Oct 29. Of QE and burn rates

–FOMC announcement this afternoon.  First, a couple of notes about yesterday’s action.  Back end of the dollar curve was relatively weak, with red/gold pack spread posting a new recent high of just under 188 bps, +2.375 on the day.  Ten year yield rose 3 bps to 228.5.  For the three months prior to October, tens felt comfortable trading a range from 240 to 260, but now it seems as if something like 210 to 235 might be more appropriate, even as the Fed is expected to end [this round of] QE.
–Implied vol was crushed as stocks soared higher and high yield spreads tightened a few more bps.  On Friday, USZ 142 straddle settled at 2’60, yesterday at 2’28.  TYZ straddle has gone from 1’40 to 1’23.  FV straddle was trading over 1 point, now 51.5.  Blue Dec closed 30.5 from 32.0 on Monday; during the mid-Oct panic atm blue Dec settled as high as 37.5.
–Ruble makes a new low every day… destabilizing.

–Now just a couple of quick thoughts on broader issues this morning, tied together with acronyms: FB and QE.  Starting with FB, which gave forward guidance of massive increased spending related to recent start-ups.  From a BBG article: Whatsapp…”The messaging service, which reached 400 million active users in December, generated less than 3 cents in revenue for each one last year. By comparison, Facebook paid $55 per user when it acquired the company. WhatsApp’s net loss was $138.1 million for 2013.”  In the middle of September there were several articles about stratospheric tech company “burn rates”, with a notable warning by Bill Gurley.  http://online.wsj.com/articles/venture-capitalist-sounds-alarm-on-silicon-valley-risk-1410740054  What is sort of ironic is that FB, is now doing it to themselves.  They made acquisitions with the funny money of their own stock that threatens to burn them.  But perhaps it’s temporary, and one company, though it is down 10% after the announcement, is perhaps not symptomatic of the stock market as a whole.  But I think the whole idea of QE is analogous to a “burn rate”.  Money keeps getting pumped in, but the returns aren’t showing up.  So now it’s being ended.  In the capitalist model, the company has to sink or swim.  We’ll see.  It will be interesting to see how the Fed responds to diminishing inflation, and whether the statement will still note “significant underutilization of labor resources.”
–In terms of inflation/deflation, central banks note the huge risks of the latter, now brought into focus by the large decline in energy prices.  But to worry about disinflation due to energy is ridiculous, it’s a tax cut to consumers.  Certainly a decline in energy prices won’t make consumers put off purchases today (though it might halt some capital expenditures).  The real risk is when financial assets no longer generate a stream of income to cover debt service payments.  That’s the harrowing ‘deflation’ scenario that leads to an asset liquidation spiral.  That’s what the ECB stress tests are supposed to calm us about.  But DB just announced a loss and replaced their CFO, and the bank is beset by a regulatory spiderweb.  What seems more tangible?  DB’s actions or ECB’s words?
–QE by its very design is supposed to force money into riskier assets with less cushion.  It succeeded.  But the question is whether those assets have the income streams to cover debt service, even at extremely low rates.  Has QE thus far ended the ‘burn rate’?

Posted on October 29, 2014 at 5:22 am by alexmanzara · Permalink
In: Eurodollar Options

Leave a Reply