May 29. Mad Cows

From Bloomberg, May 25.  “In the creative world of Chinese lending, there’s a new trade in town: the cow leaseback.  …China Huishan Dairy Holdings Company, which operates the largest number of dairy farms in the country, is selling about a quarter of its herd –some 50000 animals – to Guangdong Yuexin Finance lease Co. for [pinkie to corner of mouth] 1 BILLION yuan ($152 million) and then renting them back.” The article goes on to helpfully point out, “It’s not very common to use cows as collateral.”

Of course, it’s likely that Live Cattle Futures were also met with skepticism from the general public when they were introduced.  And I recall being pretty surprised when David Bowie securitized future income streams from his music.  So perhaps there’s nothing to see here.

However, there IS something to see in terms of credit since mid-February.  In March, several things happened to accentuate the rebound from the drubbing seen in the first six weeks of the year.  First, the ECB announced on March 10 an expansion of its QE program including purchases of investment grade non-financial corporate bonds.  Second, the FOMC press conference in March was dovish and was punctuated in late March by an accommodative speech by Yellen.  The dollar eased, oil rallied, as did stocks.  Importantly, junk bonds staged a powerful rally as well, as can be seen by the precipitous decline in the spread chart below:

fredgraph hi yld spd


A report by Evergreen/Gavekal notes that bonds of US companies with European operations are eligible to be purchased under the ECB plan, and that there has been a surge of US firms issuing euro debt (further noting that MCD and JNJ were able to issue at 0.25% and 0.50%).  The Fed minutes cited the accommodative tone in March as a factor that eased financial conditions.  So once again, the central banks used their influence to dampen risk (and support fertile financial engineering conditions with cow pies as the fundamental underlying asset).

I had hypothesized that the end of QE in the US would spur a shift to more realistic pricing of risk. And, with additional restraint in the form of the first Fed hike, that appeared to be the case.  But the ECB is leaning in the opposite direction.  Perhaps the Fed is striking the right policy balance in light of other central bank actions.  However, there is an unsettled undertone, as articulated by Soros, Druckenmiller, Gundlach, Icahn etc.  Last week it was Bill Gross who said “the entire system is at risk.”  In April of 2016, Gross was interviewed by Barrons and talked about selling strangles to augment bond yields.  From that article: “…my premise is that central bankers will do anything possible to contain interest-rate fluctuations. The sale of volatility is producing the predominant amount of return in my fund.”  In an interview last week he takes a diametrically opposed viewpoint.  May 26 summary from Bloomberg:  “Gross …said he expects corporate-bond prices to fall in part because they’ve risen so fast since mid-February but also because he believes a day of reckoning will come when central banks will no longer be able to prop up assets and investors will withdraw from markets.”  As Gross himself notes, it’s quite a transformation in psychology.   “Eliminating credit as an investment means ‘not buying stocks, not buying high-yield bonds,’ Gross said. ‘It means going the other way, which comes at a price.’”  I would add, it means withdrawing volatility offers at these cheap levels.

Andy Xie, the former chief economist for Morgan Stanley in Asia, penned an op-ed with a view that is even more dour than Gross’.  Just a couple of lines: “…China’s overcapacity bubble will kill global capex for many years to come.” “All indications are that China wants to export the overcapacity.   …China’s strategy would lead to de-industrialization in most of the world, in particular middle income emerging economies.  Weak capital expenditure would lead to weak employment and labour income. The resulting bankruptcies may further weaken the global credit system.” [link at bottom]


OK, let’s get back to the immediate issue at hand, that of data-dependency.  On Friday, Yellen allowed that the Fed could hike “in the coming months.”  More on that below.  The problem will be if the releases this week don’t clear the ‘data dependent’ bar.  Mfg ISM threatens to be weak and has been holding just over 50 (last at 50.8).  I had previously put out a chart that showed that the Fed never hikes with Mfg ISM sub 50, but of course was proven wrong in December.  Nov ISM 48.4, Dec 48.0 and Jan 48.2.  What if we go sub 50 again?  Also, NFP (Friday) is only expected 160k due to a Verizon strike.

Delving a bit deeper, Andrew Zatlin’s  (Moneyball Economics) Vice Index has gotten some play in the past week, and it’s not particularly encouraging for consumer spending going forward.  The Vice Index tracks prostitution, gambling, booze… i.e. the little luxuries in life.  “If someone is going to go out and spend a day or two of wages, then what you are seeing is that they really feel good about today and they really feel good about tomorrow… it’s a very economically sensitive barometer …it leads consumer spending by a few months.”

“Right now it’s saying steady as you go for a couple of months and then when we come out of the summertime, it looks like there’s going to be some belt-tightening that’s going to happen.

vice index zatlin


The Vice Index is in red and is lagged.


Back to Friday.  As Yellen conferred her imprimatur on a hike in coming months, the short end reacted immediately.   For example, here are the settlements Friday (due to the early floor close) and some late (post Yellen) prices.  EDU6 9916.5s, post-Yellen 9913.0.  EDU7 9884.0s. to 9878.5.  EDU8 9860.0s, to 9854.5.  Also, August Fed Funds settled at 9946.5 and then traded 9944.5.  This contract captures both June and July FOMC meetings, and at 19 bps below the front May contract, it indicates over 75% odds of a hike at one of those two meetings.  The October contract traded 9940 late (also captures the Sept FOMC).    At 9913.0 EDU6 is 24 bps above the prevailing 3mo libor setting before renewed hiking rhetoric started.   In short, the Fed has prepared the market for a hike.  The curve remains flat and is likely to get flatter.  Stocks absorbed the news without mishap and closed at the highs.  As one client said, there’s no one left to sell.  Shorts based on high profile warnings had already been placed, and the prospect of a stronger dollar attracts foreign capital to US assets.  However, volume at the highs is quite low and is not providing confirmation of the move.

One personal note on this Memorial Day weekend.  One of the cool things about being on the CME trading floor in the glory days was that celebrities would tour the floor.  And I had the privilege of being there when a Congressional Medal of Honor recipient visited.  Trading basically stopped.  The reception and applause from the trading community, was nothing short of awe inspiring.  (You won’t get that from a screen).


5/20/2016 5/27/2016 chg
UST 2Y 88.4 87.9 -0.5
UST 5Y 137.0 135.7 -1.3
UST 10Y 184.7 183.4 -1.3
UST 30Y 263.8 263.9 0.1
GERM 2Y -50.6 -52.3 -1.7
GERM 10Y 16.5 13.8 -2.7
EURO$ U6/U7 31.0 32.5 1.5
EURO$ U7/U8 23.5 24.0 0.5
chg to Sept
EUR 112.26 111.15 -1.11
CRUDE (1st cont) 48.41 49.33 0.92
SPX 2052.32 2099.06 46.74
VIX 15.20 13.12 -2.08

________________________________________________________   cows explain ideology

Posted on May 29, 2016 at 12:15 pm by alexmanzara · Permalink
In: Eurodollar Options

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