Nov 23. Tight ranges in fixed income, but curve appears ready to flatten further

–Groundhog day.  For the past three Fridays the settlements in TYZ have been 126-21, 126-22 and 126-22.  The last two Sunday evenings marked highs for the week, 127-005 on Nov 9 and 127-00 on Nov 16.  I am sending this out on Sunday Nov 23, half an hour prior to the open, and my guess is that we’ll open near 127-00 (though I doubt that level will cap the market this week).

–It’s not just TY that trades with a decided sense of boredom.  In the past three weeks the range of the red/green eurodollar pack spread (closing basis) has been just 3.5 bps, 92.125 to 89.625.  No surprise then, that implied vol is grinding lower.

–Treasury curve spreads have also, of course, been narrow.  However, they have quietly consolidated at the lows, as enclosed charts show.  All look ready to flatten further.  2/10 is 181.4,  5/10 is 70.4 and 5/30 closed 141, which I marked as a slight new low. 

5/10 treasury spread

5/10 treasury spread

 

 

 

 

 

 

 

5/30 treasury spread

5/30 treasury spread

 

 

 

 

 

 

 

 

Given fairly steady gains in employment, new highs in stocks that have potential to spur wealth effect spending, and foreign central bank words and actions (PBOC ease Friday) to support global growth, one would think that inflation expectations and long end yields in the US would perk up.  Indeed, in reviewing global yields the US does have a relatively high yield at 2.315.  With global yields low and the dollar growing ever stronger, the US looks quite attractive.  French 10’s are at 1.11, so the US is more than double.  Germany at 77 bps, so the US is 3x higher.  Japan at 45, so the US is 5x higher.  Italy is just under the US at 2.21.  But Italy’s debt to GDP was 132.6% at the end of 2013 and is expected to grow to 137% this year as the latest GDP was -0.1; Italy hasn’t had growth in three years.  How can the US yield be higher?

–The stronger dollar forces more price competition on US products.  The fact that Japan, China and Europe are fighting to try to generate some sort of price inflation underscores the risk of deflationary pressures building in the US.  The flattening curve is a clear reflection.

–ZH cited an interesting report from Barclay’s noting that wider spreads on junk bonds can be used as a sell signal in stocks.  My own conclusion is that wider spreads aren’t necessarily a catalyst for weaker stocks;  correlation doesn’t automatically indicate causation.  In any case, it appears that junk bond spreads bottomed in June and have, since then, been making higher highs and higher lows…worth keeping in mind.

Posted on November 23, 2014 at 5:03 pm by alexmanzara · Permalink
In: Eurodollar Options

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