Jan 6, 2019. FLEXIBILITY

To start this note I am listing a few bullet points of important events, in reverse chronological order.  It was a pretty extraordinary week. 

BIG EVENTS in the week 12/31/2018 to 1/4/2019

There’s a link below to the Credit Bubble Bulletin which does a superb job of summarizing these events.

At the American Economic Association Conference on Friday, Powell described policy-making in times of uncertainty as a function of ‘risk management’ specifically citing 2016.  If you recall, the end of 2015 going into 2016, featured a continuing slide in the price of crude oil and an explosion of credit spreads, though mostly in energy names.  Powell said that the Fed had initially forecast four rate hikes in 2016 (which can be seen on the table below). In December 2015 the Fed had initiated its first hike to 0.25/0.50, or to 0.4 on the table, and at that meeting the FF projection for the end of 2016 was 1.4%.  (Shaded red on the table, a forecast of 4 hikes over the year).  Powell said that as financial conditions tightened, the Fed ‘flexibly’ adjusted the expected rate path, but eventually ended the year with one hike in December.  Then he said, “No one knows whether this year will be like 2016, but what I do know is that we will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy…”  He also said the Fed will listen carefully to markets and incoming data.  In other words, even though we have two hikes penciled in for 2019, we might stay on hold.  He said the market is “pricing in risks” to which the Fed is highly attuned. 

On the other hand, he was somewhat dismissive of possible negative effects from balance sheet reduction.  “We don’t believe that our issuance is an important part of the story of the market turbulence that began in the fourth quarter of last year.  But, I’ll say it again, if we reached a different conclusion, we wouldn’t hesitate to make a change.” On Saturday, Bernanke also said he didn’t think the balance sheet was responsible for market turbulence. It’s oddly coincidental that the increase in balance sheet run-off to $50 billion per month at the start of Q4 almost exactly marked the peak of stock index prices.  But the Fed has certainly bought time until the January FOMC to determine if changes need to be made.  My guess is that they WILL tweak the balance sheet schedule at the January meeting unless there is concrete progress made in China trade negotiations.  Trump continues to insist that the US is negotiating from a position of economic strength, while XI has ordered his military to improve combat readiness and prepare for the possibility of war, warning of “unprecedented risks and challenges.”    


Powell has simply acknowledged what the interest rate markets have already proclaimed.  No hikes in 2019.  On Thursday, euro$ and Fed Fund calendar spreads plunged to new lows, indicating increased odds for an EASE in 2019.  In euro$’s, March’19 to March’20 settled MINUS 27 and June’19/’20 settled minus 28.  In Fed Funds, January’19/’20 settled -18 on Thursday but rallied back to -8 on Friday.  The point is, that in spite of a powerful bounce in stocks and a huge payroll report, forward contracts are still signaling lower rates ahead. EDH9/H0 settled -19.5 Friday and EDM9/M0 settled -23.5.

Consider TYH9 contract.  On Thursday prior to ISM, the contract was trading around 122-06.  By the end of the day it had topped at 123-08. After Friday’s massive payroll report, the settle was 122-095.

The fact that what used to be the most important economic data release of the month couldn’t more than reverse a rally from Manufacturing ISM reflects a continued underlying bid.  Perhaps a strong Service ISM number on Monday will build on Friday’s price reversal.  I would also note this week’s auction schedule of $78 billion in 3’s ($38b), 10’s ($24b) and 30’s ($16b) which will raise $39 billion in new cash.  In any case, I continue to watch the area from 2.49-2.52% as key resistance.  Last week I noted that a long term trendline off the 2016 low had been breached, and added:  “The 38.2 retrace is 2.52%, which would approximately equate to TYH9 123-08.” The actual low yield was a couple of bps above 2.52%, but the high of the week/move, was exactly 123-08. 

There are a lot of Fed speakers this week, primarily on Wednesday and Thursday.  Wednesday features Bostic, Evans and Rosengren, while Thursday Powell speaks during the day and Clarida in the evening, with additional appearances by Bullard, Barkin and Evans (again).  FOMC minutes are released on Wednesday afternoon.  I would expect a generally dovish tilt to officials’ comments, with the word ‘flexibility’ being emphasized.  One other quick thought.  AAPL has lost $400 billion of market cap since the high in October.  It’s just one company, but that loss of wealth represents 2% of GDP in a $20 trillion economy.  The reverse ‘wealth effect’ may become a topic of increasing importance.


As mentioned above, near STIR calendars lean towards Fed ease.  I will just highlight here the FF contracts which bracket the next three quarterly FOMC meetings: Feb/April, May/July and Aug/Oct.  Spread settlements Friday were -0.5, +1.0 and -1.5.  On Thursday they settled -2.0, -2.0 and -2.5.  Spreads which barely moved for weeks are now bouncing around easily.  Once again I will mention the week over week change in January’19/January’20 FF spread, from -1 to -8.  Odds for an ease have increased, and moved forward in time.  Every FF contract is higher in price (lower in yield) than the current Fed Effective rate of 2.4% except July 2019 which is 0.5 bp higher at 97.595.  On Thursday both the 2 and 5 year note traded at a yield below the Fed effective.  On Friday the March SOFR contract settled 97.58 or 2.42%, with 2’s and 5’s just barely above 2.48%.  Carry has vanished.

On Friday, it’s notable that open interest declined in nearly all treasury contracts.  The closer contracts which represent ‘disaster insurance’ lost the most: 2y -135.3k, 5y -52.6k, 10y -17k. Ultra 10y -2.2k.  The 30y and Ultra showed small increases of +1.7k and +3.3k.  The euro$ strip open interest fell by 101k.  Longs pared back.  What does it mean?  Fear of a stock market melt-down is very powerful, and Powell was able to squelch that risk for the time being.  But even if the monetary authorities in the US recognize their role in the risk landscape, it doesn’t mean that all the global players do.    

12/28/2018 1/4/2019 chg
UST 2Y 253.4 248.4 -5.0
UST 5Y 257.0 248.1 -8.9
UST 10Y 273.4 265.7 -7.7
UST 30Y 304.1 297.4 -6.7
GERM 2Y -60.9 -59.5 1.4
GERM 10Y 24.2 20.8 -3.4
JPN 30Y 70.4 65.2 -5.2
EURO$ H9/H0 -13.5 -19.5 -6.0
EURO$ H0/H1 -9.0 -11.0 -2.0
EUR 114.43 113.98 -0.45
CRUDE (1st cont) 45.33 47.96 2.63
SPX 2485.74 2531.94 46.20
VIX 28.34 21.38 -6.96
Posted on January 6, 2019 at 8:38 am by alexmanzara · Permalink
In: Eurodollar Options

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