Expedient Exaggeration
June 30, 2019 – Weekly comment
‘Ah, Maggie, in the world of advertising, there’s no such thing as a lie, there’s only the expedient exaggeration. You ought to know that!” — Cary Grant as Roger Thornhill, protagonist in Alfred Hitchcock’s North by Northwest (1959).
There was an article on ZeroHedge which featured all of the overly zealous market predictions that the site is known for, but this one also featured a twitter post from Raoul Pal, relating the story of the “greatest macro trade I’ve ever seen.” The premise of this anecdote is that the current interest rate set-up is similar to that of 2000-2001, when this macro trader went limit long one trade and one trade only, EDZ01, right after the Fed cut rates by 50 bps on Jan 3, 2001. “His bet was that after a massive equity bull market, a tech bubble, Y2K inventory unwind and over confidence, the economy was likely to be very fragile and the Fed were going to have to massivley cut rates.” Nice ending, as this trader added to longs and it ended up being a “career trade”.
https://www.zerohedge.com/news/2019-06-28/recession-now-inevitable-may-be-trade-lifetime
Here’s an excerpt from Pal:
I strongly believe we have the near exact same
set up now, with the added kicker that if the dollar goes up, there is a gigantic tailwind to the trade, making it an
extremely skewed risk reward. Maybe one of the best I’ve ever seen. This set up has been in place
for 9 months now and is why I’m very long Eurodollar interest rate futures.
Options were ultra cheap and the dollar hasn’t yet made its move. Vol is too
low compared to the potential upside in these as we head to negative rates, if
the dollar squeezes higher. This
makes an asymmetric trade crazily asymmetric.
To Pal’s credit, he says that he’s been long eurodollar futures for quite some time, and further, he loosely quantifies the idea by saying rates are going negative. But there are some key differences, which I will outline below.
First though, I’ll note that this same ZH post also contains the following chart, which I have now seen several times, indicating a ferocious gap between stocks and the ten year yield. I have reproduced it below. Since the end of May, stocks have soared yet yields have declined. There MUST be a huge macro trade here, right? [On the following charts, SPX in white and 10-year treasury yield in green]. The problem is, as the second chart reveals, that over a longer term time frame (the first chart is two months, the bottom is over one year) it’s not really clear that there’s any conclusion to draw at all, except that, as rates fall, stocks become more attractive, and the present value of the future stream of earnings becomes greater. Sure, maybe things are a bit stretched currently, but it’s more micro than macro.
Like a lot of other market commentary, mine included, there can be a lot of expedient exaggeration to sell the story. So let’s get back to the big picture and compare 2001 to 2019.
On Dec 31, 2000, the FF rate was 6.5%. On Dec 31, 2001 it was 1.75%. This was indeed a massive and rapid cut in rates of 475 bps. The protagonist in Pal’s story thus knocked the cover off the ball. Let’s recall that previous to this episode, the low in FF was 3%, so it took a bit of imagination to think about rates moving toward zero. Currently, it takes no creativity whatsoever to conjure up a scenario of negative rates, as they have become mainstream. In 2000, the US gov’t deficit as a percent of GDP was…oh, wait a second, it wasn’t a deficit. There was a surplus of 1.2%. Now, it’s a deficit of around 5% and getting worse. In Sept 2001, 9/11 occurred. The Nasdaq had topped in March 2000, having nearly doubled in the previous year. Perhaps there’s some similarity presently as Nasdaq went up 60% from around 5000 in late 2016 to 8000 in Q3 2018. But a reverse wealth effect isn’t likely to have the same bite as the dotcom unwind. The chart above shows that tens have already sunk 100 bps over the past three quarters to end at Q2 ‘19 at 2%. The Fed has not yet begun to lower rates, but EDH20 has rallied over 150 bps since last October and EDH21 (the peak contract on the curve) has surged over 175. Is it really the same set-up now? Is the FF target going to simply change sign to achieve the 475 bp move to take us from +2.375% to -2.375%? Pal mentions one other aspect of the trade, and that is the US dollar, implying that a (likely?) move higher in DXY will spur lower rates. Perhaps so, but DXY appears to be probing the downside as the prospect of lower official US rates looms.
What’s the point of this exercise? (“…when you’re telling these little stories, here’s a good idea: Have a point. It makes it SO much more interesting for the listener”). My point is that this set-up is much more conducive to a curve trade rather than outright. The chart below is the red/blue euro$ pack spread from 1999 to 2002. That’s the second year forward vs the fourth year forward. The curve had already started to steepen from 0 to 45 bps prior to the first cut. But then ran another 140 bps through 2001.
The chart below is the current constant maturity red/blue pack spread. It too, has perked up a bit, from -5 bp to +25 since March.
I agree that the Fed will cut. However, it’s not at all clear that the dollar will rally, it may continue to decline. Additionally, US government deficits are set to increase, which, in my opinion will temper any gains in the longer end of the curve. Wage increases are set to continue even if the labor market loses a bit of luster. Of course, the faster and more aggressively the Fed cuts, the more likely that the curve continues to steepen. I think the steepener is still in the early stages.
In Hitchcock’s classic movie North by Northwest from which I quoted to start this missive, Cary Grant plays Roger Thornhill, a Madison Avenue ad executive mistaken for a secret agent named George Kaplan. Kaplan doesn’t actually exist, he was a fictitious diversion created by US spies led by the Professor, hoping to ensnare the suave villain Phillip Vandamm (played by James Mason).
Our story could also see twists in the plot if Kaplan, in this case the very real Robert Kaplan of the Dallas Fed, holds sway with his thoughts outlined last week: “I am concerned that adding monetary stimulus, at this juncture, would contribute to a build up of excesses and imbalances in the economy which may ultimately prove to be difficult and painful to manage.”
If the Fed were to remain on the sidelines
at the July meeting, the curve would flatten viciously. If a magical US/China deal had been inked
this weekend, it might be a different story.
But it’s more of the same, an agreement to keep working on the last 10%,
with the China Daily editorializing on Sunday:
“Agreement on 90 percent of the
issues has proved not to be enough, and with the remaining 10 percent where
their fundamental differences reside, it is not going to be easy to reach a
100-percent consensus, since at this point, they remain widely apart even on
the conceptual level.”
Early Monday morning Clarida speaks. Then ISM Mfg is released, expected 51.0 with Prices 53.0. China’s Mfg PMI released this weekend was 49.4, still weak and slightly lower than 49.5 expected. On Wednesday, ADP and Service ISM, expected 55.9. After Thursday’s holiday, the employment report is released Friday, with NFP 165k from last at 75k, and yoy earnings 3.2%.
| 6/21/2019 | 6/28/2019 | chg | |
| UST 2Y | 175.0 | 173.9 | -1.1 |
| UST 5Y | 180.7 | 175.5 | -5.2 |
| UST 10Y | 206.4 | 199.8 | -6.6 |
| UST 30Y | 258.9 | 252.7 | -6.2 |
| GERM 2Y | -73.7 | -75.0 | -1.3 |
| GERM 10Y | -28.5 | -32.7 | -4.2 |
| JPN 30Y | 32.8 | 35.4 | 2.6 |
| EURO$ Z9/Z0 | -33.0 | -35.5 | -2.5 |
| EURO$ Z0/Z1 | 9.0 | 6.0 | -3.0 |
| EUR | 113.70 | 113.72 | 0.02 |
| CRUDE (1st cont) | 57.43 | 58.47 | 1.04 |
| SPX | 2950.46 | 2941.76 | -8.70 |
| VIX | 15.40 | 15.08 | -0.32 |
Bitcoin driving economic prosperity
June 28, 2019
–It was a pretty bland day yesterday unless you happened to be trading bitcoin. A parabolic rise in June took BTC from around 7500 in the beginning of the month to over 14000 Wednesday, only to crash 3000 yesterday to around 11000. After exhaustive research (feeding the data through our proprietary models) we’ve developed a working theory of bitcoins ebbs and flows. Hackers are targeting vulnerable Florida cities with ransomware. These cities are buying bitcoin to pay the ransoms, thus driving up the price. Having received bitcoins, the perpetrators recycle the bitcoin back into the real economy, buying Teslas and Beyond Meat burgers and the services of tattoo parlors. This temporarily drives the price of bitcoin back down. Initial targets like Baltimore had to be changed because strained city finances caused officials to balk at paying. However, wealthy Florida residents who have fled the high tax districts in the north are more amenable to paying the fines. It’s like Bastiat’s broken window fallacy for the modern, interconnected, world. Economic vibrancy with an added element of wealth redistribution. The only thing left to do is buy CrowdStrike.–Yields fell yesterday with tens falling 4 bps to 2.007% as auctions ended and we wrap up the month/quarter. Eurodollar strip rose 3 from reds thru golds.
–News today includes Personal Income and Spending, expected +0.3 and +0.5. Core PCE Deflator +0.2% with yoy Core expected 1.5% from 1.6%. Chicago PMI expected 53.5. The big event happens this weekend as Trump and Xi meet. There has been sizable buying of EDU9 puts in the past few sessions, with the hope that the meeting goes well and the Fed tries to hold fire on easing.
–Lake City FL paying 42 bitcoins (roughly $480k), this from June 25.
–Riviera Beach also in Florida paid $600k in bitcoin.
–Key Biscayne data breach earlier this week….
From the Guardian
“We have an exponentially increasing problem,” said Katie Moussouris, founder and CEO of Luta Security, which helps businesses and governments work with hackers to identify vulnerabilities. “We don’t have an exponentially increasing workforce. If we don’t see cities and towns … start pouring a bunch of resources into hiring more people, we are going to see it happening over and over again.”
https://www.theguardian.com/cities/2019/jun/03/ransomware-attacks-hackers-cities-baltimore
From the NY Times
It was the second city to agree to a large ransom in two weeks. Riviera Beach, in Florida’s Palm Beach County, signed off on an extraordinary $600,000 payment last week, also in Bitcoin, a cybercurrency that is difficult to trace.
ORLANDO (CBSMiami/AP) — The Village of Key Biscayne reported a data breach earlier this week, becoming the third Florida city to do so in the last few weeks.
The Village of Key Biscayne hacking comes a week after Riviera Beach in South Florida agreed to pay $600,000 in ransom to hackers last week.
Lake City pays 42 bitcoin ransom to cyber attacker to restore hacked systems
The city’s insurance began negotiating with the attacker, resulting in an agreement to pay 42 bitcoins–roughly $480,000.
Pot luck
June 27, 2019
–Bitcoin is once again providing an interesting roller-coaster side show, as it plunged $1800 late yesterday afternoon, rallied 1300 and is now down 2500! Gold is also down $10, and stocks have recovered from a later afternoon press. Rate futures are a bit lower, as the market continues to adjust to a less aggressive easing path following Tuesday’s comments from Bullard and Powell. July/Aug Fed Funds settled -30, still certain of a 25 bp cut in July, but shaving back the idea of 50. Aug/Oct settled -20. Jan’20 FF settled -6 at 9834.0, which is still 71 above FFN’19, (comfortably pricing 3 cuts by year end). The most negative one-year euro$ calendar spread is EDU9/EDU0 at -45, up 3.5 bps on the day. Implied vol oozed out of options. Attention is now focused on Trump/Xi.
–Q1 GDP revision expected +3.2. KC Fed expected 1.0…regional Fed surveys have been coming out on the weak side. 7-year auction today.
–Although TYU only -3 this morning, the long end trades somewhat tired and feels like a more significant retracement is coming, having essentially held 2%. Typically there is a rally out of the auctions, but likely to be muted today if it occurs at all. All the crazy ingredients of US/China, US/Iran, Brexit, N Korea, and Central Bank pronouncements have been put in the pot and are now at a slow simmer on the back burner.
Give me some water
June 25, 2019
–It was June of 2007, exactly twelve years ago, when Bear Stearns was forced to inject capital into two of its funds loaded with mortgage ‘securities’ which had lost almost all of their value. These funds eventually failed, as did, of course, the firm. The bell was ringing at the top. But it wasn’t the top. Stocks pulled back but went on to make new highs before the ultimate conflagration. What brings this footnote of financial history to mind is Natixis’ H20 Fund, with a bit over $32 billion AUM. This fund was flagged by FT Alphaville and Morningstar last week, and is now facing a liquidity squeeze as investors rush to withdraw in the face of markdowns and illiquidity.
The analogy with Bear perhaps is unfounded, but the broader issue of illiquidity is central to the current market environment.
–Yields in the US dropped yesterday, with tens falling 4.5 bps to 2.019%. On the euro$ strip reds through golds were +5.0 to 5.5. The Dallas Fed manufacturing survey was particularly weak at -12.1, but Dallas Fed President Kaplan was out later in the day saying that he thought adding monetary stimulus at this time might be counterproductive, and increase imbalances. However, the market is darn sure of a move in July, with July/August Fed Fund spread settling at -34.5.
–Both bitcoin and gold soared to new highs yesterday and are higher this morning in a flight to something other than assets controlled by central banks. Russell led stocks a bit lower. As I’ve noted before, Russell and NFIB small business optimism are closely correlated; not a particularly comforting sign going forward. The chart below shows the ratio of Russell to SPX, which has matched the 2016 low and is not all that far from the depths of the 2007-2009 crisis levels.
–Powell speaks at 1:00 pm today, and is slated to deliver semi-annual testimony to the House on July 10. Other news includes New Home Sales expected 684k, Consumer Confidence 131.0 and the 2-year auction.
Rhymes with delicious
June 24, 2019
–Bitcoin is up 10% this morning at 10935. Precious metals are higher, stocks are higher, bonds are higher, the dollar is weaker. Chicago Fed’s National Activity Index is out today. Last was -0.45, with the three month moving average at -0.32, the lowest since Q2 2016 when bond yields were making historic lows. Today’s CFNAI expected +0.10.
–From AP, US military cyber forces launched a strike against Iranian military computer systems in response to the drone downing. I don’t know if it’s connected, but I was repeatedly blocked from sending out my weekend note, receiving the response, ‘blocked by recipient’s e-mail service’. I thought it was too long, so I removed a bunch of charts, but that didn’t help. The title was ‘Pernicious’. Once I changed that, the email went through. I guess it’s because Pernicious rhymes with Malicious. I am sort of joking around here, but I have a feeling the cyber security cold war is about to move into higher gear. I had to change the title to Zombie Economy. I guess Zombies don’t scare anyone any more.
–I marked 2/10 at a slight new high Friday just above 28. This week the treasury auctions 2’s, 5’s and 7’s starting tomorrow.
Pernicious
June 23, 2019 – Weekly Comment
Lawrence Lindsey was interviewed on CNBC by Kelly Evans on Friday. He said a couple of things that strike at the heart of monetary policy. One interesting quote: most people don’t want inflation; central banks want it “because if you have a little higher inflation then you have a little more wiggle room.” He was then asked about low long term rates and he said, sure, they hurt savers. “…but there’s even a more pernicious effect of low long term rates, and that is that you get a zombie economy …any business that can service debt at low rates stays in business, therefore there’s no creative destruction.” He added that he would not cut rates now.
Many commentators blamed the administration for tax cuts and other fiscal stimulus at the beginning of 2018, saying it was at the wrong time given full employment. Now, the Fed is coming under the same attack for easing policy with record low unemployment and stocks near all time highs. Perhaps the real problem has been identified by Lindsey: ZOMBIES. They’ve gone global and hold prices down in a negative spiral. Lower rates, which encourage zombies, which keeps employment high but lowers inflation expectations, which in turn, spurs a call for lower rates. Someone has to kill these things!
When the financial crisis was in full storm, the federal government shifted bad private debts on to the government’s balance sheet. Central banks cut rates to the zero bound. In the US, banks were forced to merge and bolster capital. Sure, one goal was to help over-mortgaged households. But the broader objective was to save the financial architecture. Without a strong banking/financial system the smooth transmission of monetary policy locks up, and the loss of confidence is catastrophic. In Europe, the move to zero (and below) didn’t come with the same sort of banking stringency. Hence, the banking system wasn’t ‘saved’ and still seems to be choked with bad debts that need to be extinguished or isolated through bad banks, etc. Lowering rates further can’t help the situation, though that seems to be the ECB’s course of action. Higher rates and a positive curve help build capital.
Brainard also gave an interesting speech on Friday. Here are a couple of excerpts:
My own assessment is that the most likely path for the economy remains solid. The latest data suggest that consumer spending is robust, and consumer confidence is high. Although the pace of payroll gains has moderated recently, unemployment is at a 50-year low, wages are growing, participation in the labor force has expanded, and unemployment insurance claims are at cycle lows. Despite recent volatility, financial conditions overall remain supportive. [This sounds an awful lot like an argument for hiking!]
In addition, recent indicators of inflation and inflation expectations have been disappointing, making it all the more important to sustain the economy’s momentum [ I guess the declines are NOT transitory]
The downside risks, if they materialize, could weigh on economic activity. Basic principles of risk management in a low neutral rate environment with compressed conventional policy space would argue for softening the expected path of policy when risks shift to the downside. [ Insurance cut, but I’m not sure if it prevents, or causes, mayhem ]
However, when equilibrium interest rates are low, we have less room to cut interest rates and less room to buffer the economy using our conventional tools. [Here comes something new? ]
We heard in Chicago that most members of the public care a lot about the job market and the cost of credit, but they are not aware of our communications about monetary policy.
First of all, these clips are all from the same speech. I have the highest respect for Brainard, but is this a cohesive message? Maybe it’s good the public doesn’t know about the Fed’s ‘communications’. Employment is at a 50 year low but some risks MAY materialize and so we need to change path? The markets parse the Fed’s communications, the public views the resulting prices. That’s the transmission mechanism. Below is a chart showing how the market has interpreted the Fed and has communicated its response, through pricing. In mid-September, the Fed hiked. At the time, 3 month libor was 2.35%. The Fed then hiked in December. At that time, 3 month libor topped at 2.82%, so very nearly 50 bps higher. Since then the Fed has NOT eased. But the market has. Three month libor is again at 2.35%, thus reversing the last two hikes. [Red vertical lines denote hikes]
In fact, financial conditions have loosened dramatically in the past several months. Short end rates are shown above. Long term rates as defined by the ten year have fallen from over 3% in Q3 of last year to printing just under 2% this week. Stocks are near all time highs. The BBB corporate spread which started the year around 190 bps, fell 12 ths week to 151. Strength in the dollar had indicated tight conditions, but DXY gave way this week, closing decisively below the 200 DMA. The yield curve has signaled a tight Fed, but even that is changing, with a new high in 5/30 this week to 79 bps. A year ago this spread was around 25 bps.
Aside from the major stock indexes, many markets are giving signs of impending disaster. Most clearly this can be seen through interest rate futures/options, where trades are being piled into at ever higher call strikes. It wasn’t long ago that there was large buying of October EDV9 9800/9825 call spreads around 3.0 bps, (then out-of-the-money, but now in, as EDZ9 settled 9811.5). Currently the favored long call strikes are above 9900, which of course, requires sub-1% fed funds. There is once again continuous buying of 100 strike calls (in EDM20, U20, Z20 and H21, total 100c open interest is 500k). Besides the rally in rate futures, the gold/silver ratio is at its highest level since the early 1990’s, and is threatening new highs. Bitcoin has pierced 10,000. The ratio of SPX to the Russell has plunged to nearly match the low at the depth of the early 2016 wash-out (oil and commodity rout, EM unravel, corporate spreads jacked). Banking shares have severely lagged the general rally. Mfg and Service PMI surveys released last week indicate a further drop in inflation expectations In the last few weeks the amount of sovereign debt trading at negative rates has gone from just under $12 trillion to $13 trillion. Charts are attached at bottom.
This week attention is focused on the meeting between Trump and Xi, which almost certainly will result in ‘progress’ and the promise to re-engage in high level talks. It’s too early for Trump to announce a deal. The Democratic presidential debates will air on Wednesday and Thursday, to see who can promise to give away more. Perhaps it’s in Xi’s interest to wait for the election with the hope of a new administration. On Friday we’ll get Core PCE price deflator, expected at 1.6%. Tuesday Powell speaks with the opportunity to hone his message: RATE CUTS AND ADDITIONAL ACCOMMODATION.
Economic Outlook and Monetary Policy Review 1:00 pm, June 25
At C. Peter McColough Series on International Economics: A Conversation with Jerome H. Powell, New York, N.Y.
OTHER MARKET/TRADE THOUGHTS
Heavy buying this week of 0EH 9925 calls. The main trade was +9925/9975c 2×3 with settles of 5.25 and 1.0 or 7.5 in the package (traded 8 on Friday). These two strikes now have the most open interest of any midcurve calls, with 269k and 320k. Underlying EDH1 has been the peak contract on the ED curve, settling at 9846.0. That price in and of itself is pretty astounding, suggesting a FF target around 1.375%. But the 9925 strike is another 75 lower. Let’s just go to zero and get it over with, right Neel? On the other hand, EDH21 is nearly 200 bps higher in yield than ERH21 at 100.42.
October Fed Funds which cover the July and Sept FOMC meetings, settled 9815.5, 52 bps lower in yield than front July FFN9 which settled 9763.5. This suggests certainty of at least a half percent cut, and of course July/August at -31 means that a cut of 50 at the July meeting is priced at over 60%. The last link of the chain has now responded, with the dollar (DXY) closing at the week’s low below the 200 DMA. It’s an invitation for the curve to steepen. If Trump hasn’t already blown out the deficit, then a taste of what the Dems could do will come this week.
| 6/14/2019 | 6/21/2019 | chg | |
| UST 2Y | 184.9 | 178.0 | -6.9 |
| UST 5Y | 184.4 | 180.7 | -3.7 |
| UST 10Y | 209.1 | 206.4 | -2.7 |
| UST 30Y | 259.1 | 258.9 | -0.2 |
| GERM 2Y | -69.3 | -73.7 | -4.4 |
| GERM 10Y | -25.5 | -28.5 | -3.0 |
| JPN 30Y | 36.0 | 32.8 | -3.2 |
| EURO$ Z9/Z0 | -33.5 | -33.0 | 0.5 |
| EURO$ Z0/Z1 | 7.0 | 9.0 | 2.0 |
| EUR | 112.11 | 113.70 | 1.59 |
| CRUDE (1st cont) | 52.77 | 57.43 | 4.66 |
| SPX | 2886.98 | 2950.46 | 63.48 |
| VIX | 15.28 | 15.40 | 0.12 |
BBB Corp spread. Stays low because Central Banks promise to keep zombies alive
Stocks at new highs, because of front loaded eases?
June 21, 2019
–Rates continued to drop with tens down 2.4 bps to end just under 2% at 1.999%. The treasury curve steepened with both 2/10 and 5/30 making slight new highs at 27.3 and 79 bps respectively. Precious metals soared with Dec Gold up $48/oz to 1408, though there is small profit taking this morning. New highs in stocks. Not much change in the euodollar curve with reds through golds settling +2 to +3.5. Large bullish option trades continue, for example, a buyer of 160k EDZ9 9800/9812c spread vs 9775 put for 3.5/4.0. The FF curve continues to suggest that easing will be front-loaded, with July/August at -33.5 while Aug/Sept is -21.5 and Nov/Jan is -12.0.
–There’s now over $12 trillion of negative yielding government securities. And yet, the dollar fell to its 200 day moving average yesterday and appears to have formed a longer term top. It’s no wonder that zero-yielding precious metals are bid (although Monetary Metals does offer a yield on precious metals). The back end of the curve really isn’t reflecting the prospect of much higher inflation, but an actual 50 bp cut in July could be the spark.
–One trade from yesterday was a buy of 30k 0EZ 9887/9812 risk reversal covered 9850, paid 2.0 for the call (settled 1.25 vs 9849). Bid for the calls remains strong, not a big surprise, although given absolute futures levels as compared to current libor, this sort of trade is harder to justify in my opinion. EDZ22, blue Dec, settled 22.5 lower than red Dec, 9826.5 vs 9849. The same 75 wide risk reversal, i.e. 9862.5/9787.5 settled 2.0 for the call, 6.5 vs 4.5 for the put. Given my views on the possibility of curve steepening and an ‘unexpected’ rise in inflation, I’d rather sell the calls on the blues.
When doves fly
June 20, 2019
–Easily the most bullish reaction I’ve ever seen to a non-ease, as Powell said the case for accommodation has strengthened in light of global risks and lower market measures of inflation. He said that near the effective lower bound, an ounce of prevention might be worth a pound of cure. I had thought the front end would shift lower on disappointment as the Fed held FF unch’d, but the market immediately priced the ‘pound of cure’, with an added dollop of prevention. Near euro$ and FF contracts exploded to new highs and the curve massively steepened. At settlement, the white pack (1st four contracts) gained 12 bps, reds +10.25, grns +6.125, blues +3.0 and golds +0.875. Thus, red/gold pack spread rose nearly 9.5 bps. At futures settle, the 2yr note had sunk over 10 bps to 1.758% while tens fell 3.3 to 2.023%. Tens are sub 2% this morning, with additional support coming from news that Iran shot down a US drone. 2/30 treasury spread jumped nearly 9 bps to a new high over 79 bps, as shown below.
–July Fed Funds necessarily fell as the FF target won’t change through July (97.64 settle) but the July FOMC is priced at around 2 in 3 odds of a 50 bp cut. At settle, July/Aug FF spread was -31.5, while the spread which prices the Sept FOMC, Aug/Oct, fell only 2.5 bps to -20.0 (80% odds of a 25 bp cut in Sept). Front-loaded prevention.
–Implied vol was hammered both prior to and after the Fed. Straddles lost another 2-3 bps on the dollar curve. As an example, on Monday I marked EDZ9 9850c 7.0 bid vs 9806.0. Yesterday they settled 6.5 vs 9812, and later, against 9815 bid were barely 6.5 bid. On Monday the Sept 127.5 TY atm straddle settled 2’03, while yesterday TYU 128^ settled 1’57.
–In August of 1971, then President Nixon issued an executive order which ended the US redemption of gold at $35 an ounce. In December the US dollar was devalued. This morning Dec Gold is up just a bit more than $35/oz, currently at $1398. Stocks have also exploded and are near all-time highs, while the dollar continues to weaken after yesterday’s drubbing.
FOMC day
June 19, 2019
–FOMC announcement today. No change expected in FF target. The last three statements said “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient…” That language will, of course change, as the market has strongly signaled the need for lower funding costs. In the March projection plot, 11 members had 2.375% as the appropriate level for FF by the end of 2019. The other dots were higher. So, the average is going to come down, but perhaps not the median. In any case, the market is pretty comfortable in ignoring the dots at this point.
–Interesting session yesterday, with Draghi kicking it off by saying more stimulus might be needed, and Trump following up, accusing Draghi of trying to weaken the euro. (Well, yes, that is one of the goals and outcomes). Then Trump announced that a meeting with Xi at the G20. Finally, it was reported that the White House had looked into ways to demote Powell. The possibility of a trade deal will certainly keep the Fed on hold for now. The Fed has already indicated that trade tensions are the primary cause for the slowdown. It would be ironic if Powell kicked the ball back into Trump’s court by saying, ‘we’ll see how the President does on trade talks’. The longer term prospect of a Trump Fed, which is a low probability event, would result in a massive steepener.
–Price action yesterday gives a hint about what may come today: weaker in the front and stronger in the back, a flatter curve. EDZ0 was the weakest contract on the euro$ strip, settling -1. Reds +0.5, Greens +1.5, Blues +2.75 and Golds +3.75. Tens fell 2.6 bps to 2.056%. Implied vol declined with most ED straddles down 1.5 to 2.5 bps. I expect the statement and presser to lean dovish. Interestingly, July/Aug Fed fund spread settled -20 (80% odds of a cut at July’s FOMC), but Aug/Oct settled -17.5, somewhat lower odds of a cut at the Sept meeting.–Just a couple of levels from Dec 20, the day after the last hike, until now:
SPX 2467 to 2918, +18%
2yr 2.67% to 1.86%, -81 bps
10yr 2.81% to 2.06% -75 bps
Below is a constant maturity chart of red to gold pack (2nd to 5th year). With the expiration of June, the packs now begin with EDU20 and EDU23. Rising trend since the December hike remains intact.
…Additional Stimulus Will Be Required
June 18, 2019
–Draghi this morning said risks are tilted to the downside and that additional stimulus may be required. New low German bund -28 bps. Treasuries at or near new highs this morning. Stocks higher. Tomorrow it’s Powell’s turn to sweet talk the market – without cutting rates. There is some talk that the Fed will deliver a surprise cut, for example, Jim Grant was on CNBC espousing that view. I’ll believe in surprises from the Fed when Grant appears on tv without a bowtie. The Fed will wait for the G20 to play out. The next FOMC is 6 weeks away.
— Yesterday the eurodollar curve flattened with EDZ9 the weakest contract, -4.5 bps, as market pricing clearly shows there will NOT be a cut tomorrow. Reds -2.625, greens -1.25, blues unch’d and golds +0.625. Tens fell 1 bp to 2.082%. Implied vol eased. Empire State Mfg data posted a startling drop to -8.6, from an expected +11 and previous +17.8.
–There’s a bit more talk about the Fed front-loading eases and then signaling a stop. Sounds good on paper, but that strategy limits future policy options. If Powell refers to this idea without actually cutting tomorrow, it would likely thwart the impact; such a policy has to deliver ‘shock-and-awe’. It would, however, steepen the curve.
