June 13. Your conclusions are highly questionable

–Yields edged slightly higher Monday and the curve flattened as 3 year and 10 year auctions went well, with huge indirects (foreign central bank) demand for 3’s.  While the red/gold pack spread didn’t make a new low, 2/10 slipped to a slight now low of 85.8, as did 5/30 at 109, as did the ten year note to TIP spread at just 177.6..  Not too surprising given supply.

–There was a fairly large trade, Buyer of EDZ18 9812/9800/9787/9775 put condor on a ratio of 5x8x2x5 for a credit of 9.5 bps.  (prices 18.0/13.5/9.5/5.5).  This trade was a roll up of a previous butterfly; it appears to now essentially be 9812/9800p 1×2.  So, this trade makes max profit at expiry — just a short 1.5 years away — if we settle right at 9800.

–So…I wasn’t going to talk about the stupid Fed dots but this trade sort of leads down that path.  Wait…did I say “stupid”?  Yes, ok…well that’s what I meant.  As of the last quarterly meeting in March, the Fed was projecting 2017 growth of 2.1 with Core PCE Prices of 1.9 and Fed Funds at 1.4.  Let’s take these in turn.  Q1 GDP was 1.2% according to the second estimate.  Though Fed officials think the Q1 softness was transitory, Q2 doesn’t exactly seem to be going gangbusters.  However, Atlanta Fed is estimating 3.0 for Q2 (but estimates are being revised down with new bits of data).  So, Maybe 2.1 for the year is plausible, but I doubt it.  Core PCE prices aren’t quite getting there…both Brainard and Bullard have voiced concerns that inflation is sluggish.  So then we have FF at 1.4 vs current .91 with an expected hike Wednesday which will take the Fed effective to 1.16.  In FF, that equates to FFN7 at 9884 or 9884.5 given month end discount. Now note that January FF are 9872, or just 12 bps higher in yield than July’s expected value, so we can figure the market’s at about 50/50 for the Fed hitting the FF target.  It seems pretty clear to me that there’s a risk all three variables could be trimmed at this meeting.  They sure as heck aren’t going higher.  So then we get to the 2018 year end projection for FF of 2.1, meaning ANOTHER 3 hikes.  Given current lois, that would mean EDZ8 would be around 2.25% or 97.75.  Obviously that’s a lower price than the condor (or the 9812/9800p 1×2) target.

–The market doesn’t and hasn’t believed the Fed’s longer term projections for a long time.  Why?  Because they’re sloppy.  It’s like the scene in Ghostbusters where Dean Yager says to Professor Venkman (Bill Murray), “Your theories are the worst kind of popular tripe, your methods are sloppy, and your conclusions are highly questionable! You are a poor scientist, Dr. Venkman!”  …”Yeah, but the kids love us.”

–One last item of note, ZH has another article about Illinois sprinting toward its downgrade to junk, including an interesting chart, which shows that IL GO Bonds (5.0%
of 2035) have seen their spread vs treasuries increase from 190 bps to 290 JUST THIS MONTH.  Remember when we were worried about Greece?  Illinois GDP is $791 billion.  That’s almost 4 Greeces.  Maybe IL can just securitize the $14 billion of unpaid bills, and the Fed can buy it and tuck it away in an inconspicuous corner of the balance sheet….


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Posted on June 13, 2017 at 5:26 am by alexmanzara · Permalink
In: Eurodollar Options

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