The Fed can’t cure the virus
January 30, 2020
–Yields continued to fall yesterday right through Powell’s press conference, with tens shaving 5 bps to 1.592% (at futures settlement). The Fed raised IOER 5 bps to 1.60% (so it now just eclipses the 10y yield), and directed the desk to continue buying bills at least into Q2. The Fed’s implementation statement continues to specifically reference the reserve level from September, an implicit guarantee to the market that it won’t let the repo surge occur again. At the same time, the CBO projects a trillion dollar deficit this year and beyond. The bonds issued because of those deficits will need to be bought and financed. With REPO. In a logical extension that means the Fed will need to buy more… and more. Interestingly, stocks fell as the press conference was taking place, and are lower this morning as FB results swamped the ‘feel-good’ TSLA report. Of course, the Wuhan virus is spreading and impeding movement of people, goods and services, an overarching threat to economic activity, as reflected by the continuing plunge in copper (off 12% in two weeks).
–In the short end, near eurodollar calendars are making new lows. The lowest one-year calendar is the front EDH0/EDH1 which fell 5 bps yesterday to -38.5. FFF0/FFF1 was down 4.5 to -36.25. Earlier in the month, until a week ago, these spreads had been holding around -20 to -25. That is, the market was leaning toward the possibility of one Fed ease of 25 bps in 2020. Now the market is perceiving one and a half, or certainty of one ease and 50/50 for another. Reds through golds (2nd year to fifth year forward) all rallied 5 to 5.5 bps, so not much change in deferred calendar spreads. Red/gold pack spread settled 20.375 while 2/10 edged to a new low of 17.3.
–There are indications that uncertainty surrounding impeachment will end Friday as the Senate acquits, but if the trial continues, it’s likely another risk for stocks.
–There has been a bit more mention of ‘fifty-cent’, the large buyer of otm VIX calls. Large open positions are in the following strikes: Feb 22 calls which expire 19-Feb were trading 0.65 late and have a whopping 333k of open interest. March options expire 18-Mar, and 25c are around 0.65 with 161k, while 28c are 0.45 and have 212k. Spot VIX was 17.6 at the end of the day.
Wuhan virus acceleration starting to look like palladium chart
Jan 25, 2020
–All eurodollar calendars making new lows as back contracts outperform front end. The Wuhan virus spread is not likely to respond to monetary policy, though some firms are probably going to encounter cash flow problems from reduced activity.
–EDH0/EDH1 is lowest one-year calendar spread and settled -31.0, down 4 on the day. EDM0/M1 settled -24.0, down 3.5. Implied vol firmed, though it’s still relatively low across the curve. 2/10 closed at a new low below 20 bps, 19.5, while the ten year inflation-indexed yield closed just barely above zero, i.e. no real yield. Ten year treasury to tip breakeven at 1.677%, a new recent low suggesting a decline in inflation. Ten year yield fell 6 bps to 1.679%.
–Red/green pack spread (2nd to 3rd year) settled 3.0 bps, a new low for 2020. These levels were last seen in late November.
–EDH0/FFJ0 settled at a new low of 14.5 bps.
–The dollar index (DXY) continued its 2020 rally and closed 97.88, nearing the halfway back point from the Q4 high to low of just above 99.50 on Oct 1 to just below 96.50 on Dec 30.
Lockdown
January 24, 2020
–40 million people on lockdown in China due to Wuhan virus according to BBG. Stocks yesterday reversed early losses and closed higher; this morning ESH is at 3333 like a magnet. Yields eased yesterday with tens down 2.8 bps to 1.738%. As the chart below shows, Leading Indicators were -0.3, the weakest since early 2016. TYH posted a high of 130-01, shy of the Jan-8 high of 130-06 associated with Soleimani.
–On the euro$ curve, near one-year calendars made new recent lows, with EDH0/H1 still the lowest at -27.0 (down 0.5 yest). EDM0/M1 fell 1 to a new low of -20.5. The peak euro$ contract has moved slightly out the curve to the third red, EDU21 at 9857. The front end is capped by Fed talk that policy is in the right place, while the back end edges higher. The ten year inflation-indexed yield was barely above zero late yesterday at 0.007, the low since early Sept of last year. Real yield at zero pushes money out the risk horizon, ADG notes that the average yield on BB Corp debt (the top rung of junk) is just 3.47%. EDH0 to FFJ0 (lib/ois proxy) settled at a new low of 15 bps.
–Implied vol was slightly bid. Feb treasury options expire today.
–Next Wednesday is the FOMC. As mentioned on my weekly note, the four month surge at the end of 2017 into 2018 peaked on Jan 26, the gain was near 20% over that time frame due to the tax package. The past four months of Fed t-bill buying have seen a similar percentage move higher. Does Powell give the green light to more liquidity or signal that he’s going to drain the swamp? FOMC date is Jan 29. Financial conditions appear quite loose…
–Interesting note by Joe Carson on ZH says that operating profits have not grown in the past five years. Another post from this morning blares that the “World’s richest are Stashing Large Sums of cash in vaults as Swiss bankers rage against negative rates.” Maybe that’s why EURCHF is at new lows, closing in on 106; it was at 120 in Q2 2018.
https://www.zerohedge.com/economics/2019-5th-consecutive-year-no-operating-profit-growth
Risks spreading
January 23, 2020
–The Wuhan virus has caused the Chinese gov’t to quarantine the city (with more likely to follow). While there are various reports with exact numbers of infected and dead, other sources suggest a far broader risk; hospitals swamped, the virus has spread to every province, “the severity of the outbreak has alarmed China’s leaders.” When there’s going to be a bad snowstorm in Chicago the supermarkets are quickly mobbed and picked clean; I can’t imagine what a quarantine would do. Global markets are currently taking it in stride, though March WTI crude is making a new low, currently below $56/bbl, nearly $10 below the spike high associated with Soleimani’s demise. As an aside, palladium posted a new high above $2400, up $59 as of this writing.
–ECB meeting today. Yesterday the Bank of Canada meeting sparked a rally in BA’s with BAM0 through reds up 8 to 9 bps on a tilt toward future cuts.
–Yields were essentially unchanged yesterday in the US, though there’s a consistent bid in long bonds which have fallen another couple of bps this morning. Feb treasury options expire Friday. Yesterday TYG 129.5^ settled 19 ref 129-175, futures exceeded breakeven this morning at 126-265. TYG 130c trade 5/64’s; the spike Soleimani high was 130-06.
A bid for long dated USD assets
January 22, 2020
–Stocks are at new highs this morning, shrugging off concerns about the Wuhan flu. Negotiators say there are o immediate plans for US/China Phase 2 talks (probably until this whole pandemic thing blows over). Treasuries have barely given back any of yesterday’s gains. Tesla has exceeded $100 billion in market cap.
–Tens fell 6.5 bps yesterday to 1.769%. On the euro$ curve, reds through golds were up 6 to 7 bps, with marginal outperformance by blues (4th year out). While calendars didn’t change much, there were new lows posted in a few of the near one-years, for example, EDM0/EDM1 settled down 3.5 at -19. The first, and lowest one-year is still EDH0/EDH1 which settled -25.0, down 4 on the day; still leaning toward one Fed ease over the next year. Jan20/Jan21 FF are on the same page at -22.5 (-3.75). Implied vol better bid across the curve, but still at low levels.
–The fixed income market is reflecting concerns about the coronavirus with yields under continued pressure, but perhaps stocks are reacting to the same thing in the same way: a bid for long dated dollar based assets. DXY has firmed since the recent low made at the end of last year.
–Chgo Fed Natl Activity Index was a strong 0.56 last, expected 0.13 today.
Human Contact
January 21, 2020
–Now it’s all about the Wuhan coronavirus that is spread by human contact, potentially made worse by travel plans during the lunar new year. US stock futures down just 40 to 50 bps from record highs last week. Hang Seng down 2.8%, Nikkei down 90 bps. TYH traded a high of 129-155, the highest since Soleimani hit. Feb treasury options expire Friday and can provide cheap short term protection. An acceleration of this virus will be a large impediment to the movement of goods and people. For now, authorities seem to be monitoring the situation with body temperature scans; for example, Macau is not restricting the flow on incoming visitors,”…local authorities would be enforcing body-temperature checks on all passengers arriving in Macau via flights from mainland China.” https://www.ggrasia.com/for-now-no-limit-on-macau-visitor-flow-amid-china-virus-govt/
–Some people are comparing this potential outbreak to SARS in 2003. According to ‘the internet’ SARS was first discovered in Asia in Feb 2003. US stacks had sold off from 2000 to 2002 but were already turning back up at the time of the SARS discovery.
–It’s a light week for US economic news, so Impeachment and Davos will have to suffice for news and entertainment.
No Free Lunch
January 19, 2020 – Weekly Comment
On Wednesday, Dallas Fed President and 2020 FOMC voting
member Robert Kaplan said this in an interview:
“It’s a derivative of QE when we buy bills and we inject more liquidity, it
affects risk assets. This is why I say
growth in the balance sheet is not free.
There’s a cost to it.”
Of course, another new voting member, Minnesota’s Neel
Kashkari had this to say on twitter.
“QE conspiracists can say this is all about balance sheet growth. Someone explain how swapping one short term
risk free instrument (reserves) for another short term risk free instrument
(t-bills) leads to equity repricing. I
don’t see it.”
I think I’ll go with Kaplan on this one. By the way, if there’s no effect, why should the Fed even swap nearly identical instruments Neel?
In any case, maybe it’s not causation, but the chart below shows what appears to be a strong response to the Fed’s onset of bill buying in October: SPX has rallied just over 17%. As the chart also indicates, there was a powerful rally in Q4 2017 through January 2018. That episode was spurred by the tax package and corporate repatriation. From September 2017 to January 26, 2018, SPX surged nearly 19%. What followed was a rather sharp pullback as short vol positions blew up and the VIX exploded to 50, having been around 10 going into the start of 2018. By the way, at that time, the out-of-the-money VIX call buyer known as ‘50 cent’ reportedly made a quick $200 million in February 2018. Perhaps unsurprisingly, there was a buyer the week before last of 75k Feb VIX 25c for 49 cents. (Jan 8). In any case, spot VIX is now languishing just above 12, although the Feb future settled 14.925.
The chart above would seem to indicate that if one wanted to take a stab at shorting the major stock indices, which have continually posted new record highs in January, that the last week of the month might be the time. The year’s first FOMC meeting, with our aforementioned new participants, takes place on Wednesday, January 29.
Kaplan said in his interview last week that he would like to pare back the stimulus. Indeed, it would appear that even a marginal decline in liquidity provision might prove to be a tipping point. On that score, I would note that the NY Fed this week trimmed two-week term repo amounts to $30 billion from $35 billion starting in February. Also worth noting is that IOER is expected to be tweaked higher by 5 bps to 1.60%. The Fed Effective rate has been coming in at 1.54%. February Fed Funds have already given the nod to a potential move, settling at 98.42 or 1.58%, compared to January at 98.4525 or 1.5475%. In fact, Feb, March and April FF all settled 98.42. However, from there forward, contracts gently rise, reflecting an unshakable bias toward further easing. The October contract (FFV0), which is the last month prior to the election, settled 98.56 or 1.44%, a spread of -14 bps to Feb. Therefore it’s fair to say that the market is expecting somewhere around a 50/50 chance of a 25 bp cut by then. While it appears as if no Democratic candidate has a chance to beat Trump, I’ll call that the Bernie effect.
The Eurodollar curve tells the same story. EDH20 settled 98.255 while EDU20 settled 98.385, a spread of -13.0. The spread between EDU20 and FFV20 settled 17.5, a forward proxy for lib/ois. Many Fed officials have said that policy and the economy are in a good place, and have indicated that the bar for changing the FF target this year is a high one. Even Bullard espouses that view, saying that last year’s eases will “come on board in 2020.” Yet there continues to be accumulation of EDU0 98.875 and 99.00 calls for 3.0 and 2.0 bps respectively. The call strikes from 98.75 to 99.00 have the most open interest in both June and Sept. EDU20 9875c settled 4.0 and have 414k open while 98.875’s have 420k. (And no, you can’t buy the EDU0 9875/9887/9900 call fly for zero even though it settled there). Given where EDH0 is trading, it would take two rate cuts to reach the 98.75 strike in Sept. Of course, UBS put out a call for three rate cuts in 2020.
The Fed has indicated it will continue its pace of buying $60b/month in t-bills into Q2, to at least cover the April 15 tax date. While there are some clues of a coming reversal in liquidity provision, the music is still playing for now. However, warnings are evident. For example, KKR is reportedly cutting its exposure to BBB to underweight, fearing a wave of fallen angels. The Treasury’s announcement of 20-year bond issuance underscores two things. One, the administration is going to continue deficit spending to support the economy at least through the election and two, if the Fed does trim its reserve building operations sometime in Q2, it’s effectively a double doink with respect to pulling back on liquidity. More supply financed by repo with less support from the Fed.
OTHER MARKET/TRADE THOUGHTS
The announcement of renewed issuance of 20-year bonds steepened the curve, which had been flattening since the beginning of the year. Both 2/10 and 5/30 spreads rallied 3 bps on Friday, to 26.7 and 66.5 respectively. The Fed’s on hold with the possibility of higher inflation as last year’s stimulus measures take effect, while a degree of uncertainty has been lifted due to the US/China agreement; both of these factors should support the curve. The extra long-end supply adds another ingredient to the mix. However, 5/30 has to exceed 80 for confirmation of a renewed steepening trend.
Last week EDM0 and EDU0 both fell 2 bps on the week to close Friday at 9831.5 and 9838.5. There has been significant covering (buying back) of short EDM0 9825/9812 put spreads. The weekly change on EDM0 9825/9812ps was 1.25 bps, from 1.5 to 2.75, and open interest fell 90k in the 9825 strike to 634k while the 9812 strike fell 67k to 333k. Still a lot of paring back possible in this put spread. I favor a long in EDU0 9825p which settled at 3.75. This put also has large open shorts due to previous buys of 9837/9825/9812 put flies. The market treats the downside like Rodney Dangerfield (no respect) but what if Powell sounds a hawkish note on the 29th?
| 1/10/2020 | 1/17/2020 | chg | |
| UST 2Y | 156.8 | 156.2 | -0.6 |
| UST 5Y | 163.3 | 162.9 | -0.4 |
| UST 10Y | 182.1 | 183.4 | 1.3 |
| UST 30Y | 228.2 | 229.4 | 1.2 |
| GERM 2Y | -60.0 | -58.9 | 1.1 |
| GERM 10Y | -19.9 | -21.5 | -1.6 |
| JPN 30Y | 43.6 | 45.8 | 2.2 |
| EURO$ H0/H1 | -21.5 | -21.0 | 0.5 |
| EURO$ H1/H2 | 3.0 | 2.0 | -1.0 |
| EUR | 111.22 | 110.93 | -0.29 |
| CRUDE (1st cont) | 58.99 | 58.58 | -0.41 |
| SPX | 3265.35 | 3329.62 | 64.27 |
| VIX | 12.56 | 12.10 | -0.46 |
More bonds
January 17. 2020
–Stealing Bernie’s thunder: We’ll issue more bonds to pay for a middle class tax cut…
–Tens are unchanged this morning while USH contract is down 20/32 as the US says it will begin to auction 20-yr bonds to help fund the deficit. Yesterday tens rose 1.4 bps to 1.802% on solid retail sales and Philly Fed. In eurodollars there continues to be accumulation of EDU0 9887 and 9900 calls (3.0 and 2.0). With EDU0 settling at 9840, the 9825p are 15 away and settled 3.25. The 9887c are 47.5 away and settled 3.0. The market is projecting the possibility of forced, aggressive easing…due to what? A violent reversal in stocks? The need to keep funding low in order to place the avalanche of bond sales? A deluge of Trump tweets calling for lower rates just before the election (with new Fed nominees Shelton and Waller as compliant doves)?
–Euro$ one-year calendars over 2020 continue to indicate one ease. EDH0/EDH1 settled -22.5 and FFF0/FFF1 -20.75.
–Stocks continue to power to new highs with ESH now 3324. This contract is now about 4.5% higher than the low after the US eliminated Iran’s general Soleimani.
–China’s annual growth was reported at 6.1% but Q4 shows signs of improvement. –Today’s news includes Housing Starts, Industrial Production -0.2 expected, U Mich Sentiment.
Making up excuses to buy palladium
Jan 16, 2020
–Not a lot to talk about in rate markets. Ten year yield fell another 2.8 bps to 1.788%. The curve eased to new lows for this new year, with 2/10 down just over 1 bp to 22.8 and red/gold euro$ pack spread at essentially the same level, 22.625, also a new recent low. The China deal is signed, we now move to impeachment. Real yields, as depicted by the ten year inflation-indexed note, are hovering just above ZERO, with the ten year tip yield of 3 bps. In Q4 2018 it was over 115 bps. If there’s no real yield, might as well buy any asset that throws off some type of cash flow. Right?
–And that leads me directly into the palladium market. There IS some excitement there, as the March contract is up $70 this morning to a record high of $2240/oz. It’s more than double its previous spike high of just over $1000 in the beginning of 2001 (recession ensued shortly thereafter). Its recent low at the start of 2016 was around $500 and has been surging ever since; in July of last year it was around $900. By now it’s probably no secret that Elon Musk has been stockpiling the metal for the expected surge in demand for Teslas (as reflected in the stock price) which of course, will require a LOT of catalytic conve…. Oh, wait a minute. Scratch that. No. it’s actually for the redesign of the new Ford 150 pick-up, which will be part of the new middle-class tax package being unveiled by the administration (tax credits for pick-ups). In any case, beware a turn. Because the price of palladium tumbles with the onset of recession….
Gingerly withdrawing liquidity
January 15, 2020
–Today is the US/China Phase 1 signing. It’s also settlement day for last week’s auctions and a tax date, but there appears to be plenty of liquidity. Yesterday afternoon the Fed released the Jan/Feb repo schedule, which shows a modest $5 billion decline in 2-week term repos starting in February (down to $30 billion each). https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/repo-reverse-repo-agreements/repurchase-agreement-operational-details
–It was reported that the Fed is considering lending repo directly to hedge funds. A separate article said UBS is looking for three Fed cuts in 2020. Did the entire world legalize recreational weed at the start of the year? I thought it was just Illinois.
–It seems that massive US gov’t borrowing has increased the size of the bond market being financed with repo. The decline in global trade has led to diminished buying by foreign central banks, so leveraged domestic buyers have filled the gap. Borrow short, lend long. It’s fine in moderate size as long as the curve remains positive. Maybe that’s why the Fed is so intent on creating inflation, and is so sensitive to removing liquidity. As a hedge fund mgr quoted in WSJ said, “The system cannot work without leverage, but a system with too much leverage is unstable.”
–The curve flattened yesterday. On the euro$ curve, spreads from reds back flattened to new lows for 2020. Reds/greens down nearly 1 bp to 4.625 bps, reds to golds down 1.25 to 23.375. The ten year yield eased 2.8 bps to 1.816%, with 2/10 at 24 bps. CPI released yesterday showed YOY Core +2.3%. The NY Fed released its Underlying Inflation Gauge, with the “full data set” at 2.4% up 1/10th from the previous month. Today Core PPI yoy expected 1.3% and Empire State 3.6 from 3.5.
