March 20. The Producers

In 1968 a movie came out called the Producers, subsequently rolled out as a Broadway play.  The comparison to current events is irresistible (and I’d bet someone has already made it, but I can’t find it).  Wikipedia describes the movie as below.  I have inserted brackets with my own interpretation.

From Wikipedia:  Max Bialystock is a washed-up, aging, fraudulent corruptible and greedy Broadway Producer [Wall Street] who ekes out a living romancing lascivious, wealthy elderly women [Yellen] in exchange for money for his next play.  Accountant Leopold “Leo” Bloom [Congress] arrives at Max’s office to do his books and discovers there is a $2,000 discrepancy in the accounts of Max’s last play. Max persuades Leo to hide the relatively minor fraud, and while shuffling numbers, Leo has a revelation: a producer could make a lot more money with a flop than a hit by overselling shares in the production, because no one will audit the books of a play presumed to have lost money. Max immediately puts this scheme into action. They will oversell shares on a massive scale and produce a play that will close on opening night, thus avoiding payouts and leaving the duo free to flee to Rio de Janeiro with the profits.

The name of the play, destined for ruin but inexplicably adored by the public, is ‘Springtime for Hitler in Germany’.  Well, it is the onset of Spring, and many are comparing our very own Donald Trump to Hitler.  And sure enough, last week Yellen assured risk assets of monetary largesse in order to keep the farce going.  Just keep over-selling shares with the promise of future returns in the form of higher equity prices and a robust economy.

The Fed had two choices last week, it could either lean dovishly, thereby weakening the dollar (or, said another way, boost commodity prices in terms of the dollar) which might relieve pressure on commodity dependent emerging markets and energy producers the world over, while also aiding banks and US exporters.  This course of action might also give cover to China to push the yuan higher and crush speculators.  The other choice was to push a hawkish agenda, and risk nascent rallies in commodities and further flatten the US curve.  The Fed chose door number one.  Equities and the more speculative fringes of the market ran with the message.  EEM and HYG added to powerful gains made since mid-Feb.  VIX closed near 14, its lowest level since right before the August yuan devaluation.  Happy days.

The interest rate markets also took the message, but in a slightly more mechanical way.  The curve steepened, with the belly leading way.  The five year yield fell about 15 bps on the week to 133, while bonds only fell about half that amount, down 7.3 on the week.  In Eurodollars, the curve is robotically linear.  The first 10 one-year Eurodollar calendar spreads are between 25.5 and 28.  It’s almost like central planning from China.  One hike per year, we’re loyal communists.  The pack spreads:  White/Red 27.25.  Red/Green 27.125.  Green/Blue 25.25.  Blue/Gold 23.625.  Sell volatility and quell dissent.  I don’t know that I’ve ever seen it like this.

Bernanke put out a blog this week (a link is at the bottom of this note), where he discusses negative interest rates and other tools of central banks.  It’s just more of the same theoretical hogwash, though there is an interesting line in the beginning (echoed by a WSJ article Thursday):  “…there are signs that monetary policy in the US and other industrial countries is reaching its limits, which makes it even more important that the collective response to a slowdown involve other policies-particularly fiscal policy.” [Wishful thinking].  According to BB, a cheaper cost of money should make people want to borrow and invest, and compress yields further out the rate spectrum.  But, as soon as the central bank backstop is in question, things get shaky in a hurry, as we saw at the start of the year.  Like Spock, he concludes with this: “Logically, when short term rates have been cut to zero, modestly negative rates seem a natural continuation; there is no clear discontinuity in the economic and financial effects of, say, a 0.1 pct interest rate and a -0.1 pct rate.” However, there are at least two real world considerations.  First, the move to ZIRP or negative brings out the “Leo Blooms”, sharp penciled financiers who engage in stock buybacks and financial engineering rather than capex. (As an example, the spread between GAAP and non-GAAP earnings reports is consistently widening).   Second, the constant discussion of unorthodox monetary policy reflects a lack of confidence in the economic system and makes the business sector uneasy.  As Donald might say, reaching deep into the theoretical playbook is, well, stupid.  Let me add a quote from a friend Derrick W, on how he perceives the CB’s:

Your comments about global central bankers and markets front-running them reminds me of an observation I recently had. Think of it as a trader would. Let’s say you figure out that every time the market crosses the 20 day moving average and you go with the momentum, you can make at least x number of ticks. So you start trading the strategy and make money doing it. You keep doing it because it works, but then after a while other people start to figure it out and do it also. Before you know it, your highly effective trading strategy is being taught in every business school, every analyst training program, every CFA and CMT textbook, and even in youtube videos, yahoo chat rooms, and CNBC. At that point, with every last market participant trying to pursue the exact same strategy, it stops working; there’s no one left to sell to when you want to sell, and no one left to buy from when you want to buy. Soon, the only way to make money in this overly crowded strategy is to anticipate and front run everybody else. Until everybody else figures that out too…

This is precisely what’s happening with monetary policy today. The “crowd” is the global central bankers all pursuing the exact same “trading” strategy, committing obscene amounts of capital to the same trade at the same time and falling flat because it’s simply too crowded. There’s no one left to sell to. And unlike a prudent trader who cuts his losses and adapts his strategy to an evolving market, the bureaucrats just keep doubling down, because all they have to do is print money to go bigger. Where traders have discipline and accountability to their PnL, central bankers have academic theory and accountability to no one but the bureaucrats and academics who created them. When will they get stopped out? That’s like asking a politician to admit he’s wrong. They only get stopped out when the people force them out, and by then the damage will already have been done… In the meantime, we’ll just keep front-running them.


The real problem is this.  Official inflation statistics are starting to firm up, and the Fed’s dithering is helping commodity prices.  As can be seen from the updated Bloomberg Commodity Index versus 2/10 chart below, one of these two has turned up.  The other tends to lag a bit.  I would also note that the ten year inflation indexed note yield ended Friday at just 25 bps, the lowest since last May, while the spread between tip and treasury closed at a new recent high above 162.  At the same time, the Inventory to Sales Ratio at 1.4 is the highest it’s been in the past decade, outside of the peak of the great recession.   Stagflation.


White line 2/10 yield spread.  Red line Bloomberg Commodity Index. BCOM has broken green trendline

bcom v curve 3 2016

One final note.  China is still a big wildcard in the global economic picture.  From a Bloomberg article Sunday quoting the PBoC head Zhou: “Lending as a share of GDP, especially corporate lending as a share of GDP, is too high.”  The story goes on to quantify it, corporate debt alone(!) is 160% of GDP.  In the US, though at a record of over $8T (according the Q4 Flow of Funds report), corp debt is only about 45% of GDP.  On Business Insiders ‘Most Important Financial Charts” DB’s Joe LaVornga says that Household balance sheets are now stronger than corporates.    ( )   _____________________________________________________________________________________

Trade thoughts

The Fed’s dovish tilt would seem to be an engraved invitation to buy curve, though a stock market reversal to the downside or further shocks globally might change that picture in a hurry.  Green/gold pack spread at 49…too cheap.  June/July FF spread at 4.5…doesn’t reflect high enough odds of a hike in June and is a good hedge for long curve trades.

We all tend to remember the specifics of trades that did not quite go our way.  One of mine was in April, 2001.  I had all sorts of calls that expired right before Easter that year, which was April 15.  They expired worthless.  Then, on April 18, between meetings, the Fed announced a surprise cut of 50 bps.

There will never be a surprise hike out of this Fed.  But there are plenty of things that could lead to a surprise rally in rate futures.  Don’t be the guy that buys calls expiring  Thursday.  Get yourself some cheap May treasury calls (Apr 22 expiry…FVK 121.5c 7.5) or some April ED midcurves, which ironically settle on April 15.  Green April 9925c for cab.


3/11/2016 3/18/2016 chg
UST 2Y 95.3 83.5 -11.8
UST 5Y 148.1 133.3 -14.8
UST 10Y 197.5 187.0 -10.5
UST 30Y 274.7 267.4 -7.3
GERM 2Y -46.6 -47.6 -1.0
GERM 10Y 27.1 21.2 -5.9
EURO$ M6/M7 35.0 28.0 -7.0
EURO$ M7/M8 31.5 27.5 -4.0
EUR 111.51 112.70 1.19
CRUDE (1st cont) 40.09 41.14 1.05
SPX 2022.19 2049.58 27.39
VIX 16.50 14.02 -2.48


Posted on March 20, 2016 at 9:22 am by alexmanzara · Permalink
In: Eurodollar Options

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