June 28. Complacency meets reality
COMPLACENCY MEETS REALITY
Themes
- Greece Plan B
- Bear Steepening last week, bull flattener this week?
- China cuts
- Employment data (payrolls this week, FOMC minutes next, HH July 15)
- Everything hinges on theme #1
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Week to week changes in selected prices:
| 6/19/2015 | 6/26/2015 | chg | |
| UST 2Y | 61.7 | 70.8 | 9.1 |
| UST 5Y | 157.4 | 175.3 | 17.9 |
| UST 10Y | 226.5 | 247.4 | 20.9 |
| UST 30Y | 305.7 | 324.7 | 19.0 |
| *new 2 & 5 yr | |||
| GERM 2Y | -20.4 | -19.1 | 1.3 |
| GERM 10Y | 75.2 | 92.2 | 17.0 |
| EURO$ Z5/Z6 | 81.0 | 88.0 | 7.0 |
| EURO$ Z6/Z7 | 63.5 | 71.5 | 8.0 |
| EUR | 113.52 | 111.67 | -1.85 |
| CRUDE (1st cont) | 59.61 | 59.63 | 0.02 |
| SPX | 2109.99 | 2101.49 | -8.50 |
| VIX | 13.96 | 14.02 | 0.06 |
Just because you do not take an interest in politics doesn’t mean politics won’t take an interest in you.
— Pericles
It appears as if the situation in Greece was downgraded to default on Saturday, as Tsipras called for a surprise referendum to be put to voters, and the other 18 members of the Eurozone unanimously rejected extending aid beyond Tuesday’s IMF payment deadline.
From Reuters on Sunday: “The European Central Bank can no longer give emergency liquidity to Greek banks due to the breakdown of talks between Athens and its creditors and doubts over Greece remaining in the euro, former ECB board member Lorenzo Bini Smaghi said in remarks published on Sunday.”
It seems likely there will be a bank holiday and capital controls imposed.
From El-Erian: “As such, investors would be well advised to wait for further technical shakeouts before committing significant resources.” Huh? Don’t buy the dip?!?!
Guideposts: March 27, 2013 Cyprus imposes capital controls. January 15, 2015 the SNB drops the EUR peg.
In terms of market action, stocks should be lower and were already on somewhat shaky ground technically, with both DJ Transports and Composites essentially at new lows for the year last week. (Chinese cut could spark a rebound in shares there, more on that below). The Eurodollar market will certainly lessen the odds for near term rate hikes, and will probably take the chance of a September meeting down to around 1 in 3. However, given the relentless bear steepening last week, I would think that we’ll see flattening initially this week, and if that does occur then it’s probably tactically best to look for pull backs to put steepeners on. 2/10 jumped over 10 bps last week to 176.6. I wouldn’t be surprised if we revisit the previous week’s close around 165.
EURUSD was 111.67 Friday. Low from a month ago was 108.73 and from March just below 105. The ECB is likely to become the buyer of last resort for sovereign debt. [as of Thursday afternoon 109.85 in Asia according to Reuters]
LAST WEEK…
US rates rose pretty much throughout the week with relentless bear steepening. On the previous Friday (June 19), there was a flight to quality bid on Greek worries, but this week it was, ironically, the opposite, with the 30 yr bond closing at a new recent high yield of nearly 3.25% (up 19 bps on the week). The complacency engendered by an endless stream of “last second deals” is now shaken by the reality of unsustainability. The dollar strengthened, and the German bund yield also rose, closing up 17 bps on the week at 92. To give a sense of the steepening, the week to week changes in Euro$ packs were as follow: Reds (2nd year) -11 bps, Greens (3rd) -18, Blues (4th) -23 and Golds (5th) -26.
The domestic calendar this month has several important events: Employment on Thursday the 2nd, FOMC minutes the next week on the 8th and Yellen’s semi-annual congressional testimony on the 15th. There were also warnings of terrorist activity around the July 4th holiday. While we didn’t see a flight to quality bid in terms of lower treasury yields, vol for the ten year straddle expiring on Thursday was pretty well juiced by the end of the day Friday. Just before the electronic close at 3:55 CST, the 125^ was 1’08/1’10, around 9% if using 6 days (thanks ML). As a comparison, the TYN atm straddle that expired Friday was 0’55/0’56 on the previous Friday (with a week to go). So the employment straddle is 30% more premium, (which was clearly justified by Greece).
In terms of monetary policy, The Fed has become fixated on its communication to the markets, hewing to the message (this week it was Governor Powell) that it’s the path of rate increases, not the start date that matters. Powell also said he wasn’t concerned higher volatility will harm economy [I guess we’ll see], and that the Fed and markets are getting into closer alignment. It’s as if the Fed thinks its initial 25 bp hike in the funds target is the biggest shock the global markets could possibly experience. NEWSFLASH: Greece is defaulting, Chinese stocks have fallen 19% from the high and the US ten year yield was up nearly ¼% last WEEK. The US domestic data now takes a back seat to the interconnected financial dislocations in Europe.
One last note about China’s easing and the Shanghai Composite. In late 2005 SHCOM was at 1100. In two years it had rallied to 6100 (up 5.5x), and then took another year to collapse down to 1660. In the middle of 2014 the index was 2000. It has taken about one year to get to this cycle high of 5200 (an increase of 2.6x). If it was to have the same magnitude of the move in 2006-7 then it would run to 11000. From the high so far this year it’s down 19%. Note that on the big rally in 2005, there was a pull back of 23% in June 2007, and then a move to new highs. The US market hasn’t really moved much in sympathy with China, so I don’t think China’s ease can help global stocks at this point.
The Fed will be fearful of further roiling international markets with hawkish rhetoric (let alone an actual hike), while the ECB will have to pull out all stops in terms of financial largesse. Should eventually lead to further steepness in the back end.
