June 21. Kruger Industrial Smoothing



1)      Fed’s fear of commitment

2)      Greece

3)      Eurostox/VIX, Global stocks

4)      Bond Street


Week to week changes on selected prices:

6/12/2015 6/19/2015 chg
UST 2Y 72.2 61.7 -10.5
UST 5Y 173.3 157.4 -15.9
UST 10Y 238.5 226.5 -12.0
UST 30Y 309.5 305.7 -3.8
GERM 2Y -18.4 -20.4 -2.0
GERM 10Y 83.4 75.2 -8.2
EURO$ Z5/Z6 * 89.0 81.0 -8.0
EURO$ Z6/Z7 64.5 63.5 -1.0
*peak one-yr spd
EUR 112.57 113.52 0.95
CRUDE (1st cont) 59.96 59.61 -0.35
SPX 2094.11 2109.99 15.88
VIX 13.80 13.96 0.16


On Seinfeld, one of George Costanza’s employers was Mr Kruger, the apathetic head of Kruger Industrial Smoothing.  That’s the mantra for the Central Banks of the world: Industrial smoothing.  But, as with Kruger (and George), it doesn’t always go according to plan.  “Watkins, you’re having a t-bone too? Then we should call you ‘T-Bone’.

In the US of course, the big deal was last week’s FOMC, and Yellen’s tepid stance in terms of raising rates.  We saw the dots move lower.  We knew that 2015’s growth forecast had to be trimmed given weakness in Q1.  (Although in his speech on Friday, SF Fed’s Williams dismissed Q1’s result with the magic of re-seasonal adjustment and “…something called GDP Plus, a new measure that…strips out the extraneous noise.”)  As Mr Kruger would say, “I’m not too worried about it George.”

We saw a large decline in yields with tens falling 12 bps to 226.5.  The market is taking the Fed at its word that the pace of tightening will be gradual.  The peak one-year Eurodollar calendar spread fell 8 bps on the week, from 89 to 81, from closer to 4 hikes in a year to more like 3.  Unsurprisingly, the dollar fell in the aftermath of the Fed.  Yellen repeated she is more worried about the trajectory of rate hikes than the timing of the onset.  Williams in his speech on Friday mentioned the trajectory of inflation (concerned that it might not hit and sustain the 2% target), but also said he would favor two hikes this year.  “My own forecast would be having us raise rates two times this year,” he said. “But that would depend on the data.”  NOTE: On Monday the NY Fed will release its new Economy Snapshot.  http://www.newyorkfed.org/newsevents/mediaadvisory/2015/0619_2015.html

Though some now call for the timing of the first hike to be deferred until December (Hatzius), RBC’s Cloherty made this point: “Launching a tightening cycle a week before Christmas when everyone is terrified about liquidity seems like an awful idea.  If the Fed skips Sept, we will move all the way out to 2016 rather than assuming that the Fed will start tightening in an illiquid market at an illiquid time of year.”  It’s hard to argue against that point.  However, with EDU5 at 9962 and October Fed Funds at 9978.5 (just 8 bps below July), the market is pricing less than 50/50 for a September move.

The other factor driving down yields on Friday is lack of movement on Greece.  According to several reports, capital controls are likely to be instituted after Monday.   Certainly there is a flight to quality trade, as implied vol in treasuries is again favoring higher strikes.  On a week to week basis, the 5/30 treasury spread rose 12 bps.  The long bond was very weak after Yellen’s press conference, which probably gives more of a pure signal on the curve than Friday’s trade, which was driven by the Eurozone situation.  Five year was the star performer, down nearly 16 bps on the week to 157.4.

Another reflection of stress in Europe is noted on a zerohedge post, “Europe’s VIX has never been higher relative to the US  VIX… ever.”  http://www.zerohedge.com/news/2015-06-19/europe-has-never-been-riskier  While US VIX is around 14, Europe is close to 30.  The gold/silver ratio is also quite firm at 74.5.  It posted a high of 85 in Q4 2008, a low of around 32 in Q2 of 2011, and has been grinding higher ever since.  (In 2015 it’s been in a relatively narrow range of 70-75).  On Friday US stocks reversed some of the relief trade associated with an easy Fed, as SPX closed down 11.0, though still up nearly 16 on the week.  It’s worth noting that the Shanghai Comp fell 13% on the week.   A continued reversal in China along with the crystallization of the EU’s dilemma – if capital controls and depositor losses are imposed on Greece –  will surely spill over into the US, and put risk aversion back into the driver’s seat globally.

One other quick topic regarding the Fed:  technology, and monetary policy.  BusinessInsider ran a feature on Bond Street, a start-up firm that lends to small businesses.  http://www.businessinsider.com/bond-street-raises-110-million-2015-6  This company has harnessed new technology to make loans to small business in a fraction of the time that an ordinary bank would take.  “He might have paid 2% more with us, but it was a no-brainer for him to be able to open his store and work with people he likes and have that process feel very transparent.”  The article notes Jamie Dimon’s warning that Silicon Valley is coming and will shake up the financial world.  Peer to peer lending has already become a huge force.  In the Dow Jones US Mortgage Finance Sector, Lending Club (LC) at a  $6.4b market cap (went public in 2014 at $870 million), is now larger than the next four companies in the index: Nationstar NSM, Ladder Capital LADR, Ocwen OCN, and Lending Tree TREE.  [thanks JD].  How does this rapid technology and transparency affect monetary policy?   Obviously, it’s not always the RATE that matters, it’s access and availability of credit, and those factors have likely improved by a huge order of magnitude.  Should we really be wringing our hands over a 25 bp move?


Posted on June 21, 2015 at 1:09 pm by alexmanzara · Permalink
In: Eurodollar Options

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