Pricing a quiet 2020?
December 16 2019
–EDZ9 expires today and has been stable around 98.105, despite all of the repo angst. 1.5 million futures in open interest, with 11.4 million options on the contract. Dec midcurves expired Friday, eliminating 2.7 million calls and 3.07 million puts.
–Friday featured a strong rebound in rate futures despite the Phase One agreement. Ten year yield fell 8.5 bps to 1.82%. Red pack +8.25, greens and blues strongest at +9.5. Implied vol continues to soften going into a quiet week. Today features Empire State Mfg, expected 4 from 5, and Markit PMI data, expected to show slight improvement. Stock index futures made all time highs, but interestingly, so did the CBOE Skew Index which closed 144.51. https://www.cnn.com/2019/12/15/investing/stocks-week-ahead/index.html
–So stock index puts are pricey vs calls, but they’re giving away euro$ puts. EDZ0 atm straddle settled 38.5 with a year to go. In the beginning of August, with just a little over 4 months until expiry, the EDZ9 atm straddle was 33.5. In the words of Elvis Costello, ‘Accidents will happen, we only hit and run…’
–Jan20/Jan21 FF spread settled -25 and the EDH0/EDH1 calendar is nearly the same at -24.0. The market has one ease priced through the coming year…but is currently pricing for boredom. For libor/ois spread proxy is EDH0 vs FFJ0 which settled at 20.5 bps.
Crisis levels of stimulus
December 15, 2019 – Weekly Comment
In Q2 2018 stocks and other assets levitated due to the tax package (Tax Cuts and Jobs Act). At the time, many analysts warned of a ‘sugar high’. In April ‘18 both Morgan Stanley and the IMF put out reports warning that growth was being pulled forward, and that future deficits might make it difficult to engage in fiscal stimulus should the economy slow. Obviously, at the end of 2018, the Fed’s attempt at normalization, coupled with trade tensions, derailed stocks.
Currently we’re in the midst of massive stimulus even as growth is good and unemployment is at historic lows. The Fed is pumping gargantuan liquidity to prevent another repo scare. M2 is growing at a 7.3% yoy rate and is accelerating. The Federal government is running epic deficits, though there is little in the press to suggest the public has any concern about such matters. The 2019 deficit was $984 billion. In October, the first month of fiscal 2020, it was $134 billion and in November, $209 billion. This compares with previous year levels of $100b and $205b. “The Treasury Dept reported Wednesday that the federal gov’t took in $225 billion in tax and other revenue but spent a record $434 billion in November.” Going into the election year there is little to suggest anything besides wide-open spigots on spending, and the Fed has overtly said that hikes are off the table unless inflation is persistent and significant. A 2020 deficit of over $1 trillion is a lock.
Against this backdrop, the administration completed Phase One of a trade agreement with China, and the Tories won a resounding victory on the ‘Get Brexit Done’ slogan. After the Q4 2018 rout in stocks, returns this year have been phenomenal with SPX up 26% ytd. However, versus the 2018 high the current level is only 8% higher, which is still, of course, a solid showing.
Even with a layer of trade uncertainty being withdrawn, SPX only gained 70 bps on the week. Of course, these are all-time highs. Yields were little changed, with tens down 2.8 bps on the week to 1.819%. Implied vol in the short end was crushed and is on the low end of the recent range in treasuries. The market continues to forecast one more ease in 2020, with Jan20/Jan21 FF spread settling exactly at -25 bps. With EDZ9 expiring Monday, EDH0/EDH1 will be the front euro$ one-year calendar and it’s also the most negative, at -24 bps. Twin engines of money supply growth and Federal Gov’t deficit spending should be cranking up inflation and term premium in the long-end, but confidence in the Fed to provide ‘whatever it takes’ to guarantee absorption of treasury supply (or absorbing it itself) is rock solid for the moment. The NY Fed’s Q4 GDP Nowcast of just 0.7% allays any fear of an uptick in inflation. USH0 at-the-money 158 straddle settled just over 4 points at 4’06, just 7.5 vol.
There was a lot of press surrounding the Phase One deal and China’s vow to buy $50 billion in US agricultural products over two years. Sounds like a lot. But what the US really needs someone to buy is the near $90 billion per month of treasury supply to plug the deficit. Maybe that’s the undertone of a China deal: we’ll make it easier for you to again sell goods in the US, but take those tariff savings and recycle them into US bonds to help our funding needs.
The only market beginning to reflect a modicum of concern about US policies is the dollar, which is starting to turn lower. The fact that stocks didn’t see more of a boost this week is a warning sign going forward.
OTHER MARKET/TRADE THOUGHTS
Quick update on large call calendars bought in the week previous to last: TYF/TYG 130 call calendar had been bought from 14 to 16 in size of >100k. A grinding rally going into Jan expiration (Dec 27) works best for this trade. I had surmised that China talks would drag on, making this a reasonable play. In fact, the December tariffs were suspended as Phase One appears to have been completed, and the Tory win diffused another situation that removes, at the margin, demand for the safety of treasuries. However, on the week the ten year yield actually declined by 2.8 bps, with TYH0 going from 128-28+ to 129-01. TYF 130c settled 5 and TYG 130c settled 21.
Last week I highlighted some call structures that had been bought as plays for continual (forced?) easing. I had mentioned EDU0 9887.5/9937.5 call spreads which had settled 4.75 on Friday, Dec 6, versus EDU0 9844.0. This call spread settled at 3.5 vs 9843.0, but with the dip during the week, the buying shifted one strike lower, to the 9875/9925 call spd. At least 60k were bought in the week just ended, settling at 4.75. Two more 25 bp eases would likely see EDU0 approach the 9875 strike, but an actual payoff would require three cuts…prior to the election.
On Friday, I mentioned buying EDF0/EDH0 9825 straddle spread for 3.0 (traded and settled there Friday). EDH0 9825 straddle settled at just 8 bps with three months to go. On 9/13/19, with three months to go, atm EDZ9 9800^ settled 24.0. On 6/14/19 with three months to go, atm EDU9 9787.5^ settled 26.5. Certainly the market was poised for Fed eases earlier in the year. But the market is now really, really, really sure nothing is happening in the next three months. On Friday, EDU0 9837.5 straddle settled 27.0 with NINE months until expiry. In June the THREE month until expiry straddle settled 26.5.
| 12/6/2019 | 12/13/2019 | chg | |
| UST 2Y | 161.9 | 160.2 | -1.7 |
| UST 5Y | 166.8 | 165.3 | -1.5 |
| UST 10Y | 184.7 | 181.9 | -2.8 |
| UST 30Y | 228.3 | 225.3 | -3.0 |
| GERM 2Y | -62.5 | -61.8 | 0.7 |
| GERM 10Y | -28.6 | -28.9 | -0.3 |
| JPN 30Y | 44.4 | 42.1 | -2.3 |
| EURO$ H0/H1 | -20.5 | -24.0 | -3.5 |
| EURO$ H1/H2 | 6.0 | 4.5 | -1.5 |
| EUR | 110.62 | 111.22 | 0.60 |
| CRUDE (1st cont) | 59.20 | 60.07 | 0.87 |
| SPX | 3145.91 | 3168.80 | 22.89 |
| VIX | 13.62 | 12.63 | -0.99 |
https://fiscal.treasury.gov/files/reports-statements/mts/mts.pdf
In: Eurodollar Options
Shifting sands
Dec 13, 2019
–There is a LOT going on that may portend trend shifts. First, a Phase I deal jolted stocks to new highs. Yields jumped, with the curve steepening. As of the futures settlement, tens had surged 12 bps to 1.904% while twos were up 6 to 1.672%. On the euro$ curve, reds to deferred packs made new high spreads. For example, red/gold pack spd (2nd to 5th year) rose 4.75 bps to 23.25. [chart below]. This is the highest since early August. However, 2/10, which is at the exact same level of 23.2 bps, is NOT at a new recent high, and longer end yields have not yet broken out (the Nov 8 high in tens was 1.943 and in 30’s was 2.425 vs 2.333 yesterday). So, the euro$ curve is hinting at bigger things to come, but implied vol was hammered, indicating that a true breakout in the long end is not quite in the cards. On the other hand, relatively cheap options allow for breakout views to be expressed at good risk/reward levels.
–GBP exploded with the decisive Tory win. Euro also higher; the dollar index appears to have shifted to a more bearish posture. If this is indeed the case, it would be another argument for a steeper US curve. I read an interesting piece (BBG) about the Swedish krona yesterday, which has been in a weak trend but has firmed significantly in the last few weeks, with the Riksbank poised to hike Dec 19. It’s perhaps a small example in a globally shifting trend away from negative rates. (It also seems to me that moves in the krona lead DXY).
–Front ED vol is being crushed. A few weeks ago the expiring EDZ straddle was trading 10; yesterday the EDH0 9825^ settled 8.5. EDZ9/EDZ0 yesterday settled -27.75, a new high. EDZ9 will expire Friday, and with that, there will be NO one-year ED calendars below -25. In other words, the market is accepting the Fed at its word that eases are not likely to occur in the upcoming election year. FFF0/FFF1 settled -21.0. Having said that, the Fed is using a bazooka to make sure that repo is kept under control through year-end, so liquidity will be amply supplied even if the FF target isn’t lowered. And, in spite of the sell-off in rate futures yesterday, there was heavy buying of call spreads in ED’s for the prospect of a forced move by the Fed. Examples: +30k EDM0 9837/9850cs vs 9825/9812ps flat premium. Buyer of another 30k EDU0 9875/9925cs for 4.75 (settled 4.25 vs 9838).
–Dec midcurve option expiry today. 2EZ1 9837.5 straddle settled 5.5 with EDZ21 exactly at strike. Interestingly, the contract is unch’d currently, but early this morning traded 9831.5, just a shade thru the straddle b/e. Retail Sales today expected +0.5%, but economic news pales in comparison to China and Brexit. In the FT, El-Erian writes that two clouds are lifting. In another interesting development, it seems that the Saudis are trying to ease tensions with Iran, perhaps another small cloud moving off the horizon.
Steady as she goes
Dec 12, 2019
–As expected the Fed left rates unchanged. The dot plot indicates gently rising FF over the next few years; not a single dot is lower than the current 1.50-1.75% target over the next three years. In Q4 of last year, the Fed also perceived policy to be on auto-pilot, with balance sheet tapering quietly running in the background against a bias for an increased FF target. The stock market intervened and forced a response. The current stance projects a growing balance sheet (running in the background) and a stable FF target with a continued forceful hammer to nail down repo funding costs. So, the question is, what outside market is going to upset the apple cart? From past experience we know that rapid adjustments in stocks to the downside elicit a knee-jerk answer by the Fed; therefore call structures targeting lower rates are still prevalent in euro$’s. We know from fx volatility levels near historic lows that for NOW, the value of the dollar is not a big risk. The perception of longer term US rates is similar, that potential increases will be smothered in an environment of low inflation and tepid global growth. On this last point, I’m not so sure. The Fed is welcoming the idea of an inflation overshoot and is shoveling coal as fast as possible to keep funding costs low and stable. Keep an eye on the caboose.
–Yields eased with reds thru golds up 4..0 to 4.5 on the dollar curve. Tens fell 5 bps to 1.784%. Today we have PPI expected 0.2 with Core yoy 1.6%. Thirty year auction. UK vote.
–A couple of trade notes from yesterday: buyer of EDZ0/EDZ1 calendar at -2.0 appear to be an exit of about 15k. Settled -3.0. An opposite trade occurred in options, not particularly large but interesting: buyer of EDH1 9900c for 10 with a delta hedge in EDZ0 at 9841.5. The calls settled 10.5 while EDZ0 settled 44.5. Sort of a synthetic sale of EDZ0/EDH1 which closed -0.5 bp at -7.0. Once again, this points up relative weakness in EDZ0. EDM0/U0 is -7.0. EDU0/Z0 is -0.5 and Z0/H1 is -7.0.
FOMC. Policy in good place. Primary risk is trade policy.
Dec 11, 2019
–FOMC today. No change in stance expected barring an exogenous shock; policy is in a good place. CPI is released this morning, expected +0.2 with yoy Core 2.3% from 2.3 last. The average of the last twelve Core CPI readings is 2.18%. It hasn’t been below 2.0% since February of 2018. Why not just claim victory on the inflation target and let it go at that…
–Rate futures traded on the weak side coinciding with the ten year auction, although the losses were in the front end of the curve with 2’s up 2.9 bps to 1.654% and tens up just 0.6 bp to 1.835. Red Dec (EDZ0) was weakest on the eurodollar curve, settling -3.0 at 9840.5, the lowest close since Nov 12. Interestingly the dollar index is also forecasting further softness.
–Perhaps the Fed will more specifically address end of year funding pressures, as Zoltan Poszar from CS released a note indicating that the Fed hasn’t done enough to stifle the risk of a surge. In a way, EDZ9/EDH0 at -17.5 reflects this concern. Ordinarily, an inverted front spread is simply pricing the chance for a near-term Fed ease. However, April FF are only at a 4.5 bp premium to the current EFFR (FFJ0 98.495 or 1.505% vs EFFR 1.55%) so that’s only about a 20% chance of an ease in Q1. Additionally, front ED straddles continue to compress, indicating comfort with the idea of a Fed on hold through election year. EDH0 9825^ settled 10.5 vs 9828, EDM0 9837.5^ 22.0 vs 9836 and EDU0 9837.5^ 31.5 vs 9841.5. There has been a consistent seller of EDU0 9837/9850 straddle strip from 66.5 to 66.0; settled 66.0 yesterday. Having said that, there have been many targeted upside plays for continued (forced) easing, for example, the large long in EDU0 9887/9937 call spds bought from 4.5 to 5.5. Yesterday this idea was added to with lower strikes, paying 5.5 for the 9875/9925 cs.
Interest rate anguish
December 10, 2019
–Yields steady to slightly lower yesterday with tens ending 1.829% in front of today’s auction. There continues to be buying in TY calls: TYF 131 call 4 paid for 45k, settled 4 vs 128-31 with open interest up 36k, expire 2 weeks from Friday, approx 24 bps away. TYF/TYG 130 call calendar was also added to, buyer of 16-17 for >10k, settled 15 (27, 12). Tomorrow is the last FOMC of the year, with impeachment proceedings moving along and a China tariff decision looming over the weekend.
–Trucking company Celadon filed for bankruptcy, apparently due to executive fraud for cooking the books that couldn’t withstand a slowdown in business combined with high debt levels. Reportedly 3000 truckers are stranded as gas cards have been shut down. One-off, or more pervasive?
–The death of Paul Volcker, former Fed Chairman who led the fight against inflation is naturally being compared to the life of the bond bull market which Volcker initiated. Both over? 30-yr bond auction on Thursday, yielding just a shade over 225 bps. Volcker used to move Fed Funds more than that in a DAY.
–Really interesting thread on Saudi Aramco by Jawad Mian ( https://twitter.com/jsmian/status/1204298059921993728 ) briefly outlining how Standard Oil developed Saudi oil infrastructure (and almost failed) in the 1930’s, only to finally hit big in 1938. Softbank’s Masayoshi Son is giving up on his 50% stake in the dog-walking business Wag, which was recently valued at $650 million (the Saudis are big investors in Softbank).
Trade agreement with pencil and paper.
December 9, 2019
–Headline on FT: Beijing orders removal of foreign computers and software. Doesn’t sound like progress on the trade war, though there’s another news blurb on Reuters that says “China says hopes it can reach trade agreement with US as soon as possible.” I wanted to check how long it has been since the first trade agreement blew up… here’s a helpful link with a timeline. https://www.china-briefing.com/news/the-us-china-trade-war-a-timeline/ In any case, the new tariff deadline is this upcoming weekend. Trade wars do not seem to be easy to win.
–On Friday yields rose as the employment report was a blockbuster with NFP gaining 266k and yoy avg hourly earnings +3.1%. Tens rose 4.7 bps to 1.842%. Green pack (3rd year forward) was the weakest on the dollar curve, falling 5.75 bps. This week bring a fresh round of auctions with 3’s and 10’s on Monday and Tuesday, followed by 30’s on Thursday. Amounts of $38, $24 and $16 billion, raising $54 billion in new cash. FOMC meeting Wednesday. And Lagarde’s first meeting for the ECB is Thursday.
–EDZ9 expires one week from today and settled 98.11 or 1.89%. The turn volatility never re-emerged, with the 98.125^ settling 3.50 Friday. However, there was one interesting trade reported on Friday (though I don’t see it on open interest reports). Apparently FFF0 98.4375 put was sold at 1.0. This would make the contract breakeven 98.4275. The Fed effective on Dec 31 will be the rate used for January 1, which is used in the calculation for final FFF0 settle. If every OTHER day in January was 1.55% (where EFFR has been printing), then 98.4275 would derive a rate of 2.2475% for Dec 31. Probably a useless exercise, as there will also be other factors which will likely cause a bit of deviation from 1.55 over the month… The point is that 1.0 was the offered price in those puts at the end of the day. For some, probably worthy of a purchase as a hedge.
Stockholm Syndrome
December 8, 2019 – Weekly Comment
“That was totally worth it,” she says one morning, eyes pleading through the camera for relief from her torment. The final moments show her sitting on the couch with her partner—the man who gave her this albatross in the first place—to review her video diaries from the past year. He smiles, and she looks at him with the sort an expression that manages to convey duty and fear, mixed with a dash of Stockholm syndrome, all at once.
(Link is below, credit to the author Reid McCarter, avclub.com).
The above quote is a review of the Peleton ad, ‘The gift that gives back’ which managed, in my opinion, to destroy any cachet the product might have had. The stock sold off this week in reaction to the ridicule heaped on the company. Aviation Gin created an immediate response ad which subtly captures the next step in this insecure, beautiful young woman’s journey, ‘The gift that doesn’t give back’. At an upscale holiday-decorated bar, two supportive girlfriends toast “To new beginnings” and she gulps down (the first) martini. One friend reassuringly says, “You’re safe here.”
Here are the links to the two ads. Amazing that this actress agreed to do the gin response.
In a way, the market reminds me of the Peleton ad. Stocks nervously but dutifully pedaled up near new highs to close the week. The Fed is assuring us of the gift of never ending liquidity, right? [ I can stay in the tastefully appointed house in the suburbs with the sliding glass doors opening to the deck and lovely yard?] Isn’t that what they’re going to say this week? That they will officially tolerate inflation overshoot so we can just keep buying. It’s a strong counter to the insecure Fear Of Missing Out. “You’re safe here.”
I’m not even sure how I should frame the analogy. Maybe the Fed has Stockholm Syndrome – hostage to Trump and no longer even bothering to look for a graceful exit from the path of capital misallocation and malinvestment. “I just want to please my captor”.
Economic news articles continue to paint a mixed picture. A BBG piece touts this: “US Wage Growth Eclipses Mortgage Rate for the First Time Since 1972.” Average hourly earnings for production and nonsupervisory employees – who comprise more than 80% of the US private sector workforce – rose 3.8% from a year earlier in October [Friday’s data was 3.7%]. The average 30-year fixed mortgage rate in the US in October was about 3.7%.” That’s great right? In fact, the current rate of cited wage increase hasn’t occurred since January 2009, when it was on the way down. Charlie Bilello tweets, “US hourly earnings up 3.1% in the past year, outpacing core inflation (YoY) for the 84th consecutive month.” Gee, that’s great for the household sector but probably not so good for company earnings right? Oh. Corporate earnings growth has been declining. Pedal harder.
John Mauldin’s Thoughts From the Frontline this week is titled ‘Inflationary Angst’ and it outlines another side of cost of living increases, including now common huge healthcare deductibles. “Try to look at this like an average worker. Your rent keeps rising, your kids can’t go to college without racking up debt, your health insurance is astronomical, and your wages, while up a bit, aren’t keeping up with your living costs.”
I looked at it another way on Friday, comparing Avg Hourly Earnings (total private) of +3.1% with the University of Michigan’s long-term inflation expectation survey which was released Friday, bouncing along multi-year lows at just 2.3%. Which scenario will win out?
For a long time, the last piece of the missing economic puzzle for the Fed was wage growth. Now, the Fed is promising to ignore wage increases. Shouldn’t that augur poorly for the longer end of the curve? This week, the short answer to that question was ‘yes’ though the response to the strong employment data was still fairly tepid. The two year yield rose 1.7 bps on the week to 1.619% while tens rose 6.6 to 1.842% and 30’s gained 8 to 2.283%. The curve thus ended on a firm note, with 2/10 at 22.3 bps and red/gold euro$ pack spread at the same level, 22.0. 5/30 ended at 61.5. For context, the highs in these spreads were around the summer solstice, with 2/10 28.5, red/gold euro$ pack spread 43.0 and 5/30 79.8.
My contention is that these curve highs will all be revisited and exceeded, due to central banks’ policies, and, in the US, due to supply. We will have a test this week with both factors figuring into the equation. There are auctions of $38 billion 3-yrs on Monday, $24b tens on Tuesday, and $16b thirties on Thursday, raising $54 billion in new cash. In the midst of this supply, the FOMC meeting is Wednesday, widely expected to endorse the current policy stance (no ease but a flood of liquidity to prevent another repo accident, and to provide the lubricant to positively carry the unending weight of supply). An additional factor is the dollar, which has been in a steady upward sloping channel for a year and a half, but which now appears to want to test the lower boundary. As an aside, note that 10-yr JGB ended at a new recent high of -1.4 bps, a level not seen since early in Q2, with a high in 2019 just above zero and a low of -29.5.
Apart from the auctions and FOMC, inflation data are released Wednesday and Thursday. Retail Sales on Friday. The December 15 tariff deadline is one week from today. Pass the gin.
OTHER MARKET/TRADE THOUGHTS
Large trades Friday featured the purchase of Jan/Feb call calendars in treasuries. TYF/TYG 130 call calendar was paid 14 to 16 for 100k. With TYH0 settling at 128-28+ TYF0 130c settled 11 with a delta of 21, open interest was +78k and TYG0 130c settled 27 with 30 delta and an open interest increase of 90k. The expiration dates are 27-Dec (just after the Christmas holiday) and 24-Jan. A slow rally works best for these trades…the thought is probably that China trade deal talks will drag on, and the market will grind higher in holiday trade.
Apart from the ten year, this same view was expressed in FV: +30k F0/G0 119.5
call calendar, settles of 3.5, 13d and 12.0 ref 118-21.25, 25d and in US, +15k
F0/G0 161 call calendar, 14s with 13d and 47s with 25d ref 157-20.
There continues to be buying for forced easing, I will just highlight EDU0 9887.5/9937.5, 5.5 was paid this week ref 9848, then 4.5 on Friday ref 9841 with a settle of 4.75 vs 9844.0. The two strikes have 269k and 287k open, so the core long in this spread is ~150k or more. This call spread prices aggressive easing going into the election; it would take at least three 25 bp cuts to get above breakeven (9892.5) in the contract.
| 11/29/2019 | 12/6/2019 | chg | |
| UST 2Y | 160.2 | 161.9 | 1.7 |
| UST 5Y | 161.8 | 166.8 | 5.0 |
| UST 10Y | 177.6 | 184.2 | 6.6 |
| UST 30Y | 220.3 | 228.3 | 8.0 |
| GERM 2Y | -62.6 | -62.5 | 0.1 |
| GERM 10Y | -35.3 | -28.6 | 6.7 |
| JPN 30Y | 40.7 | 44.4 | 3.7 |
| EURO$ H0/H1 | -26.0 | -20.5 | 5.5 |
| EURO$ H1/H2 | 3.0 | 6.0 | 3.0 |
| EUR | 110.19 | 110.62 | 0.43 |
| CRUDE (1st cont) | 55.17 | 59.20 | 4.03 |
| SPX | 3140.98 | 3145.91 | 4.93 |
| VIX | 12.62 | 13.62 | 1.00 |
https://news.avclub.com/this-peloton-commercial-needs-to-calm-down-1840147803
https://news.avclub.com/ryan-reynolds-helps-the-peloton-lady-off-the-bike-and-o-1840286248
Beyond Payrolls
Dec 6, 2019
–While yields pushed a bit higher on Thursday, several large trades favored a move toward lower rates. For example, early in the day there was a buyer of 40k EDG0 9850/9862/9875 call tree for 0.25 (settled flat; 2.0, 1.25 and 0.75 vs EDH0 9831.5), and late in the day on a negative China headline, there was a buyer of 50k TYF0 130.25 calls for 14 (settled 14, 25 delta, vs TYH 129-10; approx 11.5 bps away). The ten year ended with a yield of 1.795, up 1.6 on the day. Curve was slightly steeper as the 2-yr note was unchanged. In euro$’s, red pack closed -1.125, greens -2.5, blues and golds -3.0.
–Today of course, is the jobs report, with NFP expected 184k vs 128k last, and yoy Earnings +3.0%. My payroll predictions are notoriously bad, but I think this report will show disappointingly low payroll growth, perhaps sub-100k. In any case, the impact of the data will likely fade quickly as the market looks toward next week’s FOMC meeting and the China tariff deadline on Dec 15. In addition, treasury will be auctioning 3, 10, and 30 years next week. The auction amounts are slightly smaller than last month, but the new cash raised is over $50b. One interesting aspect of yesterday’s trade was weakness in the dollar index, probably welcomed by both the Fed and the administration, but might give the marginal non-domestic buyer of treasuries a pause. My position is that even if payroll data is soft, a rally in longer treasuries likely won’t be sustained, even as a China stalemate and impeachment proceedings near.
–With regards to the front part of the curve, it’s worth taking a look at a few spreads. EDZ9 to FFF0 settled yesterday at 32.5, never having come close to re-testing the mid-Sept repo scare of 41.5. The forward spread of EDH0 to FFJ0 is 21 bps (9831.5/9852.5). Call the forward ois/lib spread somewhere around 15 to 22 bps, allowing for a chance of further compression. FFF0 trades 9844.5 so there is no expectation of ease in December. FFF0/FFG0 settled -3.0, indicating a small chance of an ease at the Jan 29 FOMC (but also reflecting slight hedge pressure for a high EFFR on Dec 31). FFG0/FFJ0 settled -5.0; around 20% odds of an ease on March 18. On NO ease, EDH0 should settle somewhere between 9823 and 9829. If there were to be an ease in January, odds of a further cut in March would probably increase to 1 in 3. So EDH0 would then likely trade 9850-ish plus another 8 for March odds. So that’s how the Feb call tree above would target the 9862 strike. The same strike tree in March expiry is also zero (2.75, 1.75, 1.00). EDH0 expires 16-March, FOMC is 18-March.
Finding neutral ground
Dec 5, 2019
–Both bonds and SP500 gave back about half of the large moves seen Monday and Tuesday to leave markets in a more neutral stance going into the employment data. On Nov 21, TYH0 topped at 130-04 and on Tuesday at 130-045, and is now 129-135, leaving a double top. As seen on the chart below, EDZ20 has left three tops at 9857 to 57.5 since the beginning of November. It would likely take a very weak non-farm payroll number to pierce these levels. The employment report on Friday expected to show NFP +180k
–According to an article on Reuters yesterday: “Capital investment by Chinese firms has ground to its slowest pace in three years…a Reuters analysis showed.” While wrangling for a Phase 1 trade deal continues, the below article from the South China Morning Post is of broader interest: General Mark Milley, chairman of the US Joint Chiefs of Staff and his Chinese counterpart General Li Zuocheng conducted an “introductory” telephone call, to “…discuss building a constructive and results-oriented defense relationship.” “The two military leaders agreed on the value of a productive dialogue effectively managing differences and cooperation on areas of common ground.”
–I don’t know whether to take comfort from that article or the exact opposite.
–EDH0/EDH1 settled -25.5. FFF0/FFF1 at -29.5. EDH0 9825 straddle settled 12.0, a 24 bp range breakeven around the 9825 strike. The market has gotten pretty comfortable with the idea that the Fed is just going to manage things with repo operations and not adjust the FF target all that much next year. I’m not all that confident in that sort of assessment.
