March 24. Curve grinds lower in a world of financial instability

–Another day, another move to new lows in eurodollar calendar spreads.  For example, red/green pack spread (2nd to 3rd year) fell 2.375 bps to a new low of just under 52.  Red/gold (2nd to 5th) was down over 2 bps to a new low of 105.5. These are both new lows for 2015.  2/10 treasury spread down 1.6 bps to 134, also a new recent low, though I had marked at 120 in the beginning of Feb. (Treasury auctions 2’s this afternoon).  As a comparison, red/green averaged around 90 bps in the month of November…nearly halved in four months.  With the flatter curve comes declining implied vol, with the June bond 164 straddle down especially hard from 6’54 to 6’32, down 0.5 vol to 12.3.  The $/val bp of the bond contract is over 3x that of the ten year future; the atm straddle is 2.7x higher in the bond.
–The dollar continues to generally weaken since the Fed, with the Euro now trading around Wednesday’s spike high of 110.  An especially violent gap (like the FOMC spike in the euro) is almost always retested, as it clearly reflects a crowded trade.  That is, everyone who wanted to be short the euro already had the position on and there were few resting sell orders to control the upside move.
–China’s PMI was lower than the expected 50.6, coming in at 49.2, suggesting additional monetary stimulus is on the way.
–Fischer’s comments yesterday suggested that a move away from the zero bound is as much about getting away from unintended distortions caused by unconventional tools and policies as it is about the actual need to raise rates as a response to economic strength.  The one comment that stood out for me, in the discussion of Fed moves after the crisis first hit in 2007/08 was, “These steps likely prevented a second Great Depression, but they were not sufficient to avoid a severe global contraction.”  It’s my belief that when there is widespread leveraged malinvestment, NOTHING can stop a contraction, central banks can only cushion the blow.  That’s why financial stability is such a hot topic; why it’s important to lean against bubble behavior in the first place.  This is probably a big stretch, but as an example I saw an item on Business Insider that suggested Slack, a tech start-up was worth $2 billion.  “The app itself is a chat room for the workplace…”

Really?  Isn’t that what YAHOO chat is?  Clearly I don’t know any details about the nuances of Slack, but I do know that for $2b you could buy both Bob Evans and Briggs and Stratton.  Both yield over 2.5%.  Are we back to excessive financial speculation on the high-fliers? Go have breakfast and cut the lawn…
Posted on March 24, 2015 at 5:18 am by alexmanzara · Permalink
In: Eurodollar Options

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