June 25. Trending

Brief notes this week with the main themes being 1) continued curve flattening,  2) financial deregulation as a stimulus program, and 3) unrelenting pressure on energy markets.

The curve signals stagnation. 2/10 treasury spread made its low of 79 on the FOMC meeting, but has never really bounced since and closed 80.6, versus a high last December of 135.5.  5/30 made its low this week at 95.25 bps and closed 95.8. Old support of 102 to 109 should now be major resistance.  In eurodollars, all near one year calendar spreads made new lows, with EDZ17/EDZ18 ending the week at 26, down 2.5 from last Friday. Jan’18 to Jan’19 Fed Fund calendar closed at just 21.5, indicating less than one hike over the year.

Outside of the US, the German curve also flattened to a new recent low with 2/10 at 88 bps.  Schatz closed at a new ytd high yield of -62.4, and appears to have made a longer term bottom.  As can be seen on the chart below, this turn also underpins support for the EUR. [Chart: SCHATZ Amber and EUR White]

Some Fed officials have back-pedaled on the need for further hikes, but I would note relative weakness in banking stocks since the Fed’s recent move, in spite of sailing through the Dodd Frank stress tests, and in spite of the prospect of regulatory relief.  For example, the Bloomberg article ‘Treasury’s Regulation Unwind Already Having an Effect on Markets’, highlights easing of both the Supplementary Leverage Ratio and the Leverage Coverage Ratio.  Mnuchin’s quoted as saying “we want to unlock billions, if not trillions, of new liquidity.”


I’m not pretending that I know the right mix of regulation in terms of economic nirvana, but I do think that the Fed perceives ‘macroprudential policy’ as an important tool against banking excesses which contributed to the last meltdown.  If the Treasury rolls back regs in the face of the Fed, does the Central Bank respond with the blunter tool of FF rate increases, which further flattens the curve, which puts more pressure on banks, which creates more incentive for banks to find profits in…financial engineering?

The real question is this: will such regulatory relief find its way into the real economy in a sustained way?  Or will it be just another straw in the basket of the financial engineering camel?  The chart below is probably just a dated relic of an economy that previously attached some importance to commodities, but it’s still stark in its divergence since 2011, and could be loosely interpreted as a ‘financial engineering vs real economy’ picture.  It’s the Bloomberg Commodity Index (amber) and the SPX (white).

In terms of recent ‘transitory’ declines in inflation, I’ve heard a couple of officials refer to large declines in cell phone bills.  Repeat: cell phone bills.  Can that possibly be bad?  Is that what’s making it hard to raise wages and increase living standards?  We still seem to be in a financial engineering world, with increasing debts that still need servicing.

The decline in energy markets is another large factor which has begun to spill over ever so slightly into high yield spreads.  (The BCOM index in the chart above is heavily influenced by the price of oil).  Oh, and it also has a negative effect on inflation readings.  I was completely in the ‘reflationista’ camp early this year as oil had bottomed in early 2016 and I thought yoy comps this year with oil over 50 would give inflation a boost.  It didn’t happen.  In terms of the longer end of the curve, it seems like yields are too low.  On the other hand, there were fears some time ago that Chinese selling would drive the US long end yields up.  Didn’t happen.  The prospect of balance sheet reduction was supposed to have a negative effect on the long end.  Didn’t happen.  The longer term bias continues to be lower yields in bonds, despite nominally low levels already.

The quarter and first half ends this week.  Monday Durables,  Thursday Q1 GDP (1.2).  Friday Personal Income and Spending.



6/16/2017 6/23/2017 chg
UST 2Y 131.5 133.6 2.1
UST 5Y 174.3 175.5 1.2
UST 10Y 215.5 214.2 -1.3
UST 30Y 278.1 271.3 -6.8
GERM 2Y -65.8 -62.4 3.4
GERM 10Y 27.6 25.5 -2.1
JPN 30Y 81.4 80.0 -1.4
EURO$ Z7/Z8 28.5 26.0 -2.5
EURO$ Z8/Z9 22.0 20.5 -1.5
** EDZ7/Z8 now peak 1-yr
EUR 111.98 111.93 -0.05
CRUDE (1st cont) 44.97 43.01 -1.96
SPX 2433.15 2438.30 5.15
VIX 10.38 10.02 -0.36


Posted on June 25, 2017 at 5:16 pm by alexmanzara · Permalink
In: Eurodollar Options

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