimatums, portrayed China as having a weak hand, and pursued a sale of $2 billion in arms sales to Taiwan.  Additionally, a Dept of Defense document referred to Taiwan as a “country” in an oblique challenge to the One-China policy.  As noted in the Taiwan Times, the DoD Indo-Pacific Strategy Report  of June 1 included this passage:

As democracies in the Indo-Pacific, Singapore, Taiwas, New Zealand and Mongolia are reliable, capable and natural partners of the US.  All four countries contribute to US missions around the world and are actively taking steps to uphold a free and open international order.     

What’s more likely is that CNY tests 7 between the FOMC and the G20, which would psychologically signal a further deflationary impulse. (You want to see currency ‘manipulation’?)  Nothing quick will happen in China negotiations unless the US folds. In the meantime, the situation with Iran is heating up, Italy and the EU are on different pages, and protests in Hong Kong are continuing, all of which present headwinds for risk assets.


The fed effective has been setting at 2.37%.  June Fed Funds settled 97.64 or 2.36% on Friday.  If there is no move and the EFFR remains at 2.37% for the rest of the month, FFM9 will settled 97.627.  If there’s an ease on the 19th and the EFFR goes to 2.12 for the balance of the month, then the settle will be 97.718.

6/7/2019 6/14/2019 chg
UST 2Y 184.7 184.9 0.2
UST 5Y 185.0 184.4 -0.6
UST 10Y 208.4 209.1 0.7
UST 30Y 257.2 259.1 1.9
GERM 2Y -67.0 -69.3 -2.3
GERM 10Y -25.7 -25.5 0.2
JPN 30Y 37.9 36.0 -1.9
EURO$ Z9/Z0 -27.0 -33.5 -6.5
EURO$ Z0/Z1 7.5 7.0 -0.5
EUR 113.35 112.11 -1.24
CRUDE (1st cont) 53.99 52.51 -1.48
SPX 2873.34 2886.98 13.64
VIX 16.30 15.28 -1.02

Footnotes and interesting links:






Posted on June 16, 2019 at 3:29 pm by alexmanzara · Permalink
In: Eurodollar Options

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