July 9, 2017. Just go with it…

In the middle of 1994 I saw an interview with Tom Baldwin on whatever the financial channel was at the time.  Baldwin was perhaps the most flamboyant local in what was then the biggest, and most heavily traded futures contract, the 30 year bond.  This wasn’t like Margie Teller in back month eurodollars, another massive trader with spreads across the entire curve, well known to every major bank swap dealer.  In the bond contract it was pure direction, up or down.  Anyway, while many locals went home flat or with a small position, Baldwin was, by that time, a position trader, carrying large inventory.  On the old CBOT floor, the pit was raised at the sides and there were concentric (in the shape of an octogon) steps down into the middle.  The surrounding desks could only see a small arc of the side of the pit where they were located.  My job as a phone clerk was to quote the market and size, and relay players…who is buying and selling etc.  Everything was flashd with hand signals, and when busy, it was LOUD.  Every firm had a hand signal, and the big locals did too.  Plaza (Salomon’s clearing arm) was like a square drawn in the air, Refco was for obvious reasons, like someone toking on a reefer, Merrill was an index finger jammed into the palm of the opposite hand (Merrill, Lynch, PIERCE, Fenner & Smith), or it might have meant getting gored by a horn.  Baldwin was symbolized by running a hand over your head (bald).  I remember many times seeing the bond drop 10 or 12/32’s and yelling to our pit clerk ‘who’s selling?’ and an inevitable, wild gesticulation of hands sweeping back over foreheads.  There was a LOT of made-up players and quoting, but that’s all a story for another time.  Anyway, back to the TV interview.  Baldwin is slouched in a chair in his trading jacket and frayed tie with the knot down to around the second shirt button, and he was telling the interviewer, “At the beginning of the move I fought it for the first few points [lower] but the selling didn’t stop.  So I started selling too.”  It wasn’t technical mumbo jumbo about spreads, and central banks, and mortgage convexity.  It was this:  I personally saw the selling pressure and went with it.

The thirty year bond contract closed Friday at 151-25.  Eight sessions ago it settled 156-29 and subsequently declined 7 out of the next eight.  There appears to be selling pressure. It’s no longer the granddaddy contract, but it’s still sending a signal.  Now in 1994, the change was that the Fed began to hike rates after a bit over a year at the then rock-bottom FF rate of 3%.  The central bank was shifting (fairly aggressively) from its accommodative stance.  Currently the markets are massively larger globally, and several central banks are signalling reduced accommodation.  In 1994, the bond contract went from 122-00 in (Oct 1993) to 96-00 (Sept 1994).  This was at the time of the 8% notional contract.  The yield went from 5.8% to 8.16%.

The point of this story, besides a pleasant reminiscence, is that when positions are simply offisdes, and the selling unwind begins, you really don’t need to know every little nuance.  The central banks have jammed everyone into long duration and higher risk instruments.  I think Peter Tchir of Brean Capital has made some pretty simple and succinct descriptions of the current market environment.  (from MNI)

“There have been a lot of convoluted answers to the question of ‘how can yields be so low and stocks be so high?'” he said. “I continue to think the simplest” explanation “is that investors of all sizes, shapes and forms have been buying long dated sovereigns as a hedge to their risky equity holdings.”
“Whether you want to call that Homebrew Risk Parity ‘or Risk Parity Lite’ or just a good old-fashioned barbell of owning FAANNG and the long bond, the result has been the same: lower Yields, lower volumes, lower volatility and “low to negative correlations between Treasuries and equities,” Tchir said.
“if this trade, which I think is extremely crowded, is beginning to unwind, then the opposite should play out. Higher yields will drag down stocks. Investors will have to return to ‘traditional’ hedging methods, which should increase the price of volatility, or VIX. This is all occurring in mkts with limited depth to liquidity. Oh, at any given price, the algos are swooping around scraping up pennies, but there seems to be little real depth to stop ‘air pocket’ type of moves, albeit in both directions. Credit spreads will go along for the ride.”

 

The chart above shows global ten year yields (I use the 30 yr forJapan since the BoJ is pegging the ten year rate).  All have been moving higher since mid-June.  Canada and Germany are at new highs.  Sometimes it’s just about bad positioning.

I don’t know if this will be a global taper tantrum.  But I do know that after Bernanke’s hints of a change in policy in May of 2013, the ten year note traded over 3% by the end of the year.  It’s now 2.39%.  The red/gold pack spread in eurodollars also traded above 3% from a starting point of around 150 bps; it’s now just 67.  In fact, in May of 2013, the 30 yr bond yield was around 2.90, which is right where it is now.  By December it had traded to nearly 4%.  Are we going to see the same types of levels?  I don’t know.  I don’t know whether the *right* price for the 30 year is 2.5% or 3.5%.  What I do know is that global central banks have shifted to a more hawkish stance.  Selling has started.

One other sort of interesting note.  In 1994 the 30y yield went from 5.89% to 8.16%.  In the May 2013 taper tantrum, the yield started around 290 and ended at 397.  If one doubles those latter yield levels, then the magnitude of the move in percentage terms is about the same as the 1994 experience, i.e. 580 to 794.

There’s not a lot of news out in the early part of the week.  PPI and CPI are Thursday and Friday, with Retail Sales and Industrial Production also on Friday.  Fed yammering throughout the week, with Williams Monday, Brainard and Kashkari Tuesday, and Yellen before Congress Wednesday and Thursday.  Treasury auctions 3’s, 10’s and 30’s starting Tuesday.

 

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6/30/2017 7/7/2017 chg
UST 2Y 138.2 140.3 2.1
UST 5Y 188.2 195.5 7.3
UST 10Y 230.0 239.1 9.1
UST 30Y 283.9 293.4 9.5
GERM 2Y -57.2 -59.9 -2.7
GERM 10Y 46.6 57.3 10.7
JPN 30Y 84.0 90.0 6.0
EURO$ Z7/Z8 32.5 39.0 6.5
EURO$ Z8/Z9 24.5 27.5 3.0
EUR 114.27 114.03 -0.24
CRUDE (1st cont) 46.04 44.23 -1.81
SPX 2423.41 2425.18 1.77
VIX 11.18 11.19 0.01

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Posted on July 9, 2017 at 4:16 pm by alexmanzara · Permalink
In: Eurodollar Options

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