July 3. Let’s have an intervention

“All manipulation comes to an end when the manipulator cannot make a stock do what he wants it to do.  When the stock you are manipulating doesn’t act as it should, quit.  Don’t argue with the tape.  Do not seek to lure the profit back.  Quit while the quitting is good—and cheap.”

From Reminiscences of a Stock Operator

At the end of the day Friday the US ten year inflation indexed note was at a yield of -0.012 bps, the lowest it has been since April of 2015.  This seems to be a critical area, as indicated on the chart below.  It’s right at the midpoint of the ‘whatever it takes’  low in 2012, to the ‘taper tantrum’ high in the middle of 2013.  A healthy economy almost by definition has a real rate above zero.  I would think the Fed wants real rates above zero.  When the rate you are manipulating doesn’t act as it should, quit.

Ten Yr TIP July 2016

A degree of publicity has surrounded Kyle Bass and his latest interview on Real Vision.  One important story he relates is that he was talking privately to a central banker who said, in a moment of cosmic clarity, “QE only works when you’re the only one doing it.”  My money is on Stanley Fischer as the one who uttered those words, as his comments, typically delivered in understated style, are honest and on point.  For example, on Friday he was interviewed on CNBC and there were several telling exchanges.  When asked about the possibility of negative rates in the US, he essentially dismissed that scenario, but, in an echo of the above, said, “…it’s certainly worked – well, it certainly worked early in its usage in Europe and Japan, but lately there have been some questions about it and we are appraising the most recent empirical results…and we haven’t changed our minds…” [about trying to avoid ever having to use negative rates].  Another interesting and direct answer came when the interviewer asked, “How do we get out of this sub 2% or 2.5% level?”  Fischer: “technically we have to get something moving on productivity growth AND THAT’S NOT SOMETHING WE’RE GOOD AT DOING.  We don’t know precisely how to do it.   And we’re all trying to find out whether what’s going on is a long term change or a result of the cyclical situation. We’ll get that right at some point and when that changes we’ll go back to higher rates of growth.  But it really turns on productivity…  We’re looking for more investment to help get productivity going.”  [Likely requires some changes in fiscal policies]

The problem with current central bank policies is that they have created an overabundance of reserves that seek to squeeze out every basis point of extra yield, encouraging financial speculation while repressing volatility with a vast offer in premium.

Another interesting overlap between the Bass and Fischer interviews regards China.  (Bass and Fischer, sort of reminds me of Bassmasters  www.bassmaster.com which is a heckuva lot more appropriate than this on a holiday weekend).  Anyways, Bass goes on at length about how everything in China leads to the conclusion that the currency MUST depreciate. “… they [China] are putting off the final day of just realizing a loss cycle.”  Indeed, the yuan is making new lows, which is likely to exacerbate global deflationary pressures.  Fischer, when asked about China’s currency said, “…an unexpected change in something frequently has larger effects.”  Now… “It’s clearer.  There’s much less uncertainty.  There’s much less concern…policies look more coherent.”  In other words, we expect continued and controlled depreciation rather than a sharp unexpected devaluation like last August.

Maybe controlled, but still deflationary as shown on chart below of CNY (inverted in red) to 5y5y inflation indexed swap… Tracks pretty closely.

CNY v 5y5y infl


It was an amazing week.  The Brexit vote not only exposed cracks in the framework of the European Union, but also the divide between markets and financial authorities.  By Thursday, the EC relaxed rules allowing an Italian bank bailout, the European Central Bank said that it might change its policy regarding buying bonds in proportion to members’ economies, and Carney said the BoE is considering an ease.  The pound didn’t recover, but the FTSE 100 made new highs, and US equities took a round trip and closed at the high of the week, just under pre-Brexit levels.  US 10’s and 30’s hit new record low yields.  The 5/30 yield spread closed at the low of the week under 124 bps.  Precious metals soared, with silver a standout performer, up 25% over the past month.  While gold was also bid, the gold silver ratio collapsed to 69.3, revisiting a level last seen in early 2015.  October Fed Funds, which traded as high as 9971 after the vote, came back to close at 9962, indicating unchanged Fed policy (rather than a near term bias towards ease).  In fact, December 2017 FF settled 9950.5; less than 50% odds of a hike through next year.  All of the nearby one-year euro$ calendar spreads trade around 3/16’s of a percent, with EDU6/EDU7 closing at just 14 bps.  EDZ16/EDZ17, which saw unusually heavy trade, settled near the low at 16.0.

Trade thoughts

While I thought that buying treasury calls was a fine idea well in advance of the Brexit vote (it was), I thought buying puts or put flies on the long end was a good idea last week.  It wasn’t.  I think the euro will soon revisit 105 and will probably break that level, and that USD strength will temper further buying in US equities.  While the US public is conditioned to look to the US stock market as a barometer of economic health, the move to lower global yields is a much more worrisome condition.

Dudley speaks Tuesday afternoon.  Friday brings the US employment report, which will be carefully dissected for information on whether last month’s weak release was an anomaly or true sign of a labor market slowdown.   No specific trades this week, as conditions are evolving quite rapidly and I have little desire to toss a coin in front of NFP.


6/24/2016 7/1/2016 chg
UST 2Y 64.9 59.3 -5.6
UST 5Y 109.1 100.1 -9.0
UST 10Y 157.9 145.1 -12.8
UST 30Y 243.3 223.7 -19.6
GERM 2Y -64.3 -64.9 -0.6
GERM 10Y -4.7 -12.6 -7.9
EURO$ U6/U7 19.0 14.0 -5.0
EURO$ U7/U8 23.0 18.0 -5.0
chg to Sept
EUR 111.17 111.40 0.23
CRUDE (1st cont) 48.31 49.65 1.34
SPX 2037.40 2102.95 65.55
VIX 25.76 14.77 -10.99


Posted on July 4, 2016 at 10:43 am by alexmanzara · Permalink
In: Eurodollar Options

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