Nov 4. Election day and instability

–Yields in the US edged slightly higher yesterday as ISM was stronger than expected at 59.0.  Tens were up 1.4 bps to 234.5.  Curve was slightly flatter with 5/30 at 143.7.  Red/gold euro$ pack spread fell 1.875 to 180.5 as the gold pack settled unchanged on the day.

–The big story of course, is not the US election, though we’ll get a small taste of ‘regime change’ here.  (Remember two years ago when Obama told Putin, “After my election, I have more flexibility…”?  Things can change pretty quickly).  The big story is oil, which had tested $80 several times in October and now has decisively crashed through that level to around $76.  While in the US, the price drop is sometimes thought to be beneficial to consumers as a ‘tax cut’, it raises the prospect of disinflation, especially in conjunction with a stronger USD.  Capital intensive projects that were economical above $90/bbl can be shelved at prices below $80.  Deflationary fears are most acute in europe, where the EU has just cut both growth and inflation projections.  From BBG:  “Gross domestic product in the 18-nation region will rise by 0.8 percent this year and 1.1 percent in 2015, down from projections for 1.2 and 1.7 percent in May…” and inflation is projected at only 0.8 as opposed to the ECB guess of 1.1.

–While Japan has stoked its financial asset prices with its latest round of depreciation, or rather, QE, pressure is now on other countries to respond to pressure on export markets.  Especially China, as signs of a slowdown continue to mount, the latest being a record 23% drop in Macau casino revenues.  Maybe it has to do with a drop in conspicuous consumption, maybe with fears of ebola, but 23% is a BIG number.

–Implied vol levels in US rates have shaken off the surge from mid-October, and some measures of risk have stabilized.  Most obvious of course is the run to new highs in major US stock indexes, and tightening of junk bond spreads following October’s jump.  However, we are seeing one example after another of destabilization being blithely dismissed by stock analysts.  The yield crash in October was the start, followed by Japan’s QE bombshell and now the plunge in oil.   There are going to be serious reverberations that could easily see US tens revisit 2%.  How can US yields at the long end drop in a growing economy with an improved labor picture?  Because growth is now heavily dependent on the value of equities.  A project that might look good when portfolios are robustly growing, could easily get put into the “maybe” category in case stocks swoon again.  I didn’t know that HLF really stood for ‘half’, as in the value of Herbalife being cut…

Posted on November 4, 2014 at 5:40 am by alexmanzara · Permalink
In: Eurodollar Options

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