July 17. Men Walk on Moon

On Friday, we had clipped a headline from Bloomberg and forwarded it; it was something about Atlanta Fed’s Lockhart (“Don’t count on quick return to ‘normal’”).  In response, we instantly received a return post from a client, a link from the NY Times, with the 1969 image of the front page headline, “Men Walk on Moon”.  Due to my being a bit slow on the uptake, I didn’t get the connection.  It was, of course, a well-deserved dig at forwarding an innocuous, stale piece of news.

In my readings this weekend I came across Blackrock’s mid year Global Investment Outlook.  It highlighted three main themes:  “1) We are living in a low return world; 2) Monetary policy has been a key driver of asset prices – but its effectiveness looks to be waning;  3) We see more volatility ahead as Brexit-related anxiety weighs on Europe’s economy and the business cycle matures.”   My immediate thought was “JFK’s Been Shot”.   To be fair, the actual report is quite interesting (link at bottom).  For example, the Reflation Debate section succinctly outlines pro and con arguments. There’s also this warning; “Those seeking to buy into market weakness should beware of notionally cheap assets facing structural challenges… We like value, but it has to have a pulse.”  (Cited European bank shares).

This week, inflation data did indicate signs of a pulse.  Core yoy CPI printed +2.3%.  As the Blackrock piece mentions, reflation can occur simply due to the arithmetic of base effects (of stabilized energy), increasing wages and service sector factors.  Retail sales also came in stronger than expected.  If there’s one thing that almost insures the return of higher inflation data it’s this:  [Mnpls Fed’s] Kashkari says “Risk of out of control inflation overshoot is nil.”  The mush.

Of course, there are global issues that tilt the other way, for example, China continues to export deflation through a weakening yuan.  Note this passage from the Q2 Hoisington Investment letter:

According to the Netherlands Bureau of Economic Policy Analysis’s (NBEPA) World Trade Monitor, the year-over-year change of the three-month average in the value of goods that crossed international borders has been hovering around 0% for the last six months. This is a dramatic slowdown from the 4.5% average growth rate registered since the end of the 2009 recession. Moreover, the last six months constitutes the weakest period since the recession. United States exports and imports confirm this deteriorating trend. In the latest twelve months, real U.S. exports and imports both contracted 1.6%. Such declines could only reflect a predominance of fragile global conditions and confirmation that the world lacks an engine of growth.

In terms of the free flow of goods and services, terrorist attacks like last week’s in Nice, and even the failed coup attempt in Turkey, likely tend to further restrict those flows (not to mention tourism).  The utter lack of warning regarding the events in NATO member Turkey (even if internally orchestrated) gives rise to concerns that intelligence resources are spread thin.  While the Republican convention this week will have massive safety precautions, as was likely the case in Paris for the UEFA Euro Football Championship, the delayed low-tech attack on a soft target like Nice can be devastating.   As the Blackrock piece implies, the world is subject to many exogenous events that can cause volatility.  I would further note that, according to a report I saw from last year, more than half the world’s annual merchant fleet tonnage passes through the South Seas.  China has given notice that it will simply ignore the Hague’s toothless decision ruling in favor of the Philippines regarding a territorial claims dispute.  According to Wikipedia, the US and Philippines have a Mutual Defense Treaty.  And while this dispute may not escalate in a military sense, economic pressure may ensue, which could accelerate yuan depreciation.

The market, having digested all the bullish underlying factors in support of treasuries as a safe haven, ran out of buyers last week, and ten year yields saw a significant back-up.  The US ten year yield rose over 22 bps to end at 159. The German bund rose just under 20 bps and edged to a slightly positive yield.  The 30 year bond contract had an outside week range and closed at the low (30y yield up 19.7 on the week to 230).  The euro ended slightly lower, GBP stabilized.  I would note that the adjustment in the pound has probably done a great deal to cushion the blow delivered by the Brexit vote; for example, the price of commercial real estate fell, but the currency translation coupled with the outright price decline provides value investors with a more compelling case.  However, Italy, for example, gets no such comfort from a weaker currency.  Just bone grinding on bone, hoping it will get better.

On the short end of the curve, it’s worth noting that Dec’16/Dec’17 one-year Eurodollar calendar spread closed at 19 bps, an indication of a turn.  Recall there had been a size buyer at 18.5 a couple of weeks ago, but that price was repelled as the spread drifted back down to 11.5/12.0.  Now with a close above 18.5, there’s a good chance to test 25-26 (which really only signifies one hike over a year…)  EDU6 and EDZ6 completely reversed; both are now at pre-Brexit levels, in part due to concerns about USD funding pressures.  Tightening odds have increased somewhat as well, for example, in Fed Funds, Aug/Oct (isolates odds of a September rate hike), settled at 3 bps, but Nov’16/Jan’16 (which targets the December FOMC) moved out 2 bps on Friday to 7.  Maybe a once a year hike in December will constitute a new ‘tightening cycle’.  Though nobody really considers the non-quarterly FOMC meetings, Jan’17/Feb’17 at 0.5 bp is quite a cheap expression for a hike at the first meeting of the new year, which is Feb 1.

This week features an ECB meeting, and a host of US earnings reports including BofA, GS and MS.


7/8/2016 7/15/2016 chg
UST 2Y 60.9 70.2 9.3
UST 5Y 95.1 114.3 19.2
UST 10Y 136.3 159.0 22.7
UST 30Y 210.4 230.1 19.7
GERM 2Y -69.4 -65.2 4.2
GERM 10Y -18.9 0.6 19.5
EURO$ Z6/Z7 11.5 19.0 7.5
EURO$ Z7/Z8 12.0 17.0 5.0
EUR 110.52 110.37 -0.15
CRUDE (1st cont) 46.12 46.65 0.53
SPX 2129.90 2161.74 31.84
VIX 13.20 12.67 -0.53




Posted on July 17, 2016 at 2:35 pm by alexmanzara · Permalink
In: Eurodollar Options

Leave a Reply