June 24. All aboard the pain train.

–Real rates continue to explode higher, as ten year inflation index note hit a yield of 52 bps.  Ten yr treasury minus tip spread fell under 2% (for the first time since late 2011).  The ten year treasury yield was up 9 bps to 251 and went higher yet after the floor close.
–There was quite a bit of weakness in the front end of the eurodollar curve as reds settled -7.5.  Some suggested that the CME margin increase was to blame, but I think that’s a minor factor, part of a much larger picture.  But before I get to that, note that total eurodollar open interest fell 174k and in the reds it was -128k, a significant drop.  Red midcurve straddles soared, with 0EZ 9925 around 32 in the beginning of day, traded as high as 37 and settled 36. (capitulation signal?)
–OK back to the larger theme.  Which is that private capital is fickle, subject to rapid retrenchment, especially given last week’s signals that both the Fed and PBoC might not provide the liquidity backstop that everyone has taken for granted.  There are many examples.  I noted ETF problems Friday (reported in FT and ZH), a decline in eurozone interbank lending, Detroit and the muni bond scare, emerging market problems, the rise in CME margins.  There has been naive trust that central banks can always provide the liquidity for a functioning financial system.  And thru the crisis. one might conclude that the point was proven, but the liquidity was never really pared back.  Now there are signs that Japan’s ‘all-in’ QE could backfire.  I’m not so sure that the credibility of central banks is perceived in the same prism these days.  And THAT’S why short term rates go up.  Because now what’s left of ‘private’ capital is forced to seek a margin of error, a cushion.  Because the implicit model of shifting losses onto the Fed/govt is looking like a more and more slender reed.   “We’ve relied on the Fed and China so much over the last few years so any signs that either might be less supportive is taken negatively — and we got both of those over the past week,” said Oliver at AMP. http://www.bloomberg.com/news/2013-06-21/china-poses-global-growth-risk-as-li-squeezes-credit-binge.html
–One more thing, I noted that the ten yr treasury/tip spread is below 200 and in a downward trend, lowest since late 2011.  In late 2011, the spread was in an uptrend and continued to strengthen as 2012 began.  Equity markets, and especially emerging markets, had strong rallies into the first quarter of 2012.  That’s when treasuries rose in yield, to 2.42 in tens in March, the level that was just surpassed this week.  It looked like a case of “escape velocity” in 2012 but then it all turned sour.  The global environment couldn’t be more different currently.  As Bullard notes, inflation is FALLING, BBG “Federal Reserve Bank of St. Louis President James Bullard said the Fed “inappropriately timed” a plan to trim $85 billion in monthly bond purchases amid slowing inflation.”  Emerging markets appear vulnerable.  But the Fed has grown to control so much that the market must heed its overlord.
–Auctions of 2’s, 5’s and 7’s this week so the pressure might continue in the first part of the week.  But I wouldn’t be surprised to see a sharp upside move into the end of the week, especially if Core PCE price index is weak on Thursday.
–As Izzy Mandelbaum (Played by Lloyd Bridges) says… “All aboard the pain train.”  https://www.youtube.com/watch?v=pcFSOnumgZA

Posted on June 23, 2013 at 4:37 pm by alexmanzara · Permalink
In: Eurodollar Options

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