Jan 28, 2018. “Why, he stumped his TOE”

A body might stump his toe, and take poison, and fall down the well, and break his neck, and bust his brains out, and somebody come along and ask what killed him, and some numskull up and say, ‘Why, he stumped his TOE.’ Would ther’ be any sense in that? NO. And ther’ ain’t no sense in THIS, nuther.

–The Adventures of Huckleberry Finn, by Mark Twain

CNBC had a 15 minute interview with Ray Dalio in Davos.  [Link at bottom]  Here are a few quotes from that segment:

If you’re holding cash, you’re going to feel pretty stupid

We’re going to have a jolt of stimulation

Classically, this is late cycle behavior

All assets trade at the present value of the future cash flows…interest rates affect all assets

It just takes a little change in interest rates to have a bear market

Now which of those quotes got all the airtime, breathlessly repeated on subsequent shows?  That’s right, “If you’re holding cash you’re going to feel pretty stupid.”  Becky Quick responded to that line with a stifled giggle, and the whole interview was summarized by, “Why, he stumped his TOE!”

I understand.  It’s tv.  Hahahaha….he said ‘stupid’ did you hear that?  He said stocks are going to be ‘jolted’ higher.  Hooray!  We have our scoop!

In the initial quote, ‘stumped’ means stubbed.  But ‘stumped’ in its present meaning can also be related back to the CNBC interview.  Because the most important things that Dalio mentioned seemed to have left the panel baffled. (Image of South Park’s Cartman silently blinking his uncomprehending eyes).   This is what he said, and he said it twice: “All assets trade at the present value of future cash flows…so interest rates affect all assets.” And he went on “…because duration of bonds and debt has lengthened, it just takes a little change in interest rates to have a bear market”.  With respect to monetary policy, “Will it be tighter than is discounted by the curve? We have a very small amount of tightening built into the curve. If it is greater…that can upset all asset prices.”  Here, Becky Quick interjected an inane comment about the number of hikes this year, at which point Ray tried to slow it down a little, in a vain attempt to bring the level back down to his audience.  He pounded it home again, “…you can’t have a significant rise in interest rates without knocking over the whole asset markets – all markets. Everything… is trading at cap rates or yields that are very low; if all of a sudden you raise the discount rate on that, they’re all going to go down.”

Now, Dalio didn’t suggest a crash was imminent. He said the key factor was how the Fed and other Central Banks respond to the current environment.  In the short term, he indicated that things are fine, but added that monetary policy is in a delicate area due to increased leverage in some parts of the economy, and noted that we now have more sensitivity to rates than ever.  He also mentioned increased bond supply as a potential issue.  When Andrew Ross Sorkin said, (as if he’d discovered a previously unknown gem of modern finance) ‘If this is the last leg, then you as an investor need to know when to get out”, Dalio just threw up his hands and said “THAT’S MY GAME!”

Dalio did not seem to be concerned that this jolt of stimulation would spark increased inflation, but I would say that the Fed may have to contend with just that possibility.

So, to bring it all back to the US rates market, where do we stand? Twos, fives and tens closed at new high yields. The Eurodollar strip out to the greens (the first three years) closed at new lows.  While the back end curve isn’t moving all that much, front euro$ calendar spreads closed at new highs.  For example, EDH18/EDH19 settled 57.0 (up 3 on the week), and Jan’18/Jan’19 Fed Fund spread settled 66.75.  This latter spread is a reasonable proxy for the amount of tightening priced for 2018, and it’s approaching the 70 bps projected by the Fed dots.  It’s true that the curve doesn’t have much priced in; indeed the red to green (2nd to 3rd year) ED pack spread is still below 14 bps, and 5/30 treasury spread closed at its ten year low of just 44 bps. However, direction and sentiment, especially notable this week, suggest that the market MAY begin to reflect a more aggressive Fed, and there are additional influences that could upset the asset apple cart.  These factors include new lows in the dollar, heightened sensitivity to bond issuance, and a parabolic rise in stocks.

With respect to the dollar, there was a bit of a dust-up this week when it was reported that Treasury Sec’y Mnuchin said the US welcomed a weaker dollar.  I didn’t see that particular clip.  I did see that both he and Trump indicated the comment was misconstrued. I always recall a remark by Richard Dennis, who said it’s critical to observe how the markets react to news.  For example, if a bearish piece of news comes out and the market doesn’t go down, or indeed goes up, that’s bullish.  Well here’s what I will say about Mnuchin’s comment.  It was bearish for the dollar.  The dollar went down.  And closed at a new three-year low in spite of the ‘misconstrued’ stuff.  Along the same lines, Draghi was expected to talk down the euro at the ECB press conference.  It closed at a three year high. I believe the dollar index is nearing important support (DXY 88.42 vs 89.02 currently).  But the trend is lower.

The risk going forward is that the interest rate curve will begin to indicate MORE tightening into the future.  That concern was on full display Friday, with large amounts of put buying in Eurodollars.  For example, EDG 9812p were bought in size of 80k, settling 1.0 ref 9813.0 with 3 weeks to go.   In midcurves, most straddles ROSE week over week.  For example, 2EM 9737.5 straddle settled on Jan 19 at 29.0 vs 9737 in EDM0, and 31.5 on Friday vs 9733.0.  3EM 9725 straddle went from 32.0 vs 9729.0 in EDM1 to 35.0 vs 9726.5.  Not particularly pleasant for the market making community, but also indicative of less certainty regarding the forward path of rates (perhaps accentuated by the passing of the torch to a Fed board with a much different composition).

On Tuesday we’ll have Trump’s State of the Union speech.  (An echo of Collidge’s “The chief business of the American people is business” from 1925?).  On Wednesday, the last day of the month, it’s the last Yellen FOMC meeting.  The end of month has also been associated with portfolio rebalancing, perhaps particularly important this time due to the runaway rally in stocks.  On Friday it’s the employment report. I believe the Treasury will also announce borrowing estimates this week.

With regard to the Fed meeting, there’s not likely to be much change in the statement, though there could be mention of increased market measures of inflation.  For example, in the first week of December, prior to the last meeting, the ten year tip/treasury breakeven was holding around 1.87%.  This past week it averaged 2.07%, a rise of 20 bps.  Note also that the CRB made a new 2 year high this week.


Apologies to Becky, Joe, and Andrew.  I didn’t really mean to say you looked stumped.  Sometimes it just comes out that way.

Pray for me! I reckoned if she knowed me she’d take a job that was more nearer her size. Huck Finn, responding in his head to Miss Mary Jane saying she’d pray for him.


1/19/2018 1/27/2018 chg
UST 2Y 205.6 211.6 6.0
UST 5Y 243.6 247.0 3.4
UST 10Y 263.9 266.0 2.1
UST 30Y 291.3 291.1 -0.2
GERM 2Y -60.3 -54.4 5.9
GERM 10Y 56.8 62.4 5.6
JPN 30Y 82.5 81.0 -1.5
EURO$ H8/H9 54.0 57.0 3.0
EURO$ H9/H0 21.5 21.5 0.0
EUR 122.20 124.27 2.07
CRUDE (1st cont) 63.31 66.14 2.83
SPX 2810.30 2872.87 62.57
VIX 11.27 11.08 -0.19



Posted on January 28, 2018 at 5:34 pm by alexmanzara · Permalink
In: Eurodollar Options

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