Jumping off a bridge
July 25, 2019
–Yesterday’s Markit manufacturing PMIs pretty dismal for US and Germany as the attached chart shows. ECB today with expectations of ease as the German bund trades negative 39 bps. An article in Reuters notes that Swiss 50-year yields slipped below zero today, “meaning none of its bonds now offer buyers any interest.” As I mentioned yesterday in an email, ERZ0 appears to have experienced a wardrobe malfunction, as it rocketed higher in the space of a few minutes yesterday afternoon. ERZ0/ERH1 calendar spread surged from 3.0 to 14.5 and right back down. Fat finger on a fat machine… As an aside, in early October of last year, ERZ0 was trading 99.640. Yesterday’s spike high was 100 bps higher, at 100.645.
–US stocks also exploded to new highs. Without the anchor of interest rate markets and yields to provide some sort of base value, the sky’s the limit. Little change in US treasuries with all maturities easing 0.5 to 2.5 bps in yield. Tens finished down 2.2 bps at 2.05% as 7-years are auctioned this afternoon.
–I looked back three months ago at some straddle levels in near euro$ contracts. On April 11, EDU9 settled 9748.0 and the 75^ 14.5. EDZ9 settled 9748.5, with the 75^ 24.0 and EDH0 9761.0 with 76^ 35.0. Yesterday, EDU9 9786.5, Z9 9796.0 and H0 9818.5. The atm straddles: 14.0, 27.0 and 35.5. Hasn’t really been much in the way of ‘decay’ : – /
–When news came out the other day that US officials were flying back to China for face-to-face meetings, stocks skipped a bit higher. Going into those meetings, the US has sailed a warship through the Taiwan Strait. Two completely separate events. Right?
–Fascinating article on ZeroHedge which was sourced mostly from a Bloomberg piece, highlighting the Fed’s Applied Critical Thinking unit, headed by Margaret McConnell.https://www.zerohedge.com/news/2019-07-24/she-has-flair-darkness-meet-person-tasked-predicting-how-fed-will-blow-world
I think it’s absolutely fantastic that the Fed has an internal group like that, tasked with finding out what can go wrong with policies, and if research is based on flawed assumptions. On the other hand, in the big global macro picture, I think you can boil it all down to what Mom used to say: “And if all your friends decided to jump off a bridge, are you going to be an idiot and jump too?” In other words, just because all the other Central Banks have jumped into the negative rate river of doom, should the Fed follow? Those policies are not working.
–According to the article, Geithner said of McConnell, she has a “flair for darkness”. Yeah, but does she have gold buried in the backyard and a stash of weapons? Extra cabin out in the woods? She ought to meet some of the people I’ve met in the euro$ option pit. Flair? McConnell, do you want to keep working here with just a minimal amount of flair?
We’re all Krugers now
July 24, 2019
–Stocks ramped up in the afternoon on news of face to face talks with China. However, a US Dept of Justice probe into big tech turned Nasdaq, which is down 50 as of this writing. Silver near a new high, euro testing the year’s low.
–Yields rose yesterday, up 2 to 3.5 bps across the board, with tens +2.5 at 2.072%. Notable morning weakness in near euro$ contracts as the debt-ceiling deal was announced, with the implication that 1) more bills may hit the market and 2) if all semblance of fiscal restraint is out the window, the Fed may not have to do as much. Decent size front call liquidation, as an example, 35k EDZ9 9800/9837/9875 call flies were sold at 7.0 vs 9797/97.5. Settled 6.75 vs 9796.0s.
–First it was the Fed that opened the liquidity spigot, now it’s the Federal Gov’t opening up the budget for larger deficits. It’s like the Seinfeld episode where George is working for Mr Kruger of Kruger Industrial Smoothing, who doesn’t really care about anything. “Oh, it doesn’t really matter, there’s no inflation right?” I have the feeling we’re going to get much more than we bargained for on the inflation front. Or maybe there will simply be a big realignment of currencies (JP Morgan released a note saying the USD may lose its reserve status. In any case, this set-up isn’t the stuff that should instill confidence in corporate america.
–WSJ has a clip noting that WeWork may try to go public in September, of course they’re considering a name change pre-IPO to Beyond Work, which ought to make it sail through the capital markets (in a seasonally challenging part of the year for equities)
https://www.youtube.com/watch?v=XcSRZJOVjWQ
Stealth MMT
July 23, 2019
–Rates were little changed across the curve yesterday, apart from weakness in the front end of the dollar curve. While every contract from EDU20 back through golds closed +1, EDU9 fell 2.5 and EDZ9 fell 1 bp. Therefore, new lows were posted in the first two one-year calendar spreads with EDU9/U0 at -51.0 and EDZ9/Z0 at -41.0. It’s not just the US; going into the ECB meeting on Thursday, ERZ9/ERZ0 closed at a new low of negative 4 bps and Dec/Dec sterling is -6.5. EUR making new recent lows this morning.
–The debt-ceiling didn’t turn into much of a fight as an agreement has supposedly been made. ‘I’ll spend more on this, while you can spend more on that.’ They’ve quietly embraced MMT. Equities like the flow of funds, but I’ve seen several articles warning of technical non-confirmation. Northman Trader points out that the Cumulative advance/decline ratio and RSI are diverging from the Nasdaq rally. Kimble charting notes that the oil and stock relationship seems to be breaking down. And the ratio of Russell to SPX edged to a new low yesterday, not seen since 2009.
–I’ve included a chart showing several measures of forward inflation, the tip breakeven, 5y 5y forward inflation swap and U Mich 5-10 year inflation expectation. All have perked up a bit from recent lows. As an aside, my understanding is that the limitation of MMT is supposed to occur when inflation begins to accelerate…
–News today includes Existing Home Sales and the 2 year auction.
Locked on 25
July 22, 2019
–Several news services, including BBG and WSJ, are reporting that the Fed will likely cut 25 bps next week. After a volatile end of the week following NY Fed’s Williams speech on Thursday, the market has comfortably priced 25. However, additional cuts are also being priced with more confidence. For example, Aug/Oct FF spread, which isolates the Sept FOMC, fell 2 bps on Friday to -19.5 (-25 would indicate certainty of a cut in Sept). EDZ9/EDH0 made a new low on Friday of -23 bps. Of course, EDZ9 trades heavy on the curve due to turn considerations, which is why EDU9/EDZ9 is only -8.5.
–Longer end of the curve was steady on Friday, with tens rising 1 bp to 2.047%. Stocks took a late dive related to Iran seizing a UK tanker; prices have been partially reclaimed this morning. One third of S&P companies report this week.
–Chicago Fed Nat’l Activity Index today, which was -0.05 last and expected +0.10 today. If expectations are met, it would be the strongest reading since last year. Worth noting as well, U of Mich 5-10 year inflation expectations released Friday popped up from the previous low point of 2.3% to 2.6.
–A big thanks to Kevin Muir and Patrick Ceresna of the Market Huddle who hosted a tavern gathering in Chicago yesterday. Fun time with a good group.
Annoying Peasant
July 21, 2019 – Weekly comment
King Arthur: I am your king.
Peasant Woman: Well, I didn’t vote for you.
King Arthur: You don’t vote for kings.
Peasant Woman: Well, how’d you become king, then?
[An angelic choir begins…]
King Arthur: The Lady of the Lake, her arm clad in the purest shimmering samite, held aloft Excalibur from the bosom of the water, signifying by divine providence that I, Arthur, was to carry Excalibur. [singing stops] That is why I am your king.
Dennis: Listen. Strange women lying in ponds distributing swords is no basis for a system of government. Supreme executive power derives from a mandate from the masses, not from some farcical aquatic ceremony.
Arthur: Be quiet!
Dennis: You can’t expect to wield supreme executive power just ’cause some watery tart threw a sword at you!
Arthur: Shut up!
Dennis: I mean, if I went around saying I was an emperor just because some moistened bint had lobbed a scimitar at me, they’d put me away!
There are a lot of parallels between Monty Python’s Holy Grail and repressive monetary policy. “How’d YOU become the one to set interest rates then? I didn’t vote for you.”
I for one, am becoming annoyed by the fixation on inflation, but even more so by the continuous blather about the neutral rate. THAT’S your new communication plan? “Listen. Strange data that can’t be seen or measured is no basis for a system of monetary policy. I mean, if I went ‘round saying I should be on the Fed board just because I had a magical conjecture for r-star, they’d put me away. It’s no wonder markets ignore your farcical dots ceremony.”
As you all know, it wasn’t NY Fed President William’s discussion of the neutral rate that sparked a violent reaction in short rates, it was his theoretical discussion of what to do for signs of a slowdown when near the ZLB: “Don’t keep your powder dry.” The market immediately adjusted to the real possibility of a 50 bp cut until the NY Fed put out a statement saying ‘Nevermind’. Then Rosengren capped it all off at the end of the week by saying he didn’t see why the Fed needed to cut at all. An anarcho-syndicalist commune would make clearer decisions.
That’s enough about The Holy Grail of monetary policy. “He’s already got one, you see? Oh yes, eet’s very nice.” Let’s move on. Below is a chart I created from St Louis Fed data. It’s Household (and Non-Profit) Net Worth over GDP. In the 1980’s this ratio was around 2.5 to 3.0x. In the unsustainable dotcom bubble it got to nearly 3.5. At that time, the FF peak in 2000 was 6.5%. Then, by 2003, as the Fed cut to 1%, smoldering embers caught fire, and the ratio peaked just under 4.5x pre-crisis in 2008, even as the Fed had hiked to 5.25%. By the end of 2008, the Fed effectively cut to zero. The ratio levitated. So here we are at 5.7x. Does this make any sense? Is it sustainable? Does reversion to the mean hold sway? Creating paper wealth as a means to generate economic activity could be running out of steam.
The reason for the 2008 crisis was pretty clear: explosive growth of mortgage debt without equity, which caused an unsustainable upward spiral in real estate prices. Income was not adequate to service the debt. Since that time, households became rather frugal, notwithstanding student loan debt. From the Fed’s quarterly Z.1 report, the peak of HH Mortgage debt in 2007 was $10.433T. Twelve years later, in Q1 of 2019, that amount is just $10.390T. Consumer Credit was $2.609T in 2007 and is now $4.052, with most of the change coming from student loans. The Household Debt Service and Financial Obligation Ratio (FOR) is now just 15.38% (of personal disposable income). It has never been below 15 and in 2007 hit 18.13%. HH Equity in Residential Real Estate was at a high of 61.1% in 2001, plunged to 36.8% in 2009 and has now nearly fully recovered to 60.4%. In aggregate, HH finances are fine. Just one more note, since 2015 the Fed raised the FF target by 225 bps. The average credit card rate has gone from 12% to 15%, a nice protection of margin.
Now let’s consider the other big debt categories. Total business debt went from $10.115T in 2007 to $15.579T now. We all know that Corp debt is at a record of GDP. We know that a lot of debt went into share buybacks. For now, earnings are comfortably servicing the debt and spreads are tight. A further increase in rates or a decline in GDP would change that in a hurry.
The most explosive growth has been in Fed’l Gov’t debt, which surged 3x, from $6.074 in 2007 to $18.248 in Q1. It appears from these data as if all of the growth and wealth since 2009 has been engineered by the Federal Govt and central bank.
This “wealth” we speak of always has some
carrying costs. Real estate has to be
maintained, and the King comes for the taxes.
The crown needs his army. Art and
precious metals need to be stored and insured.
The wealth represented by share prices has overhead, some of it in the
form of debt service. Of course, the
debt service of one man is the asset of another. At the extreme, and I don’t know where that
is, “wealth” becomes such a multiple of “income” that all that occurs is
swapping of assets. Financial
engineering. The rats eating the
rats.
In order to keep the merry-go-round spinning the central banks have to keep
feeding money in at an accelerating rate to try to bring income more in line
with asset prices. Demographics are a
headwind, as we are always reminded.
Here’s an excerpt of Ray Dalio’s ‘Paradigm Shifts’
A classic one of those is an unsustainable rate of debt growth that supports the buying of investment assets; it drives asset prices up, which leads people to believe that borrowing and buying those investment assets is a good thing to do. But it can’t go on forever because the entities borrowing and buying those assets will run out of borrowing capacity while the debt service costs rise relative to their incomes by amounts that squeeze their cash flows. When these things happen, there is a paradigm shift. Debtors get squeezed and credit problems emerge, so there is a retrenchment of lending and spending on goods, services, and investment assets so they go down in a self-reinforcing dynamic that looks more opposite than similar to the prior paradigm.
To me, it looks like the Fed’l government is the entity that could be constrained in terms of borrowing capacity, unless the Fed comes in like the Bank of Japan and buys everything. And puts rates back down to ZLB, (or in the case of the ECB, cuts the funding rate to an even more negative level). The implication, as Dalio mentioned, is that it’s a good idea to add gold to the portfolio. The implication in US short rates is that after they ease by 25 bps at the end of the month, cuts of 50 in a shot will be priced as a possibility every time weak data points print. Who knows where it all ends. It all reminds me of the old medieval maps where the edge of seas were unknown and they just made the notation, “Here be dragons.”
OTHER MARKET/TRADE THOUGHTS
We’re now a week and a half away from the FOMC. Locked at 25 bps at this point.
This week 1/3rd of the SP 500 companies report. Q2 GDP released on Friday, expected +1.8%. The NY Fed is forecasting 1.4% and the Atlanta Fed GDPNow is 1.6%.
The largest event now likely concerns events surrounding Iran and the US/UK. Oil fell $4.50 bbl this week, but downside from here is limited. Stock index futures closed on a weak note, with the Russell making a new low for the month of July.
I continue to favor steepening positions as the Fed gets painted into an easing corner. However, an uncertain geopolitical landscape should cap risk assets.
| 7/12/2019 | 7/19/2019 | chg | |
| UST 2Y | 183.7 | 181.2 | -2.5 |
| UST 5Y | 185.9 | 180.3 | -5.6 |
| UST 10Y | 210.6 | 204.7 | -5.9 |
| UST 30Y | 263.3 | 257.7 | -5.6 |
| GERM 2Y | -72.3 | -76.8 | -4.5 |
| GERM 10Y | -21.0 | -32.4 | -11.4 |
| JPN 30Y | 39.0 | 37.2 | -1.8 |
| EURO$ Z9/Z0 | -32.0 | -39.0 | -7.0 |
| EURO$ Z0/Z1 | 6.5 | 4.0 | -2.5 |
| EUR | 112.88 | 112.34 | -0.54 |
| CRUDE (1st cont) | 60.30 | 55.76 | -4.54 |
| SPX | 3013.77 | 2976.61 | -37.16 |
| VIX | 12.39 | 14.45 | 2.06 |
https://en.wikiquote.org/wiki/Monty_Python_and_the_Holy_Grail
https://www.federalreserve.gov/releases/z1/20190606/html/d3.htm
https://www.federalreserve.gov/releases/housedebt/default.htm
Where’s that powder?
July 19, 2019
–The head of the NY Fed, John Williams, threw the market into a tizzy with his speech yesterday, ‘Living Life Near the ZLB’. Here’s the zinger: [when there are signs of a slowdown] “DON’T keep your powder dry – that is, move more quickly to add monetary stimulus than you otherwise might.” The market was thus forced to adjust to the very real possibility of a 50 bp cut at July’s meeting. August Fed funds surged from 9793.5 to 9801, settling +6.0 at 9798.5. It’s not a perfect proxy, but if we consider the July/August spread for the odds of easing, with a spread of -25 signaling certainty of a cut by 1/4% and -50 a cut of 1/2%, note that we settled almost exactly in the middle at -38.75.
–The Fed quickly issued a statement to put a damper on the market’s exuberant interpretation. It’s certainly true that William’s was citing old research, and it’s also the case that we are NOT currently near zero. So why does the Fed keep talking about zero, or its new politically correct incarnation, the Effective Lower Bound? And why do it just before the blackout period? The whole, “Fed Listens” initiative to hone communication strategy doesn’t seem to be bearing fruit. In any case, longs in precious metals and stocks rejoiced.
–Philly Fed was much stronger than expected at 21.8. But they’re not taking away the punch bowl, they’re overtly pouring in some grain alcohol. Let’s party! Until we black out.
–I mentioned yesterday that EDZ9 9800 straddle seemed a bit cheap at 28.0, settled 29.5 yesterday. The guy who has been loading up on long EDZ 9800/9812cs vs 9775p for 0.5 had a nice day, with a pkg settle of 2.25. The curve steepened of course, with 2’s plunging 6.2 bps to 1.772% and 30’s essentially unch’d at 2.57%.
–Today brings the Michigan survey, which includes 5-10 year inflation expectations, with the last reading at the bottom of the range at 2.3%
Funding pressures looming?
July 18, 2019
–Stocks slid late yesterday, prompting a bid in rate futures. The WSJ cited ‘Weak earnings weigh on global stocks’. Some pointed to continued snags in US/China talks relating to Huawei, and the gen’l malaise in global trade, NFLX lost US subscribers, sending the stock down 10% (I believe market cap was around $158b) and Ray Dalio turned bearish. Other factors include…whoa hang on a second! Did you see SILVER? On a moonshot! On July 1, SIU closed $15.19 and now it’s almost a dollar higher.
–On the rate side, early drama was associated with outright sales in EDZ9. I believe these sales are related to both funding issues and the turn, and the idea of heavy t-bill supply which may hit after a delayed debt-ceiling deal. In any case, sales were new as open interest jumped 104k contracts to bring EDZ9 open positions to 1.739 million, the peak on the strip. With five months to go and uncertainty about the Fed’s strategy, 28 bps seems a tad cheap for the EDZ9 9800 straddle (settled 9798.5). While EDU9 and EDZ9 therefore settled lower on the day (-1.0 and -0.5), all other contracts rose in a flattening curve. Reds +4.25, greens +5.5, blues +6.375 and golds +7.0. Tens sank 6.6 bps to 2.059%. One other note regarding the front end: FFF0 (Jan 2020 fed funds) closed +2.5 on the day at 9830.5, so EDZ9 to FFF0 jumped 3 bps to 32.0. This compares to EDU9/FFV9 at 18.0 and EDH0/FFJ0 at 24.0. Beware end-of-year fireworks!
–On an international note, Reuters had a piece highlighting China’s debt. They’re killin’ us there too! From the article, “China’s total corporate, household, and gov’t debt rose to 303% of GDP in Q1 2019, from 297% in the same period a year earlier” according to the IIF. The US gov’t is doing ITS part to catch up.
–Today’s news includes Philly Fed expected 5.0 from 0.3 last. Jobless claims 216k and Leading Index +0.1%.–By the way, the NY Fed has several recent posts dealing with money market flows. Here’s one (and a lot of other good stuff on the Liberty Street Economics blog).
https://libertystreeteconomics.newyorkfed.org/2019/07/from-policy-rates-to-market-ratesuntangling-the-us-dollar-funding-market.html
Purchasing Power Parity
July 17, 2019
–Yields up Tuesday as Retail Sales were stronger than expected +0.4 and +0.7 ex-auto and gas. However, import and export prices were soft. In any case, tens rose 3 bps to 2.12% while the euro$ strip from reds through blues were -3.5. Though the US economy seems to maintain momentum, Chicago’s Evans said a couple of eases would get inflation back to the 2% target. However, it’s the same song and dance globally. Coeure said the ECB is ready to act if necessary in front of next week’s meeting, and Kuroda said the Japanese economy is growing, but “…we will swiftly consider additional monetary easing steps if the economy loses momentum for hitting our inflation target.”
–Yesterday the dollar strengthened and commodities fell, with oil down $2/bbl, grains lower, gold under pressure, though silver had a notable rally. The US dollar was stronger yesterday. Which brings me to a tangent. Early in my ‘career’ a bet was made between Chase and Morgan Stanley employees about who could eat 10 big macs. I was working for Chase on the CME floor, and had met our man, a substantial lad whose name I have since forgotten. I bet $250 on him and lost. He said that the middle of big mac number 7 was like hitting a brick wall. Since that time, my normal bet was $500 against, sight unseen, I never lost, though it was accomplished by a guy in Alcocks when I wasn’t participating. (These bets and other even more disgusting wagers came up every so often. I hope they still do). The normal bet was for 10 in an hour. Anyway, I realized that it wasn’t just the quantity of food, it was that someone had to sit down in a jostling crowd of floor traders and clerks, which made the room hot and distracting. It also drove home the idea of credit risk… but I’ll leave that for another time. The story filtered into my consciousness because of the purchasing-power-parity Big Mac index. I saw an item from a few days ago, noting that the index indicates the dollar is ‘too strong’. It’s hard to generate inflation with a strong currency, a fact not lost on the US administration. Easing by the Fed won’t do it alone if everyone’s playing the same game…
–Today’s news includes Housing Starts and the Beige Book.
https://www.cnn.com/2019/07/12/investing/dollar-big-mac-index/index.html?utm_source=fark&utm_medium=website&utm_content=link&ICID=ref_fark
Slow grind
July 16, 2019
–It was a slow Monday with a bias towards a flatter curve. Tens fell 1.6 bps to 2.09%. Powell speaks this afternoon, ‘Aspects of Monetary Policy in the Post-Crisis Era’. Data includes Retail Sales expected +0.1 for both headline and ex-auto and gas. Industrial Production also expected +0.1. I believe Fitch yesterday issued a note saying the Fed would cut only once in July and then be on hold. Odds for a Sept ease after July remain quite high; for example, Aug/Oct FF spread closed -17.5 (isolates Sept FOMC meeting), and EDU9 settled yesterday at 9793.5 vs a final settle (to libor) of EDN9 at 97.6967, a spread of -23.83.
–A large trade went through yesterday in 50k in ED options that could also be thought of as reflecting a view of a few eases in July and Sept, but nothing after that. The trade was a buy of 50k EDQ 9800/9812c 2×3 (settled 3.5 and 1.0 or 4.0 in 2×3) and sold 50k EDZ9 9800/9837/9875c fly which settled 7.5. The package was sold from 4 down to the settlement of 3.5. The December call fly was an exit and the August 9800 calls were new longs. Strikes of 9800 on both… if one thought EDU9/EDZ9 were going to decline further in a slowly upward grinding market, this would NOT be the time for the trade. This trade suggests the possibility of 3 eases being priced by fall. In any case, took money off the table and kept a long in front. (EDU9/EDZ9 settled -7.5).
–One other somewhat interesting note. Cass trucking volumes show a decline in freight VOLUME for the past seven months, but prices steady to higher. A larger picture of stagflation?
Monetary Order
July 15, 2019
–Friday featured a slight decline in rates with tens -1.3 bps to 2.106%. The curve edged steeper. There was a large new 5/30 option steepener that blocked, buy of 10k USU9 151 puts at 41 to sell 40k FVU9 116.75c at 11. 5/30 cash closed 77.4 bps. I marked the ten year treasury/tip spread just above 178 bps, a new recent high. In the wake of inflation data last week, perhaps some of the Fed’s concerns about being below target are overblown.
–China’s Q2 GDP was 6.2%, lowest in 27 years, however some of the other data including retail sales indicates stabilization. Bitcoin is down $1400 this morning to 10330 while gold is up 5.50 to $1417.70. So the net change in bitcoin is almost exactly an ounce of gold.
–Powell speaks tomorrow…Bretton Woods, 75 years later. The role of the US dollar and gold in today’s monetary order seems to be in flux currently. I always recall that some analysts attributed the crash of 1987 to then Treasury Secretary Baker’s threat to devalue the dollar with respect to the German mark. Now we have the President threatening to match alleged currency manipulation with barely a ripple. It all echoes in the words of the former mayor of Chicago Richard J Daley, “The police are not here to create disorder, they’re here to preserve disorder.” Obviously an unintentional slip, but it does seem like current markets are preserving and abetting disorder. In the words of Billy Ray Valentine, “I suggest using your nightstick officer.”
