Looking for a Constant

Sept 27. 2020 – Weekly Comment

Looking for a constant

Weekly Comment – September 27, 2020

Alex Manzara/ RJO-Interest Rate Strategy and Execution/ amanzara@rjobrien.com

Two mathematicians go to lunch, and get into an argument about the knowledge of the American public.  The first one says: “The average person is, mathematically, an idiot. People don’t know algebra, can’t figure out percents, can’t read a simple graph, and don’t even get me started on calculus…”

The second professor disagrees, “Surely you’re exaggerating. Most people know all the math they need to know, or more.”

Some time later, the first professor goes to the men’s room. The other mathematician beckons to the waitress and says, “Next time you come to our table dear, I am going to ask you a question. No matter what I ask, I want you to answer by saying ‘x-squared’. Ok honey? Please don’t mess it up and there’s an extra tip coming your way.”

The waitress agrees. When the first mathematician returns, his companion says, “So let’s put your theory to the test. I am going to ask some random person who comes by our table an elementary calculus question, and we’ll see if they can solve it.”

Soon the waitress comes by and he says, “Excuse me, Miss, can you bring me more tea, please — and by the way — can you tell me what the integral of 2x with respect to x is?”

The waitress replies, “Certainly sir, more tea it is. And it’s x-squared.”

The mathematician says, “See! What did I tell you?” His friend is dumbfounded.

The waitress, meanwhile, goes to bring tea, and, having turned her back on the two professors, mutters under her breath: “Plus a constant.”

The original International Prototype Kilogram, safe within three vacuum-sealed bell jars. Photo: BIPM

Last week I watched a riveting documentary about redefining the kilogram.  I had no idea that the basis for the global measurement of weights rests on the kilogram, and this original artifact is a cylinder of platinum-iridium alloy, kept under three glass bell jars, each with a different key, in an underground vault in Paris.  I also didn’t know that one of the goals of the French Revolution was standardizing units of measurement, and that the metric system was produced as a result. (In order to create standard units “for all men, for all time”).  That part I can understand as I’ve been the victim, in one way or another, of the “thumb on the scale” deception, as you probably have been too.  In fact, the world’s simmering tensions seem to be grounded in an underlying sense of unfairness based on the thumb on the scale.  Or perhaps another good analogy is The Rolling Stones, Under My Thumb.  Unfortunately, the resolution of the kilo issue doesn’t seem to have altered the social mood, but let’s press on. 

SI,  or Système International d’Unités, uses the kilo as the basis of mass, but the other units are all defined in terms of natural scientific constants.  For example, the original meter was defined as one 10-millionth of the distance from the North Pole to the equator but was changed in 1983 to the distance that light travels in a vacuum over 1/288,792,458 of a second.  This presents a problem for the original lump of metal which had lost an eyelash worth of mass between the 1940s and 1990s. The solution was to redefine this foundation of mass measurement in terms of unchanging scientific phenomena.  Now, you know and I know that among the metrologists laboring on this problem, there would inevitably be scholarly disagreement about whether to use Avogadro’s constant, the SI reciprocal mole, or Planck’s constant, the quantum of electromagnetic action that relates a photon’s energy to its frequency.  Planck naturally won out.  Duh.  It took extremely sophisticated machinery to complete this project.  For example, a Kibble balance. (“Only two labs have managed to create a Kibble balance that can weigh mass with the necessary precision to define a kilogram.  One is the Nat’l Research Council in Canada, and the other is operated by NIST in the US.  Their balances are so delicate they have to be kept in sealed vacuums”).  As one article notes, “It’s no small task, shoring up the foundations of reality.”  Yes, I have been trying to do that in my personal existence.  “No small task”.  Well put.

Where does this leave us with respect to markets?  Our reality in terms of units of measurements are currencies, ounces of gold, interest rates, equity indices.  As opposed to the International Bureau of Weights and Measures, the institution which seeks to define measurements based on fundamental constants of nature, the Federal Reserve is a hallowed institution trying to convince the public that it can accelerate the decay of the purchasing power of the dollar to exceed 2% a year for some time.  And that we’ll like it.  Which leaves us somewhere on the reality spectrum between the unchanging laws of physics and the US election. (299792458 meters per second.  It’s not just a good idea.  It’s the law.) 

Against this backdrop, interest rates showed little change on the week with ten-yr treasuries down 3.4 bps to 65.8 bps. Stocks pushed a bit lower, VIX firmed a touch. No precise calibrations here.  As I mentioned during the week, large US banks never recovered from last Sunday’s news about continuing money laundering allegations.  Except for Goldman which closed 9 cents higher on the week.  GS, pure as the driven snow.  YTD and weekly changes, JPM -33%, -3.5%, BAC -33%, -4.9%, C -47%, -3.6%, WFC -56%, -2.8%, USB -41%, -4.1%, MS -8%, -5.9%, GS -15%, 0.  And the Eurostoxx bank index SX7E -45% on the year and -5.8% on the week.  Banks are a major transmission tool for monetary policy.  The price declines this year are unsettling.

The Fed publishes quarterly data on monetary aggregates and outstanding debt and net worth levels for the US economy in its Z.1 report.  The Credit Bubble Bulletin does a great job of dissecting these numbers.  In Q2, “Household Net Worth inflated a quarterly record $7.607 TN – to an all-time high $118.955 TN. Net Worth was up $5.0 TN over the past year. Net Worth ended the quarter at a record 610% of GDP. This compares to previous cycle peaks 492% (Q1 2007) and 446% (Q1 2000).

Total Equities surged $9.121 TN during the quarter to $51.956 TN, with a one-year increase of $884 billion (1.7%). Equities as a percentage of GDP rose to a record 267%. This compares to cycle peaks 181% at the end of Q3 2007 and 202% to conclude Q1 2000. (CBB)

These ratios rest on extreme debt levels:

At $59.304 TN, Non-Financial Debt surged to a record 304% of GDP. NFD-to-GDP ended 1999 at 184%, 2007 at 227%, and 2019 at 250%. “Off the charts,” as they say. (CBB)

We’re accepting valuations that are ever higher given the value of things being produced, i.e. GDP.  We’re paying more of our depreciating dollars for a given stream of income (sounds a lot like inflation to me) and we’re hoping that the cost to service ever-growing debt doesn’t negatively impact that  (growing less rapidly) stream of earnings. That hope is predicated on the Fed’s promise to keep rates low.  Prior to the metric system, they used measurements like the king’s foot as a unit.  We’re just calling a king’s foot a meter now.  But at some point they might call the king Bozo.


On May 20, 2019, the BIPM’s governing body, the General Conference on Weights and Measures, passed a final unanimous vote to ratify the new definition of the kilogram.  All the representatives from all the different countries met in a room in Versailles and agreed.  In a world preoccupied with the discord between and within nations, what an amazing and inspiring display of scientific unity.  


Three month libor set a new historic low this week at 0.21788.  During the week there was heavy trade in EDZ0/EDH1 calendar spread, the price of which is partially dependent on funding pressure or lack thereof at the end of the year.  Zoltan Poszar of CS now says turn pressures will be muted.  The range in the spread on the week was -7.5 to -4.5 with a final settle of -5.5 (9973.5, 9979.0).  This is the lowest 3m spread on the curve, the next closest is EDH1/EDM1 at -1.0.  All others are positive except for EDZ1/EDH2 at -0.5.  I think potential turn pressure may be under-priced.

In terms of flight-to-quality concerns and a flatter curve, I would just note a couple of things. 1) the Fed has dismissed negative rates 2) the Fed is not committing to more QE 3) in order to sell the huge amounts of debt necessary to finance the treasury, the market has to be assured of low rates and a curve with some degree of steepness to provide positive carry.  Finally, consider China. This may not have relevance to the US, but both the Shanghai and Shenzhen Composites closed near lows of the week and at the bottom of the three month range.  China’s stocks look vulnerable.  There is continuing concern regarding credit issues in the property sector, notably Evergrande.  However, the ten year gov’t yield (CNY) is  3.13% right near the high of the year.  Started 3.14%, down to 2.48 in April, and back up.  It’s not always the case that equities and bonds move inversely.     

Finally, the presidential debate is scheduled for Tuesday evening. I would bet that it will be the only one.  The dollar has shown strength over the past week, but is likely to see a pullback around this event, no matter who “wins”.

UST 2Y14.012.9-1.1
UST 5Y28.526.6-1.9
UST 10Y69.265.8-3.4
UST 30Y145.1140.3-4.8
GERM 2Y-69.6-70.7-1.1
GERM 10Y-48.5-52.9-4.4
JPN 30Y58.360.11.8
EURO$ Z0/Z1-4.0-4.00.0
EURO$ Z1/Z23.54.00.5
EURO$ Z2/Z312.511.5-1.0
CRUDE (active)41.3240.25-1.07





Posted on September 27, 2020 at 11:43 am by alexmanzara · Permalink
In: Eurodollar Options

Leave a Reply