Nov 13. He’s not selling any alibis (just bonds)

At one point you have to choose: Revolution or Frank Sinatra.  For me it was Frank Sinatra.  I want to show people a lot of things…with this.—see link at bottom, surprise quote

You said you’d never compromise
With the mystery tramp, but now you realize
He’s not selling any alibis
As you stare into the vacuum of his eyes
And say do you want to make a deal?
–Bob Dylan, Like a Rolling Stone (…mystery ‘Trump’?)


Trump’s election sent shockwaves through the markets and indeed through the world.  Protesters incite revolution; I’d rather listen to a track of My Way.  There has been a tremendous amount of analysis and soul searching, both within markets and through society as a whole.  As my friend at the local wine shop (The Bottle Shop in beautiful downtown Wilmette) told me yesterday, “We have been delivering a LOT of alcohol since the election.”  I, of course asked, “for commiseration or celebration?”

Analysts with a much broader perspective than me have laid out their ideas, some with an almost amazing sense of foresight (as they might like to think, whereas I might call it hubris).   I’ll leave it to the big thinkers.  My slant is that we’re at an inflection point, in the middle of the Fourth Turning, and the distribution of outcomes suddenly seems much wider.  The only thing I know for sure is that people are rebelling globally against the powers that be (or should we use ‘were’) paternalistically lecturing them about what’s in their best interests.  It’s still not really sinking in.  For example, Jean-Claude Juncker, President of the EC, this weekend said, “We will need to teach the president-elect what Europe is and how it works”.  Dude, did you miss the whole “America First” theme?   Do you think you’re going to set the Donald down and tell him how things work?  In terms of this being a “teachable moment”, the new model seems to be trickle up rather than trickle down, a perception, though perhaps fleeting, of a shift towards empowering labor and the average Joe.  It can easily turn messy.

Enough of that, as I’m out of my depth.  Probably better to stick to the markets, and even the broad strokes there are difficult to handicap.  I think we’ve turned.  For example, James Grant of Grant’s Interest Rate Observer has said for years that rates hit their lows and are going to start going up.  If there’s ever been a time to make that call, this is it.  I think July’s low in tens of 136 will mark the nadir going forward.  Perhaps I will be proven wrong, but at least I will be in fine company.   In any case, the shifting sands make it less likely that investors indiscriminately sell premium in order to try to squeeze out a few extra basis points of yield.  The fact that VIX came all the way back down to 14, even with the rally in stocks, is somewhat surprising to me.

From here, I will concentrate on US interest rates, without much of an overlap into macroeconomic themes.  Even more boring than usual.  And… no cartoons this week.  I know, some of you will stop right here, but before you do, note that Yellen is scheduled to speak in front of the Joint Economic Committee on Thursday at 10:00 am.  On Tuesday the 15th Fischer speaks on Bond Mkt Liquidity and Lael Brainard speaks Friday on something having to do with working arrangements.

Net changes and signals 

According to my own calculations using Friday’s settlements in treasury futures (due to the holiday), the ten year note yield soared 38 bps this week from just under 178 to nearly 217.  The blue pack on the euro$ strip (4th year forward), jumped over 54 bps in yield.  Implied volatility screamed higher.  One-year Eurodollar calendar spreads exploded and curvature returned to the euro$ strip.  The peak one-year spread is now Sept17 to Sept 18 at 39 bps (up 21 on the week).   Dec’17/Dec’18 also closed at the peak level of 39. Even with this rally in one-yr spreads, it’s interesting to note that the dot projections from the September FOMC (using a trimmed mean) for end of year levels in 2017 and 2018 are 1.30% and 2.11%, suggesting a red/green Dec spread of 81 as opposed to 39.  The red/green/blue pack butterfly leapt nearly 10 bps from -1.875 to +8.5 as spreads between reds and greens rallied much harder than the more deferred spreads.  More on that below.

On Friday, Fed VC Fischer again made comments indicating a rate hike was likely this year.  January’17 Fed Funds, (FFF7) closed at 9941.5 about 75 to 80% odds of a hike at the Dec 14 FOMC.  However, even though the domestic situation is now front and center, the Italian referendum is on December 4, and could conceivably push an already fragile euro over the edge and reignite Fed concerns over international stability.

In terms of this week’s economic impact, I read a blurb about bonds having seen $1 trillion evaporate in value.   That’s a pretty big number in the context of $18.6 trillion GDP.  Some of the capital losses are horrendous.  For example, just consider the 30 year bond future USZ6, which was 168 at the start of October and closed at 155, a loss of nearly 8%.  A 2.75 coupon doesn’t do much to take the edge off that sort of hit.  Let see, per million it’s about $3400 in positive carry and $130,000 capital loss.

Gundlach mentioned that increased mortgage rates could begin to bite into housing.  Perhaps, but on a mortgage of $400,000 (just below the conventional limit) an increase of 50 bps is just a bit over $100 per month.  (Assume 3.5% to 4.0%, 30 yr conventional, monthly pay from $1796 to $1910). Sure, it’s significant, but I would bet that health insurance premiums and deductibles are a larger concern for most people.

Eurodollar futures…  First, all curve trades made new highs.  By a lot.  On the week, white ED’s closed -7.25, reds (2nd yr) -27.25, greens (3rd) -46.0, blues (4th) -54.375, and golds (5th) -55.125.  So, the question going forward, is which part of the curve goes up or down hardest?   The market seems to be telling us longer contracts will continue to go down harder, not only because of net changes, but because of straddle prices.  For example blue midcurve atm straddles had been trading at a premium to green atm straddles of about 3 bps.  On Friday that spread is more like 5 to 6 bps.  Recall that in 2012-13 greens had higher absolute values.

In terms of one-year calendars, fronts (whites) to reds went out an average of 20 bps, reds to greens 18.75, but greens to blues only 8.375 and blues to golds 7.5, which might suggest that blue atm straddles are perhaps expensive to greens.

Note that at the start of the taper tantrum in 2013, the third red to the third blue (2 yr spread) started below 100 bps (~80) and shot up to over 200 by Q4 (Chart below).  Currently that spread is EDH8 to EDH0 and it’s just 64, below the level of all of 2012.  In 1994 and 2004 when the Fed began actual, concerted, tightening cycles, the third red to blue declined.  I think the primary considerations going forward are whether the Fed will hew to its mantra of very gradual increases, and also how the market views central banks and their policies in general.  My lean is that this episode will be similar to 2013; that central banks will be behind the curve, but my conviction level is malleable.

In terms of target levels on the Ten Year, I would note that on Friday we nearly hit the 50% retrace level of 219.4 from the 2014 high of 303 to this year’s low of 136.  The 0.618 retrace is 239.  Given the incredible shift in sentiment and the fact that positioning still needs to be adjusted, I think 235 to 240 is a reasonable level to attain prior to the next employment report.





11/4/2016 11/11/2016 chg
UST 2Y 78.5 93.6 15.1
UST 5Y 123.7 158.5 34.8
UST 10Y 177.8 216.8 39.0
UST 30Y 256.7 297.5 40.8
GERM 2Y -63.7 -60.0 3.7
GERM 10Y 13.5 30.8 17.3
EURO$ Z6/Z7 15.0 31.0 16.0
EURO$ Z7/Z8 17.5 39.0 21.5
EUR 111.41 108.57 -2.84
CRUDE (1st cont) 44.07 43.41 -0.66
SPX 2085.18 2164.45 79.27
VIX 22.51 14.17 -8.34


*** NOTE: Treasury yields were imputed from futures settlements


Quote at the top was from Jimi Hendrix

Posted on November 13, 2016 at 2:56 pm by alexmanzara · Permalink
In: Eurodollar Options

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