June 11. Throwing a Curve

There is plenty of commentary this week on the Nasdaq plunge that occurred Friday, so one doesn’t have to be a keen market observer to have noticed it.  I will just briefly mention a couple of things.  First, the trend in Nasdaq has been powerful since the election, and really even before that, since Feb of 2016.  Since the low in November, Nasdaq has gained 25%.  Friday can simply be considered an unwind of the ‘long momentum and short the underperformers’ trade.  Doug Noland points out that ‘long tech vs short financials’ had been a big winner until Friday.*  Actually, if you had surfed the Nasdaq wave and just decided to take the 25% gain off the table and park cash in short treasuries for the rest of 2017, who could possibly blame you, especially in a world where many hedge funds have posted disappointing results.

I’m not going to pretend to know exactly what sparked the tech reversal, but do you know what else has been in a strong trend [down] since the beginning of the year?  That’s right Bob, c’mon down and claim your prize…it’s the US yield curve.  Sometimes trends just fizzle out.  However, this week is also the FOMC meeting.  I think there are only 4 more after this with Janet Yellen as Fed Chair.  In terms of a possible catalyst, this is certainly a possibility in terms of the curve.  My opinion is that the curve will steepen (reverse trend) after the Fed hikes Wednesday.  Here are reasons:

First, the economy is likely slowing, and financial fissures are getting wider.  Second, several Fed officials have already said that the trajectory of hikes could be more shallow due to missed inflation targets.  Third, Harker and others have said they don’t want to upset the apple cart with respect to balance sheet adjustments, but that line of reasoning also means the Fed is wary of tightening FF too much too quickly.  Fourth, this week’s release of the quarterly Z.1 report showed that Household Net Worth increased to a record $94.8T.  Household Financial Assets (primarily stocks) rose 8% over last year.  Yet, the consumer appears stretched and retailers besides Amazon are getting crushed.  The Fed believes in the wealth effect, and is afraid to remove support for financial assets lest the consumer becomes even more cautious.  Fifth, most measures of the curve are on the absolute lows, and should have some technical support around these levels.  For example, 5/30 has a very strong support area of 100-105, and is now around 109.

I should note that trading decisions made on the back of perceived broad economic trends is rather difficult.  I make trade suggestions below to play for a reversal in the flattening trend, but mainly through the use of options to limit risk.

With regard to point number one above, troubles with auto loans have been pretty well documented in terms of increased subprime delinquencies and falling used car prices.  However, total state and local tax collections have also been quite disappointing.  Quoting from the May report from the Rockefeller Center (linked below) “State taxes grew only 1.2% in fiscal year 2016 and actually declined slightly after adjusting for inflation —the weakest performance since 2010…”  Consumer Credit for April released last week shows annual growth of only 2.6% (vs 5.0 for Q1 2017, 6.5 for Q4 2016, 6.5 for Q3 and 6.1 for both Q1 and Q2 2016).  Credit card delinquencies are inching up.

A note from MUFG rate strategist John Hermann said after an expected hike at this week’s meeting, there will “…likely [be] another hike at the Sept 19-20 meeting.”  The note goes on to say “…our models forecast a flatter curve going forward.”

If the Fed DOES signal another hike in September, then the curve will flatten further…I don’t need a model to tell me that (though it sounds impressive).  However, if recent economic trends persist, and especially if Friday’s tech stock reversal is a sign of more to come, then there is no way the Fed will hike again.  Hence, bull steepener.

I couldn’t find the exact quote, but a friend of mine mentioned an interview (I believe with Doug Cifu of Virtu) who said the “volatility ripple” from a given event used to last for weeks, and now lasts for only a few hours.  In searching for that particular interview, I stumbled upon another from last year, where Cifu said that given the explosion of product offerings, investors can choose among a variety of futures,stocks, etfs, etc, to express a view.  Given the electronic network, a company like Virtu “…distributes the volatility more efficiently.”  Of course, when there is very little vol to distribute, even the ripples become smaller…as mentioned a couple of weeks ago by JPM’s CFO Marianne Lake, “There haven’t been that many idiosyncratic events, and we need a few more of them.”  Well, perhaps we’re close to the ‘Be Careful What You Wish For’ moment…

THIS WEEK: Besides the Fed, we have auctions of 3 and 10 year notes on Monday, and 30 yr on Tuesday.  PPI on Tuesday.  CPI and Retail Sales Wednesday.  Philly Fed and Industrial Production on Thursday.

Other FED DATES to be aware of: Dodd-Frank stress tests Thursday, June 22 at 4:30 NY time.  Fed stress test Comprehensive Capital Analysis and Review (CCAR) released Wednesday, June 28, also at 4:30.


Also, from TD Securities: Congress must pass a funding bill before Sept 30 in order to avoid a gov’t shutdown.  The debt ceiling will need to be raised before October/November.  “…Speaker Ryan recently indicated that the House is unlikely to consider the debt limit during the summer, confirming our [TD] expectation that the showdown on the debt ceiling may only come after the August recess. This creates a potential risk for derailing tax reform.”


6/2/2017 6/9/2017 chg
UST 2Y 128.6 133.5 4.9
UST 5Y 171.7 176.1 4.4
UST 10Y 215.7 219.7 4.0
UST 30Y 281.2 285.4 4.2
GERM 2Y -72.4 -72.9 -0.5
GERM 10Y 27.4 26.4 -1.0
JPN 30Y 80.4 82.1 1.7
EURO$ Z7/Z8 29.0 31.0 2.0
EURO$ Z8/Z9 22.0 22.5 0.5
** EDZ7/Z8 now peak 1-yr
EUR 112.82 111.97 -0.85
CRUDE (1st cont) 47.66 45.83 -1.83
SPX 2439.07 2431.77 -7.30
VIX 9.75 10.70 0.95




Posted on June 11, 2017 at 11:05 am by alexmanzara · Permalink
In: Eurodollar Options

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