Risk-off tilt
Sept 3, 2019
–Imposition of Sept 1 tariffs by the US, immediately followed by China, put stocks under alert over the weekend, with continued Brexit and global trade concerns contributing to risk off tone. TYZ9 flirting with the 132 strike this morning as safe havens draw bids. New lows GBP and EUR, with broad dollar strength cutting off oxygen for dollar borrowers.
–EDZ9/EDZ0 settled at a new low of -60.0 on Friday and now prints -62.0. 2/10 treasury spread closed Friday just above zero, with the ten year yield essentially unchanged at the end of the day, 1.503%. At the end of last week, German two-year schatz was at a new low yield of -92.7 bps, with ten year bunds -70.
–News today includes ISM Mfg and Prices, with previous results 51.2 and 45.1. Expected today at 51.1 with a small rebound in prices to 45.8.
–The employment report comes Friday, with Powell scheduled to speak shortly afterward. This week features many Fed speakers prior to the blackout period which commences after Powell’s remarks Friday. But the tweets will continue.
What is two plus two?
Sept 1, 2019 – Weekly Comment
Greenspan told this joke. ‘Three patients at a mental institution wanted to be released. The head psychiatrist gave them a simple test. What is two plus two? The first patient said, Five. The second, Wednesday. The third got it right. FOUR, he said. The first two patients were returned to their ward. Patient three was free to go.
By
the way, asked the doc as the man was leaving, how did you know the answer?
Easy, said the patient. I just added
five plus Wednesday.
That’s an excerpt from a Washington Post profile of Greenspan on March 24, 1997, ‘The Shy Wizard of Money’, when his reputation was at its pinnacle.
Key aides to President-elect Bill Clinton are considering an unusual strategy to attack the budget deficit, in which the Federal Reserve Board would reduce interest rates while the White House pursues a program of spending cuts and tax increases. –LA Times, Jan 18, 1993, Deal With Fed to Cut Rates Studied
The debates, before and since, over the issue of our money standard have mirrored the deliberations on the manner in which we have chosen to govern ourselves, and, perhaps more fundamentally, debates on the basic values that should govern our society.
–Alan Greenspan, Dec 1996 speech, ‘The Challenge of Central Banking in a Democratic Society’ which is now referred to as the “irrational exuberance” speech. LINK at bottom, great read.
******************
August 2019 was a ‘five plus Wednesday’ month. A couple of weeks ago I outlined a few of the extraordinary events: $17 trillion in negative yields globally, the plunge in US yields, 2/10 inversion, GE accused of accounting fraud, continued Hong Kong protests, Argentina meltdown, Trump’s suggestion to buy Greenland, US Treasury considering selling 100 year bonds.
What else could happen? 1) This incendiary tweet: “…My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?” which occurred the week previous to last. 2) Carney’s (BOE) suggestion at Jackson Hole that USD as reserve currency could be replaced by something like Libra.
However, William Dudley, the former head of the NY Fed took the cake on Tuesday with a Bloomberg opinion piece including these shocking lines; “If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.” More specifically, “Trump’s reelection arguably presents a threat to the US and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives.” Wow.
The Dudley piece was simply astonishing. However, since then, so much has been written about it that I can’t possibly add more. I will only note that the Fed officially distanced itself, releasing a succinct statement: “The Federal Reserve’s policy decisions are guided solely by its congressional mandate to maintain price stability and maximum employment. Political considerations play absolutely no role.”
Dudley, of course, has now made the Fed’s job that much more difficult. But let’s return to political influence and cooperation between the Fed and the administration, highlighted in the second quote above. At President Clinton’s first State of the Union address in 1993, Fed Chairman Alan Greenspan was seated between first and second ladies Hillary Clinton and Tipper Gore. (He’ll never get those few hours back…). A Washington Post piece from March 21, 1993 said, “Simply by sitting there, he appeared to be sacrificing a slice of the Fed’s vaunted independence.” The article further added, “But his presence there was no mistake; He had been briefed on the major points of the Clinton economic plan and he was willing publicly to support its basic goal of reducing future federal budget deficits.”
It’s an incredible contrast to today’s relationship between the Federal Reserve and the Administration. I’ve re-written the LA Times quote above to capture the absurdity of the current environment:
Donald J Trump is pursuing an unusual strategy of attacking Chairman Powell, in order to force the Federal Reserve Board to reduce interest rates while the White House pursues a program of spending and tariff increases and tax cuts.
If that had been written as a hypothetical outcome at the beginning of Trump’s tenure, it would have been reasonable to conclude it would end in disaster. But here we are, with historically low unemployment, steady growth, and low inflation. Five plus Wednesday. The Fed’s mission and independence is now openly called into question at the highest level. The current climate hearkens back to Greenspan’s musings on the basic values that should govern our country. It is a fluid period where policies of the central bank are politically interwoven with the nation as a whole. Increases in the US budget deficit are masking structural problems. The Fed will be called upon for monetization.
I’ve often observed that markets test new central bank chiefs. With Volcker it was withering criticism as he crushed inflation with high rates. With Greenspan it came early, with the brief stock market crash of 1987. Bernanke of course, faced the subprime crisis and great recession. Yellen pretty much got off scot-free, but Powell is paying double now. Draghi became head of the ECB in June 2011, and, to stem the run on weak euro-countries’ bonds and save the euro, on July 26, 2012, said, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” Powell is under constant siege and now Draghi is handing off the ECB to Christine Lagarde who starts on Nov 1. She has a steady hand and deft political instincts. She’ll need them. Just as a point of reference, in 2012 Spain and Italy tens were north of 6%. Last week Italy tens traded sub 1%. On Thursday Lagarde said, “I don’t believe that the ECB has hit the effective lower bound on policy rates.”
What’s the point? The economic environment is becoming more surreal by the day. Many challenges lie ahead, relating to global trade activity and practices, central bank policies and independence, and the international monetary order. Specific flash points include Brexit, Hong Kong, Iran, Japan/S Korea and of course, US/China.
For now, these global stresses are resulting in demand for dollars. This is apparent in the chart below. DXY (not shown) closed at the high of 2019 this week, but remains below the high set at the end of 2016 which corresponded to tighter financial conditions across an array of measures. This was the time of both crude oil and EM coming under severe pressure, along with widening corporate spreads. However, the Fed’s Broad Trade Weighted USD index (TWDI) which includes a wider range of currencies, has not only exceeded the high of 2016, it has now eclipsed the high set in 2002, currently marking just above 130.
Dollar policy is under the purview of Treasury, not the Fed, but USD strength signals a demand for liquidity and presents a risk to US economic outcomes. It’s going to be Mnuchin’s turn to have his feet held to the fire, because it may become apparent that USD strength is choking the world, but the Fed, which could help by cutting 50 in Sept and guiding lower, may be loathe to make any moves outside the lines. Vulnerabllities have risen.
This coming week culminates with the employment report Friday morning, NFP expected 160k, followed by a speech on the economic outlook by Chairman Powell, which will be the last Fed speech prior to the Sept 18 FOMC. Powell will likely re-emphasize that the Fed operates solely within the constraints of price stability and full employment. The past has shown that when crises erupt, central banks must spontaneously pursue unorthodox policies. Will Powell have that flexibility?
Tuesday and Thursday will feature ISM data, Mfg expected 51.2 and Services 46.8. US/China tariffs went into effect Sept 1. China’s Mfg PMI released this weekend continues to weaken, at 49.5 vs 49.7 in July. Macau’s gaiming revenues fell 8.6% in August.
OTHER MARKET/TRADE THOUGHTS
Below is a chart of EDU21, green Sept, which closed Friday at the peak on the euro$ curve at 98.860 or 1.14%. The highest contract had been EDH21, but it has moved further back in time, indicating that economic malaise may be in our future longer than previoulsy thought. I’ve marked the last three FOMC meetings which resulted in actual changes in the FF target.
From Sept 26, 2018 FOMC
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2 to 2-1/4 percent.
From Dec 19, 2018 FOMC announcement:
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2-1/4 to 2‑1/2 percent. NO DISSENT
From July 31, 2019 FOMC announcement:
In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. DISSENT Rosengren and George; wanted to maintain.
So in the period of just under one year, starting and ending with the FF target at 2.0 to 2.25%, EDU21 has rallied a stunning 200 bps from 96.86 to 98.86!! Obviously, there is forward roll, but the constant maturity ten year treasury yield over this period dropped over 150 bps, from 3.05% to 1.50%.
I continue to think the odds of a 50 bp cut in September are being under-priced, but it would take a jolt from equity markets to force the issue. October 2019 FF contract settled 98.155 or 1.845%, which is 28.5 from the current EFFR or 2.13%. There is just 3.5 bps of ‘premium’ leaning towards 50.
November euro$ midcurve options expire 15-November, thus encompassing the ECB changeover, the Oct 31 Brexit deadline and the Oct 30 FOMC. I would expect this expiration to become more active as Oct mids expire 11-Oct.
| 8/23/2019 | 8/30/2019 | chg | |
| UST 2Y | 150.3 | 150.2 | -0.1 |
| UST 5Y | 139.7 | 138.5 | -1.2 |
| UST 10Y | 152.3 | 150.3 | -2.0 |
| UST 30Y | 201.8 | 196.8 | -5.0 |
| GERM 2Y | -89.2 | -92.7 | -3.5 |
| GERM 10Y | -67.5 | -70.0 | -2.5 |
| JPN 30Y | 20.4 | 14.6 | -5.8 |
| EURO$ Z9/Z0 | -50.5 | -60.0 | -9.5 |
| EURO$ Z0/Z1 | -5.5 | -9.5 | -4.0 |
| EUR | 111.45 | 109.91 | -1.54 |
| CRUDE (1st cont) | 54.17 | 55.10 | 0.93 |
| SPX | 2847.11 | 2926.46 | 79.35 |
| VIX | 19.87 | 18.98 | -0.89 |
https://www.washingtonpost.com/wp-srv/business/longterm/fed/greenspan/profile.htm
https://www.latimes.com/archives/la-xpm-1993-01-18-mn-1340-story.html
http://www.aei.org/publication/the-challenge-of-central-banking-in-a-democratic-society/print/
Short summary
August 29, 2019
–Once again new lows in all near euro$ calendars at Wednesday’s settle. EDU9/U0 fell 2 to -77.25 and EDZ9/Z0 fell 3.5 to -59.5. Long treasury yields made new lows early with tens closing down 2.4 bps to 1.466% and 30’s down 3.5 to 1.937%. Late in the day Mnuchin said treasury was again seriously considering issuing long term debt. TBAC (Treasury Borrowing Advisory Committee) didn’t like the idea before, so if 100 year bonds ARE approved for auction, it will probably start with modest size.
–There continues to be call buying on EDH0 underlying. Yesterday +75k EDF0 9875/9925c spd bought for 8.0 covered futures from 9849.5 to 9848.0. Settled 7.75 vs 9848.0. These are January expiration on EDH0 underlying. New position. Current target FF is 2.00 to 2.25%. This trade needs the perceived target to drop 100 bps to 1.00 -1.25% by March to break even. There are only three FOMC meetings prior to expiry as the Jan 2020 meeting is Jan 29. Of course, if the market is certain each and every FOMC through March will result in a cut of 25, then happy days.
–Stocks jumped late yesterday and this morning as US/China trade rhetoric softened. US and Ultra Bond contracts have eased a bit in response to both the prospect of long dated auctions and trade resolution, but are still well above last Friday’s settles. SP500 dividend yield is now above the bond yield.
–Tomorrow is first notice day in treasuries. Rolls are substantially done, with for example, only 450k TYU remaining vs total OI of 3.87m.
The Fed as Political Football
August 28, 2019
–The epic bond rally continues with new highs this morning and new lows in most curve measures. Reuters reports the 30 yr hit 1.906% overnight vs 1.972% at the futures settlement yesterday. Bonds and ultra-bonds exceeded Sunday night highs, shorter maturities didn’t. The bombshell William Dudley op-ed on Bloomberg yesterday is a contributing factor; he suggested that if the Fed eases due to Trump’s trade policies undermining confidence and growth, it may further embolden Trump to escalate the trade wars, thus creating a negative loop. He suggests the Fed refrain from bailing out the administration when bad political decisions hurt the economy. The Fed subsequently attempted to ice the controversy by putting out a statement saying it adheres to the dual mandate of prices and employment. However, the argument put forth by Dudley injects another layer of political intrigue and uncertainty regarding monetary policy. In addition, the idea of the Fed now holding steady when the world is clamoring for dollar liquidity risks creating a different negative loop spiral, which could impact the banking system as the curve inverts further. It’s football season, with the Fed as the new political football.
–In any case, some markets are now seeing extreme moves. All near euro$ one-year calendar spreads made new lows, with EDU9/U0 -2.5 to -75.25. EDZ9/Z0 -4.0 to -56.0. As we come closer to the Sept 18 FOMC, there is going to be strong dissension as to whether the Fed should ease 25 or 50. For now, the market is heavily weighted for 25 only (and Dudley’s commentary is part of the reason). It is still the case that a negative reaction by stocks could provide the cover for a 50 bp ease, but the move would have to be large.
–Silver and gold are surging due to global uncertainties regarding monetary policy and the underlying soundness of money. Yesterday Dec Silver was up 50 cents late to 18.29 and Dec Gold +$15 to 1552.20. The copper/gold ratio broke to a new low, pointing to lower ten-year yields. The gold euro$ pack (5th year forward) closed at a new high yesterday of 98.6925 or just under 1.31%. The red/gold pack spread is clinging to a positive level, having closed down 1.25 bps to 8.25, but 2/10 treasury made a new low of -4 bps and was marked -6 this morning.
–EDZ9/EDH0 3-month calendar spread also hit a new low of -30.5. EDZ9/FFF0 spread is 30 bps. Be wary of end of year pressure on EDZ9, especially given new uncertainties.
–Not much in the way of economic news today. Five year treasury auction.
Below is Copper/gold with Ten year yield.
Friday’s tweets shaken off
August 27, 2019
–The plunge on Sunday night in stocks completely reversed as the day progressed with ESU closing in the green by 27 points, having been down 45 near Sunday’s open. Then ten year yield overnight fell to 1.44%, just 8 bps above the all time low from July 2016; at futures settle it was 1.544%, up 2 on the day. JPY traded as low as 104.46 but was 106.10 late Monday.
–Monday’s settlements featured new lows in near euro$ one-year calendars. EDU9/U0 -72.75, EDZ9/Z0 -52.0. Post settle these spreads eased further, to -73.75 and -53.0. The 3-month spread Dec9/March0 also closed at a new low of -28, trading -29 late. Last year, Dec/March declined from +20.5 in October to -4.0 by expiration, a large move for a 3-month spread. In this cycle, the spread was -10 in May and has fallen 18.5 bps to -28.5 currently (with more to follow).
–A lot of call buying and put selling on EDH0 yesterday. Largest trade was a new position: +50k EDF0 9875/9900 call spread vs -50k EDF0 9825/9812 put spread for 1.5 debit, settled 4.5 and 2.5. Also a buyer adding to EDH0 9925 calls which settled 4.0 vs 9845.5, OI +23k. And a seller of 20k EDH0 9825/9812 put spread at 4.0
–Not much in the way of economic news today. Two year notes are auctioned and the Conference Board’s Consumer Sentiment is expected 129 from 135.7. This data series has been in a long uptrend from 2013, with the last reading near an all time high. (Looks just as frothy as it did just before the Nasdaq crumbled at the turn of the century).
–Interesting tweet from David Rosenberg of Gluskin Sheff regarding Chgo Fed’s Nat’l Activity Index (out yesterday at -0.36):
“The 85-variable Chicago Fed NAI just came out and was negative for the 7th time in the past 8 months. All 4 major categories contracted in July – only 6% of the time this happened in an expansion, but 62% of the time it has happened in a recession. Is it quacking like a duck yet?”
Rollercoaster
August 26, 2019
–Friday’s session saw yields plunge as tensions and tariffs ratcheted higher. Ten year yield fell 8.5 bps to 1.523%. Red euro$ pack was the star performer on the curve, closing +10 on the day. New lows in near ED one-year calendars: EDU9/U0 fell 5.5 to -72.5. EDZ9/Z0 fell 1.5 to -30.5. At a spread of -31.5 to the present Fed Effective rate, the October FF contract at 9818.5 is indicating 1 in 4 odds of a 50 bp cut rather than 25.
–Powell’s speech stayed inside the lines with little reaction, but Carney’s speech at Jackson Hole suggesting USD reserve status could be replaced with something like FB’s libra is a game-changer, especially given Lagarde’s ascendancy to ECB chief.
–After Friday’s theatrics, stocks opened much lower last night and treasuries made new highs. CNY posted a new low of 7.15 with offshore as high as 7.187. However, Trump said China called to come back to the table so everything veered back the other way. There’s a tremendous amount of emotion that has been injected into the market, but trends continue to favor lower rates. 2/10 treasury spread closed just under 0. Gold made a new high, with GCZ9 printing as high as 1565.00, nearly $30 above Friday’s close. However. it’s now back to unch’d.
–Tweet at 5:52 a.m. EST suggests China isn’t running ‘back to the table’ From Hu Xijin:
“Based on what I know, Chinese and US top negotiators didn’t hold phone talks in recent days. The two sides have been keeping contact at technical level, it doesn’t have significance that President Trump suggested. China didn’t change its position. China won’t cave to US pressure.”
Enemy of the State
August 25, 2019 – Weekly Comment
Enemy of the State is an action thriller from 20 years ago (1998) starring Will Smith and Gene Hackman. Highly entertaining though somewhat formulaic, Robert Clayton Dean (Smith) is a labor attorney who unwittingly receives a disc with evidence that could rock, of course, the highest echelons of power. At the heart of the film is the issue of government surveillance and the unbridled power of the National Security Agency. Through a connection of Dean’s ex-girlfriend (Lisa Bonet), Brill (Hackman) comes into the picture, a reclusive communications and intelligence expert who exposes the extent of technological surveillance and helps Dean restore his life and bring the film to its contrived (though amusing) conclusion. It’s one of those movies where you just have to suspend belief and hop on for the joy ride.
As they say, truth is stranger than fiction, and the end of this week was no exception, encapsulated by this Trump zinger: “…My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?”
Even the Mooch has been getting in on the action, saying a couple of weeks ago about Trump, “Eventually he turns on everyone and soon it will be you and then the entire country.”
In today’s world, Enemy of the State and pervasive surveillance could refer to almost anything. Hong Kong protests. China/US trade wars. Credit scores. Social scores. Alexa. Facebook. Jeffrey Epstein. However, I personally have a hard time throwing Powell into the mix.
In any case, Powell’s Jackson Hole speech on Friday was supposed to be the big economic event of the week. However, it too, was formulaic, holding to the parameters of the Fed’s dual mandate, full employment and low inflation. The speech was so bland that markets barely reacted. The key theme, however, is that the Fed can’t ignore the effects of trade policy on the economy, as referenced in this excerpt:
…fitting trade policy uncertainty into this framework is a new challenge. Setting trade policy is the business of Congress and the Administration, not that of the Fed. Our assignment is to use monetary policy to foster our statutory goals. In principle, anything that affects the outlook for employment and inflation could also affect the appropriate stance of monetary policy, and that could include uncertainty about trade policy.
Another core line in the speech is below:
At the end of the day, we
cannot prevent people from finding ways to take excessive tweeting
financial risks. But we can work to make sure that they bear the costs of their
decisions, and that the financial system as a whole continues to function
effectively.
Perhaps trade policies fit into the category of excessive risks. Obviously, it’s all tied together, because Friday’s incendiary tweets and ratcheting up of tariffs on both sides sent stocks into a tailspin, and last year’s fourth quarter made it patently clear that stocks are all that really matters for Fed policy. Trump’s order to US businesses to move away from China was icing on the cake. [For a good summary of Friday’s tweet and trade action, see Doug Noland’s Credit Bubble Bulletin, linked at bottom].
Last week I wrote that August 2019 may be looked back upon as a critical month. Friday August 23, may end up being viewed as a critical day in terms of a shift away from the US a globalist force. It’s not just Trump’s policies and tweets (“We don’t need China…”) that are turning the US inward. In a way, the ‘buy Greenland’ ploy is symbolic in terms of making sure raw resources are closer to our shores. The isolationist theme was reinforced from the outside as well, namely BOE’s Carney speech suggesting that the dollar’s reserve status should be supplanted. Carney’s argument is that the US is becoming a somewhat smaller percentage of global GDP, and that a relatively strong currency and tighter monetary policy is spilling over into the rest of the world. He suggested a Synthetic Hegemonic Currency like Facebook’s Libra might be a part of a new international monetary and financial system.
A key quote is from an interview after the speech with CNBC’s Steve Liesman. Carney said that the Fed was right to adjust policy tighter as the US economy was improving. However, he added, “That means the rest of the world policy is tighter than it needs to be, and that feeds back on the US economy in a way that ultimately slows this economy. And it leads to a substandard outcome. In a world where you only have limited policy space, it is a dangerous place to be. So the trade issues we’re talking about are reinforced by the structure of the monetary system.” Wow.
The combination of the US turn inward, the deterioration of prospects for a US/China deal, and the suggestion that the US dollar should have a lesser role in a new global financial order is not a good sign for the US equity market. Even If Trump tries to walk back Friday’s comments (which he ambiguously did at the G7) the prospects for US financial assets, apart from treasuries, have dimmed.
It doesn’t help that there is dissension within the Fed itself. The Dallas Fed’s Kaplan noted that the Fed Funds target is higher than all other rates on the curve (and it certainly didn’t get any better on Friday) and allowed that perhaps the Fed is tighter than thought. The KC Fed’s Ester George however, said on a Bloomberg interview, “I would judge policy to be at neutral or even accommodative with this last rate cut. If you think about where real rates are relative to the rate of inflation and where the FF rate is, we’re operating close to zero with real rates. I can’t believe that that is tight in any sense for the economy right now.” I would note that the Inflation Indexed ten year yield is very close to zero, having gone negative this past week ending at -2.2 bps.
The market is, of course, indicating that the Fed is tight with an inverted curve. 2/10 ended the week just under zero. On the eurodollar curve, near one-year calendars became more inverted, closing at new lows. EDU9/EDU0 settled -72.5, down 1 on the week, EDZ9/EDZ0 at -50.5, down 3 on the week and EDH0/EDH1 at -31.0, down 3.5. Zerohedge ran a piece citing BofA research that the three-month rate one year forward versus the current 3 month rate is the best predictor of forward economic growth. In other words, the front one-year eurodollar calendar. (And it’s going south).
One year ago on August 20, Atlanta Fed’s Raphael Bostic said, “I pledge to you I will not vote for anything that will knowingly invert the curve and I am hopeful that as we move forward I won’t be faced with that.” Haven’t heard much from him lately…
Net changes on treasury yields weren’t all that large week over week. The two year rose 4.9 bps to 1.525%, tens fell 1.6 bps to 1.523% and 30’s rose 1.9 to 2.018%. However, back eurodollar contracts from EDM21 through the golds posted new contract high settles. The peak point on the euro$ curve is EDM21 which settled 9881.0 or 1.19% vs last week’s high settle (also on Friday) of 9879.5. The blue pack (4th year forward) closed the week at 98.72, just 9 bps away from the peak. Apart from the geopolitical arena, economic data also provided support for the bond rally, as Markit’s US Mfg PMI fell below 50 (49.9) with a Composite of 50.9.
The upcoming week isn’t particularly heavy with respect to economic data, though the second estimate of Q2 GDP is on Thursday and Core PCE prices (expected 1.7% from 1.6% last) is on Friday. Treasury auctions 2, 5 and 7 year notes.
| 8/16/2019 | 8/23/2019 | chg | |
| UST 2Y | 147.6 | 152.5 | 4.9 |
| UST 5Y | 141.2 | 140.6 | -0.6 |
| UST 10Y | 153.9 | 152.3 | -1.6 |
| UST 30Y | 199.9 | 201.8 | 1.9 |
| GERM 2Y | -91.1 | -89.2 | 1.9 |
| GERM 10Y | -68.5 | -67.5 | 1.0 |
| JPN 30Y | 18.4 | 20.4 | 2.0 |
| EURO$ Z9/Z0 | -47.5 | -50.5 | -3.0 |
| EURO$ Z0/Z1 | -2.5 | -5.5 | -3.0 |
| EUR | 110.95 | 111.45 | 0.50 |
| CRUDE (1st cont) | 54.81 | 54.17 | -0.64 |
| SPX | 2888.68 | 2847.11 | -41.57 |
| VIX | 18.47 | 19.87 | 1.40 |
http://creditbubblebulletin.blogspot.com/
When you’re in a (Jackson) hole, stop digging
August 23, 2019
–Dallas Fed’s Kaplan, in an interview with Steve Liesman yesterday from Jackson Hole, summed up the situation, saying that the FF target (2.0/2.25%) is above every other rate on the curve. Therefore, the Fed is perceived at tighter than we thought. This observation by Kaplan argues for continued easing, though other Fed officials like Rosengren, Harker and George lean against the idea of further cuts. Kaplan also talked about the risk management aspect of the Fed’s job, something that Powell will almost surely emphasize today in his speech as he keeps the door wide open for further easing.
–In terms of risks, the geopolitical landscape looms large. China’s yuan has made a new low this week. S Korea has suspended a long time agreement with Japan to share military information, a damaging escalation in the trade war between the two countries. A story in today’s Washington Post says many administration officials and private forecasters have internally been warning the White House of slowing conditions (which is pretty obvious by Trump’s economic cheer-leading, attacks on the Fed, and proposals to spur growth through tax incentives). On the other hand, Biden is out there saying the capital gains tax should be raised back to 39.6%.
–Powell speaks at 10:00 EST. This weekend also features the G7 meeting, which has become less important.
–In terms of market action, yields rose and the curve flattened. I marked 2/10 at a fraction of a basis point above zero. The FF target (EFFR = 2.13%) is above all treasuries: 2y 1.604%, 5y 1.493%, 10y 1.608% (+3.1 on the day) and 30y 2.101%.
–On the euro$ curve, one year calendars continue to press lower, but interestingly new lows were made in more deferred spreads: EDH0/H1 fell 0.5 to a new low of -30.5, EDM0/EDM1 fell 1 bp to a new low of -19.5. Once again, this suggests that the market is comfortable with the idea of 25 bp eases (as opposed to a front-loaded Fed response), and that easing will continue in an environment of economic malaise. I would further note that EDH21 had been the high point on the curve for quite some time, but this week has ceded that honor to EDM21 and EDU21, both of which settled 98.71 (EDH21 at 98.70). The high point is moving back, not forward… Oct FF settled -2.0 at 98.14, now just 27 bp below the EFFR. The market has taken away the idea of 50 bp cuts for the time being.
–Below is the Gundlach indicator of the Copper/Gold ratio overlaid with ten year yield. Lockstep lower.
Jackson Hole starts; Powell tomorrow
August 22, 2019
–Yields rose, the curve flattened, implied vol continued to compress. Tens rose 2.2 bps to 1.577%, but 2’s were up 5.7 bps to 1.567%. I marked 2/10 at +1, but the spread inverted again briefly during the day. New lows once again in some of the near one-year euro$ calendars. EDU9/U0 settled -70 (not a new low) but Z9/Z0 settled -49.5 and H0/H1 at -30.0. The implication is that easing is coming, but not nearly fast enough to arrest flattening. On the other hand, there was relentless buying of October 9825 calls, mostly 10 to 10.5 both outright and spread against EDZ9 9825 calls and other strikes. Open interest in EDV9 9825c rose a whopping 255k to 570k, settling at 9.25, 0.41 delta vs 9818.0. Along with a buyer the other day of 70k EDH0 9887c for around 10.0, these buys suggest a hedge against a cut of 50 in Sept, or perhaps are related to hard Brexit. However, implied vol across the curve oozed out. Last Thursday (8/15) EDZ9 9825^ settled 36.5 vs 33.5 yesterday, EDH0 9850^ from 47.0 to 42.0 and 0EH 9875^ from 51.0 to 46.5.
–The minutes showed that some members wanted a 50 bp cut and some wanted to hold rates steady. As the short end has gravitated toward the idea of another 25 bp cut with more to come, it’s reasonable for premium to have pulled back, with Powell likely to try to thread the needle at tomorrow’s Jackson Hole presentation. However, going into next week it’s worth trying to buy vol. USDCNY made a new high today 7.09 (yuan weaken to new low) and China is threatening retaliation for September tariffs. Broad geopolitical risks are likely to overwhelm any good news domestically. Further deterioration in US/China relations can easily lead to a surprise 50 bp cut at the Sept FOMC. FFV at 9816 settled just 29 above expiring August. I believe this is priced too close to a 25 cut and doesn’t nearly reflect proper odds of 50.
A series of 25 bp cuts, or a 50 shocker?
August 21, 2019
–Yields declined as stocks pulled back yesterday, with tens falling 4.5 bps to 1.555%. Euro$ strip from reds through blues were +3.5. New lows posted in the near one-year calendars: EDU9/U0 fell 3.25 to -71.75, EDZ9/Z0 fell 1 bp to -49 and EDH0/H1 eased 0.5 to -28.5. Today, minutes from the last FOMC are released. The decline in one-year calendars, along with Fed Fund calendar spreads, indicate that the market is becoming more comfortable with a series of 25 bp cuts, rather than a front loaded response featuring a 50 bp cut at the next meeting. For example, the Aug/Oct FF spread rose to -30 (+1.25 bps), while Oct/Nov fell 1.5 to -19.0. and Nov/Jan fell 2 to also settle -19.0. While these moves are most likely simple adjustments in front of the minutes and Jackson Hole, they reflect a more steady easing cycle. That is, these spreads are all moving closer to 25 bps.
–The average Fed Effective rate in August so far is 2.128% and Aug FF settled at 97.87.
–There was a new buyer yesterday of >70k TYU9 131.75c for 4 to 5/64’s yesterday. Settled 3 vs 130-235, open interest rose by 62k. These calls expire Friday (Powell speaks Friday at Jackson Hole) and are about 12 bps away. At the 2pm futures close I marked cash tens at 1.555%, the low yield in July 2016 was 1.36%, so the market could still get to that strike without making a new low yield. There was also buying yesterday of EDZ9 9825/9850c 1×2 for -0.5 (took small credit to buy the lower strike). Fear remains in the upside; that’s the only reason this trade is doable (it settled 0.0, 15.5 and 7.75).
–At Trump’s press conference yesterday, it seemed to me that he talked about the China situation in past tense. I think Trump is now quite keen to make a deal with China, but China is unlikely to budge at this point. If a deal proves elusive at the upcoming talks next month, then I think the Fed will cut 50 as stocks again falter.
–Existing Home Sales today.
