Notes

May 12, 2020

–Yields ended higher yesterday and curve posted new recent highs.  Ten year up 4.5 bps to 72.5.  Thirty-year at 1.44 surpassed April’s high (chart below).  2/10 ended at 54.4, +1.5 and 5/30 at 108.4, +2.5.  Red/gold pack spread ended at 45.125, +1.5 but still 10 bps off the high from mid-April.

–CPI today expected -0.8 month-over-month.  NFIB Small Biz Optimism expected to plunge to 83 from 96.4; the low in 2009 was 81.6.  While the Fed will dip its toe into the junk bond market beginning today (the Fed announced it will begin purchases of bond ETFs including JNK and LQD), the treasury has some paper to sell, including $32B ten years, $35B in 119 day Cash Mgmt Bills and $65B 42 day CMBs.   The Fed’s paying Blackrock for this service of buying ETFs.  Blackrock, in turn, is using an unpaid college intern named Jack to point and click to enter bids. High finance.

–Trump ordered government retirement investment funds to avoid China. 

–Fed Presidents Evans, Bostic and Bullard all made negative comments about negative rates.  So that’s a positive right?  In any event Fed Fund futures retreated, although contracts in the middle of next year are still stubbornly holding 100 to 100.01.  Powell tomorrow.   

Double Vision

May 11, 2020

–January 2021 FF contract trades 99.985 this morning, having notched a high of 100.04 on Friday.  Peak contracts June and July ’21 still trade above 100, with yields of -1 bp.  The Fed announced that Powell will address the economic situation on Wednesday, which caused afternoon profit-taking in short-rate futures.  Peak euro$ contract on Friday was EDU21 which settled 99.82 or 18 bps and is currently down 1.  The late week FF breach of 100 jolted euro$ options into the realization of un-capped prices with a fresh reminder of market turmoil regarding negative oil futures.  For example, on Wednesday, EDU21 settled 9975.  This is long dated, just under 500 days until expiration.  On Wed, the atm 9975 straddle settled 24.5 and the 9987.5 straddle at 29.5.  With Friday’s close of 9982, the 9975^ settled 30.0 and the atm 9987.5^ at 32.5. (Thanks Brent C).  

–5/30 closed at a new recent high of 106, just shy of the March spike high of 110.  On Friday, twos FELL 3.2 bps in yield to 14.9, while 30’s ROSE 6.3 to 1.382%.  Treasury auctions of 3s, 10s and 30s on tap this week. 

–It all comes back to WeWork and oil.  An article on Reuters reports that Saudi Arabia will increase its VAT tax from 5% to 15% and suspend a cost of living allowance, after the kingdom  posted a $9 billion deficit in the first quarter.  Austere.  The plunge in oil demand and prices has complicated the future for KSA and its Vision 2030 strategy (“The Investment Powerhouse Hub Connecting Three Continents”), meant in part to diversify away from oil.  Of course, a key pillar of that initiative was the great early success of bankrolling Softbank’s Vision Fund.  But that took a loss last year of $12.5 billion on the back of the WeWork implosion.  Can’t they just print currency and give it to everyone?  I guess it’s not that easy when you don’t possess the reserve currency.  Oh great, now we have to worry about the Middle East being destabilized.   
https://www.reuters.com/article/us-health-coronavirus-saudi-economy/saudi-arabia-to-raise-vat-threefold-suspend-cost-of-living-allowance-idUSKBN22N05M

Saudi Arabia to raise VAT threefold, suspend cost of living allowance – ReutersSaudi Arabia’s government is suspending the cost of living allowance and raising the value added tax threefold, as part of measures aimed to shore up state finances, which have been battered by …www.reuters.com

https://vision2030.gov.sa/en

Reflation

May 10, 2020- Weekly Comment

This week I am starting with a link to the macro letter by Paul Tudor Jones and Lorenzo Giorgianni, ‘The Great Monetary Inflation’

I skim a lot of financial news sites and what seems to have been distilled by the press from this paper is that PTJ now favors bitcoin as an investment.  Yes, that’s part of it.  Unsurprisingly the paper is much more nuanced and informative.  Below is an excerpt:

Global debt was very elevated entering the pandemic, and this monetary expansion is funding additional large debt creation, for now, without provoking the disciplining response of rising market yields.  So far, the result has been asset price reflation.  A large demand shortfall will prevent goods and services inflation from rising in the short term.  The question is whether that will be the case in the long term with a central bank whose central focus will be repairing the worst employment crisis since the Great Depression.

Rather than do the injustice of trying to sum up the paper, a big part of it has to do with the idea of a possible ‘goods and services’ reflationary environment and the loss in confidence in currency.  I am just going to focus a bit on one possible outcome, and that is a steeper yield curve. 2/30 is cited, but I will include 5/30. 

First I will note a couple of events in the upcoming week.  Treasury auctions 3, 10 and 30 year paper, and on Tuesday adds in Cash Mgmt Bills: $35 billion of 119 days and $65 billion 42 days.  Also on Tuesday is CPI.  Powell is slated to speak on the economy at 9:00 a.m. on Wednesday. 

Regarding treasury auctions, I first went to the TBAC site to see the initially recommended auction schedule for this week.  The amounts for 3’s, 10’s and 30’s were $43, $30 and $21b.  Total of $94b against maturing amounts of $57b, meaning the treasury is raising $37b in new cash from these three issues.   Then I checked BBG for auction amounts: $42, $32 and $22, so $2 billion more than the original estimate, tacked on to the long end. I.e. $39b in new cash. (With a new $20 year on the way).  The May 4 Treasury Press Release for borrowing estimates says, “During the April-June 2020 quarter, Treasury expects to borrow $2,999 billion…”  I guess that sounds better than $3 TRILLION (or more) right?   

Regarding CPI, it’s expected at a month-over-month rate of -0.8%.  Hardly matters.  Everyone knows there has been demand destruction and many businesses got caught with unsold inventories.  Here’s another line from the PTJ piece: “In the last weekly release of the Fed’s Money Stock data, M2 rose 18.5% over a year ago, an unprecedented pace of growth in the history of the weekly time series starting from 1981.”  I am going to add another anecdotal thought to the reflation idea.  ZeroHedge, to its credit, ran a post from backdoorsurvival.com authored by Samantha Biggers.  She’s not famous, or maybe in some circles she is, but in any case wrote an article titled, Staying Ahead of the Shortages: What to Stock Up On for the Coming Year.  Crazy prepper right?  This is a clear, thoughtful and practical article noting that a lot of basic items are made in China and India, and can be had inexpensively right now, but may go up significantly in price in the near future.  Specifically, appliances, clothing, shoes, tires, electronics, power tools, meds, bedding.  It’s the same thread of thought that runs through the PTJ piece, but not through the econometric monetary angle, rather, as common sense strategy:  As manufacturing comes back to the US prices will increase. [Perhaps wages will as well.  I hope so.]  Actually PTJ included a line that alluded to the same thing regarding supply chains.  Maybe these reflation thoughts and changes in consumer behavior aren’t just at the margin, but are at the cusp of Malcolm Gladwell’s ‘The Tipping Point’:  The moment of critical mass, the threshold, the boiling point.    

Powell will speak on Wednesday.  After an historic week where prices of Fed Fund futures traded above 100, i.e. at negative rates, this should be a big day.  Many Fed officials have noted that negative rates have not been particularly beneficial in Europe.  The German 2y note has been below zero since 2015 and the 5^th euribor contract has been above 100 since the end of 2015.  On Friday, when the Fed announced that Powell would be speaking on Wednesday, rate futures immediately downticked.  It would be great if Powell put a stop once and for all to the notion of negative rates in the US. But I am sure he won’t.  I was reading an article on Reuters which had this asinine segment: “Negative rates also result in cheaper mortgages, which attract new home buyers.  They allow existing home owners to refinance loans at lower rates, reducing their debt obligation.  Consumers can borrow at cheaper rates to finance other large purchases such as cars or home appliances.”  Oh.  I see.  It’s all wonderful then right?  Rates go negative in a vacuum where income and credit quality just stay exactly where they were.  Maybe rates are going negative because hopeful ‘new home buyers’ don’t have jobs.  The article implies that we can buy toys and second homes and just charge it.  It’s American medicine.  Not “What are the core catalysts that made you ill that can be changed or avoided?”  It’s, “You’re sick.  Let’s give you a pill to ameliorate some of the symptoms.”  Capitalism is basically healthy.  Sometimes things don’t work.  They fail, and new opportunities sprout up which draw resources.  The healthy system adapts.  The zombie system doesn’t.  Anyway, I digress…

On July 13 of last year my weekly note was titled ‘Often Wrong, Never in Doubt’. I focused on 5/30 and posited my thesis of higher levels. “I know which way it’s going.  Higher.  And I know where.  To 150 for a start. (Currently 78).  It started the year at 48, having closed at 36 on Dec 20, 2018, the day after the last hike.” 

Well it ended this week at 106 and never reached my initial target of 150, having spiked briefly to 110 last month. I was wrong in the middle of last year, as 5/30 languished around 55 to 65 through year-end.  But I am jumping back on the horse.   Typically the curve steepens on rate cuts as these decreases are thought to spur future inflation and growth.  In the current situation, some would argue that we’ve HAD the cuts, and now the only stimulus left is lower long end rates, resulting in an even flatter curve.  I would argue that while we’ve had FF cuts, it’s only over the past month, as libor dropped from 145 bps to 44 bps, that the market’s attention was captured by lower funding rates.  Further, the amount of supply, marginally increased at the long end, is simply staggering, and that’s at both the corporate and government level. As Jones’ paper says, “Corp debt is also rising briskly to record levels as firms draw down revolving credit lines to self-fund cash flow shortfalls.”  The monetary aggregates outlined by PTJ are, of course, another huge factor.  There is another point I would like to make that may also serve to support the idea of a steeper curve.  At the start of the last crisis, corporate debt wasn’t all that high.  According to the Fed’s Z.1 Corp debt in 2007 was $6.3T.  At the end of 2019 it was $10.1T.  By contrast HH Mortgage debt in 2007 was $10.6T and is now the same at $10.6T.  Monetary stimulus had the effect of creating financial asset inflation rather than goods and services inflation.  In large measure, corporate borrowing went into stock buy backs and other financial engineering tactics that served to boost stocks.  It wasn’t too much money chasing too few goods.  It was too much investable money chasing diminishing yield (exacerbated and encouraged by the Fed) in a world where boomers were desperate for retirement income. There are two big changes: 1) Income inequality is having a stifling effect on new financial engineering and yields are already low.  2) A decline in corporate credit quality means the window to borrow in order to buy back shares has shut. 3) Government cash is not just going to banks, but also directly into the hands of consumers. 4) As global trade declines and fewer dollars filter into the world as US imports stagnate, there may be less foreign demand for US treasuries, leaving domestic players left to mop up the significant excess.  I guess those are two big changes in the spirit of, “So here come two words for you…” [Midnight Run]

Below is a chart of 2/30 spread.  Current 122 bps having peaked around 200 at the start of this administration.

The 5/30 spread is 106 bps as of Friday.  It has not seen 150 bps in the past four years.  However, both charts have turned up.  With the Fed likely to emphasize the forward guidance of low rates, the two-year yield is destined to stay quite low.  It ended Friday at just 15 bps.  So a significant rise in these yield curve spreads means that the long bond yield has to rise appreciably, which currently seems somewhat unlikely.  On the other hand, some people thought VIX could never get much above 20.  The 30 year yield averaged around 2.15% for the six months from last August through January.  That would represent an increase of more than 75 bps from Friday’s level of 1.38%.  In November of 2018 the 30 year yield peaked at 3.45%.  It was only one and a half years ago. 

The case for a steeper curve isn’t a surge in economic vitality.  It’s an avalanche of supply and an increase in inflationary expectations.  It’s monetary expansion run amok that saps the confidence of lenders. 

OTHER MARKET/TRADE THOUGHTS

This week the two year yield fell 5 bps to 14.9 and 30’s rose 10.5 bps to 138.2.  On Wednesday the June Ultra-bond contract WNM0 had the lowest settlement since late March at 218-24.  On Thursday rate futures rallied hard.  But on Friday, long contracts again sold off, with the Ultra settling 219-29. Bearish. Although Ultrabond options never trade, it’s worth noting that there’s more open interest in WN futures (1.062m) than in the classic bond US (1.003m).  In my opinion a close below Wednesday’s low will lead to a quick decline of 10 more points ~205-209.  The same set-up in US would lead to a move to around 172/173 vs Friday’s settle of 179-22.  June treasury options expire a week from Friday.  USM 175/173 p spread settled 9/64’s. 

	5/1/2020	5/8/2020	chg
UST 2Y	20.0	14.9	-5.1
UST 5Y	36.7	32.3	-4.4
UST 10Y	63.9	67.8	3.9
UST 30Y	127.7	138.2	10.5
GERM 2Y	-76.0	-77.8	-1.8
GERM 10Y	-58.6	-53.7	4.9
JPN 30Y	42.7	45.2	2.5
EURO$ M0/M1	-9.0	-14.5	-5.5
EURO$ M1/M2	4.0	3.5	-0.5
EUR	109.81	109.71	-0.10
CRUDE (1st cont)	19.78	24.74	4.96
SPX	2830.71	2929.80	99.09	3.5%
VIX	37.19	27.98	-9.21

https://www.federalreserve.gov/releases/z1/20200312/html/d3.htm

Warped signals

May 8, 2020

–The eye-opening news from yesterday was that FF futures traded above 100, that is, negative rates.  FFZ0 settled 100.01 and the peak contract was FFM1 at 100.03.  Contracts are higher this morning with the peak June’21 contract at 100.06 or minus 6 bps.  Eurodollars of course, also saw a rally to new highs.  Before this episode, reds had never settled above the 9975 strike.  Current peak on the curve is EDM21 and EDU21, both having settled at 9982.5 or 17.5 bps.  By the way, the two-year note also closed at that level, at 18 bps.  Oh. and I suppose these prices imply forward lib/ois at around 20 bps.

–The message isn’t lost on stock indexes, with Nasdaq having closed higher than it started 2020, just shy of 9000.  If there are no interest rates and the gov’t is handing out cash, might as well forecast NASDAQ 10k. In this new reality, the flows are all that matter and Paul Tudor Jones has reportedly embraced a long in bitcoin.  Jump in. 

–Of course, today we get the sobering news of the Employment report, expected to show a jobless rate of 16% and 22 million jobs lost.  Which can only mean MORE.  More action out of the Fed and federal gov’t.  From a Reuters article quoting Erica Groshen, former commissioner of the BLS: “Our economy is on life support now.  We will be testing the waters in the next few months to see if it can emerge safely from our policy-induced coma.”  Nicely put.  Real commodities are seeing bounces, though they are modest in scope.  A lot of attention has been given to oil, but consider copper.  HGN0 currently just a shade under 2.42, which admittedly represents a huge bounce from the March low around 2.10.  But it started the year at 2.82.  

–The other real world manifestation of the current environment can be glimpsed through the Consumer Credit report.  This report is typically ignored, and data is for March, but still somewhat interesting.  The balance on revolving credit (charge cards) actually fell over $28 billion from $1.094T to 1.066T.  The annualized rate of decline is just over 30%.  Makes sense.  However, non-revolving credit (for student loans and pick-up trucks), increased by $16 billion.  I guess that was for ‘home-schooling’ costs.  Like frozen pizza puffs and peach sangria.

–It can all be summed up by Grandpa Simpson:  Bart: “Didn’t you wonder why you were getting checks for doing absolutely nothing?”  Gramps: “I figured cuz the democrats were in power again.”

Industrial smoothing

May 7, 2020

–An apparent catalyst for this morning’s stock strength is China’s reported increase in April exports of +3.5% vs an expected fall of 15%.  Or, maybe it was Peloton’s earnings report.  Or something else.  I am not given to calling everything ‘fake news’, but this morning it seems to fit.  ESM +44 at 2877.50 and CLM0 pressing yesterday’s high at 25.50, +151.  Also worth a note that Turkish Lira is crashing to new lows.

–The main feature in rates yesterday was curve steepening to new recent highs.  Two year was -0.6 bp to 17.8, while the thirty year jumped 8.6 bps to 1.412%.  2/10 closed at new recent high of 53 bps (up 6 on the day) while 5/30 rose 7.5 to 104 bps, also a new recent high aside from a spike in mid-March to 110.   Factors include crushing issuance plans from the Treasury and a lessening of deflation fears.  Everyone knew that supply is coming like a tsunami, so I’m not exactly sure why the market chose yesterday to take yields higher…  Oh, of course, Illinois pulled a bond offering.  Just before the inevitable downgrade to junk.

–FT has a headline this morning ‘ECB to resist German court order to justify bond purchases’ and further adds that four governing council members are warning of risks to the central bank’s independence.  Actually I think the apostrophe should be moved to the end of the word banks.  It’s not just the ECB that faces that threat.  Could un-anchored rates at the long end be a result?  Seems plausible.  Also of course, China is warning that it might sell treasuries (to the Fed)  as the US administration thoughtfully floats the idea of cancelling the bonds that China holds.  “I’ve got an idea!  We just won’t PAY the rent.”

Hint from oil and curve

May 6, 2020

–Notable feature yesterday was a steeper curve, with 10/30 treasury spread at 67, its highest level since mid-2017.  The ten year yield on its own was +1.6 at 65.4 and thirties rose 3 bps to 132.5.  5/30 gained 2.5 bps to close at 96.2, not quite at a new high.  Three month libor set yesterday at 47.4 bps (new low), leaving only 11 bps of convergence with EDM0 which settled 9963.5.  An article on BBG today notes that ‘The Fed is embracing libor again…’ having used it as a benchmark in the Main Street Lending program.  Large trade in EDM0 options was a new seller of 40k EDM0 9950/9937p 1×2 at 0.25 (sold 9950p).  

–In the past six sessions oil (CLM0) has rallied from a low of 10.07 to this morning’s high of 26.08.  Just when everyone is convinced (due to the negative price debacle) that oil will never be in demand again, it rises like a phoenix.  Perhaps a reasonable idea to bookmark with respect to interest rates.  And perhaps the long end of the market is trying to send a gentle reminder.  Treasury skew is shifting to reflect demand for puts.

–Bund/BTP spread is 244 this morning, not quite to the recent high of 278, but still well above the late 2019 into early 2020 range of 130 to 165.  Unicredit posted a Q1 loss of €2.7 billion, €1b more than expected. 

–ADP today expected -21 million in front of Friday’s payrolls.     

5/30

May 5, 2020

–Quick note this morning concerns long end of the market.  The 30 yr yield is 1.33% this morning, up from 1.295 yesterday.  Since late March USM has traded a relatively tight range between 177 and 183 and is now almost in the middle at 179-25 but appears to be weakening.  Above is the 5/30 spread which is around 95 this morning (+2).  In mid-March this spread hit 110 bps, then subsequently retraced to 80.  However, over the longer time-frame, these levels are the highest since late 2017.  This spread appears to have put in a decisive bottom in 2018.  

–Whether driven by renewed concerns about future inflation, or about massive treasury issuance (Treasury expected to borrow $3 trillion in Q2! ) or perhaps even a slight spill-over this morning from the German Constitutional Court that the ECB must justify bond purchases, the idea that the curve might continue to steepen is good news for banks in terms of positive carry, but perhaps somewhat sobering for the rest of the debt-laden corporate market that faces bankruptcies if bonds can’t be rolled near zero rates.  Implied vol has been crushed in treasuries over the past two weeks, but bond vol remains stubbornly bid relative to five-year when compared to contract durations.  There is probably a reason for that.

–Might be worth considering some wingy bond put insurance.

Frogs

May 4, 2020

–Well, stocks are lower as is oil, with ESM below 2800 (-28) and CLM0 -1.35 at 18.43.  Still a long way from zero though.  Interest rate futures pushing a bit higher with a flattening bias.  On Friday the ten year yield was 63.9 and it’s now back to 60.5 with TYM0 again hovering just over the 139 strike, which seems to have gravitational pull.  TYM straddle is 1’01 with three weeks to go.  Although Friday’s 3m libor setting posted a new low just over 54 bps on Friday, EDM0 closed -2.5 at 9963.0 or 37 bps.  Still a fairly wide basis with just under a month and a half to go.

–New recent lows in euro$ calendars from reds back.  Red/green settled at just 7.75 and red/gold at 37.75.  In mid-March red/gold was as high as 61.  Nothing here to indicate a vibrant return to economic growth.  

–I’m not sure what the data releases even mean any more, but this Friday is unemployment and it’s still sort of an eye-opener to see an expected NFP number of minus 21 million.  In my formative years unemployment was always the biggest number of the month.  I worked at Chase on the CME floor at the time, and would be on two phones, as we all would, clamping them to my ears so I could hear above the floor noise that erupted on data releases.  In that time I stood right in front of the front month, and that’s the contract we typically quoted on a data release.  I was on with the Chase swap desk with Kedric, a soft spoken guy.  At that time, during big numbers, I was like the highschool experiment where you take a wire and touch it to the dissected frog leg and it jolts into a phantom hop.  No thinking, just electrical response.  The number came out and he said “Sell 230”.  And I was also doing something for the other line but yelled down, “Kedric you sold 230 at 2”.  He says, “What?”  Me: “Filled at 2…sold you 230!”  And he bursts out into laughter, saying “I said FELL 230.  The payrolls were DOWN 230.”  When he caught his breath, he told me to just cover them.  And I was really glad it was Kedric on the line and he took it so well, because not all people would find it that amusing.  Good thing it’s not this Friday.  Fell 21 million.   

The Irish Lumper

May 3, 2020 – Weekly comment

Exactly a year ago I was in NYC for a grand benefit staged by a friend as part of County Mayo Days.  I was also invited on Saturday May 4 to an event at the Irish Hunger Memorial by new friends Corina and Siobhan.  The Hunger Memorial is at Vesey and North End Avenue in Battery Park, a few blocks from the 9/11 memorial. There, the ruins of an original stone cottage from Mayo were reconstructed on a hill of wild grasses.  Strewn on the site are rocks from every county in Ireland.  For a minute, it’s easy to forget you’re in New York City.  Perhaps especially so on that day as it was a cool overcast morning under a slight drizzle.  The modern part of the memorial is tucked under the west side of the hill.  There the walls are engraved with proverbs and quotes of Irish poets.  “Hunger will break through a stone wall.”   

The Great Hunger was caused by a blight of potato crops in Ireland in the mid-1800’s.

By the early 19th century, however, the potato had begun to show a tendency toward crop failure, with Ireland and much of northern Europe to experience smaller blights in the decades leading up to the Great Famine. While the effects of these failures were largely ameliorated in many countries thanks to their cultivation of a wide variety of different potatoes, Ireland was left vulnerable to these blights due to its dependence on just one type, the Irish Lumper. When HERB-1, which had already wreaked havoc on crops in Mexico and the United States, made its way across the Atlantic sometime in 1844, its effect was immediate—and devastating.

Last week, problems related to the COVID virus affected meat-packing plants in the US, threatening reduced supply.  As Bloomberg reports there’s a downside to efficiency, as “…part of the issue is that a few big companies dominate the industry through a handful of extremely high volume plants, the result of years of consolidation.”  

Modern society has become governed by efficient and concentrated international supply chains and products.  In essence, it’s the problem of the Irish Lumper: dependence on just one variety with beneficial qualities.  “…Since potatoes can be propagated vegetatively, all these lumpers were clones, genetically identical to one another.” Clones.  Like corporate managements and the political class.

It’s clear that in the short term, vast amounts of demand will be cut, overtly reflected by the example of Buffet dumping Berkshire’s airline stocks.  There will be bankruptcies and the jobless rate, which is obviously soaring, will take a long time to come back down, perhaps never reaching the historic lows achieved recently in the US.  However, associating inflation with low joblessness and low rates has proven to be an error.  Similarly, there are now those who think inflation can’t possibly come back due to demand destruction and idle capacity.  However, as a weekend Bloomberg article notes, some aren’t so sure. “Such contrarians wonder if an environment of ultra-loose monetary and fiscal easing, commodity shortages, frayed supply chains and braking globalization might be fertile ground for surging consumer prices.” 

In the aftermath of the GFC there was significant monetary and fiscal stimulus, but much of it was drawn out over years.  At that time, I thought inflation was sure to follow.  Wrong.  I would note that many concluded the exact same outcome.  In November 2010 a group of influential economists and investors sent an Open Letter to Ben Bernanke published in the WSJ regarding QE: “The planned asset purchases risk currency debasement and inflation…”

In the current case, huge sums of fiscal stimulus have been instantly unleashed with the CARES act in the amount of $2.2 trillion or 10% of GDP, with more on the way.  In the eight YEARS from 2007 to 2015, the Fed’s balance sheet expanded from $870B to $4.5T, an increase of just over $3.6T.  In the eight MONTHS from Sept 2019 to April 2020, the balance sheet has exploded by nearly the same nominal amount, $3.76T to $6.65T.  M2 has had an eight week increase of $1.73 trillion to $17.2T.  Yesterday’s Bloomberg article notes an “…asymmetric response during the financial crisis, when CB’s cut rates and started quantitative easing, but governments reined in budgets.”  In the 2008/09 episode, money primarily flowed into efforts to save banks and the financial architecture.  The outcome wasn’t the inflationary response of ‘too much money chasing too few goods’ but rather ‘too many investment funds chasing too little yield’.  This dynamic squashed inflation.  The Fed successfully pushed the market out the risk curve, perhaps aided by boomers focused on retirement income.  In recent years, I suspect the general public wasn’t particularly informed nor did they care about corporate buybacks.  However, that issue has bubbled to the surface.  The financial engineering outgrowth of the GFC will likely be stymied during this go-around.
  
Now, money is flowing directly into the economy, not just financial institutions.  All sorts of supply chains will be duplicated and domesticated.  Inventory on hand will become more important.  Less global trade will result, but my guess is that companies and even consumers may now weigh ‘certainty’ of supply vs the ‘price’ thereof.  Though the economy is now primarily service-based, the extra layer of health safety will increase costs.  As Wilbur Ross said in his awkwardly tone-deaf manner in late January, “It should help manufacturing and jobs return to the US.”  Having experienced the oil price plunge in the last two months, year-over-year inflation comparisons are likely to significantly expand by Q4 2021.  Of course, it’s not all about oil, but still worth noting that after a significant bounce this week, CLM0 settled 19.78, CLZ0 at 28.59 and CLZ1 33.81. (The increase from Dec’20 to Dec’21 is 18%).  A slower growth world with more friction (of every sort) and less security will almost certainly lead to price pressures.

Where is this thesis emphatically NOT reflected?  In back month Eurodollar contracts.  In the past week, back month Eurodollar contracts made all-time highs.  Reds (2^nd year forward) had never settled at the 9975 strike, but on Wednesday that’s exactly where the first red, EDM21, settled.   The high in the first green in 2012 was 9952.  On Friday it was 9968 (EDM22).  The previous high in the first blue was 9923, now 9956 (EDM23), and in the first gold, 9868 to current 9940 (EDM24).   

The question might be, with central banks in accommodative overdrive, why should there be any expectation of change?  The trend is for lower rates.  Kocherlakota was just out last week making his asinine argument for negative rates.  Well, two and a half months ago, SPX also made an all-time high.  When sentiment begins to change, it can happen in a hurry.

I’ll end it with a comment from perhaps the biggest bond bull and consistent (and consistently correct) deflationist around, Lacy Hunt.  The last Hoisington Quarterly Review is once again mostly about the prospect for lower growth and declining inflation.  However, it included this caveat, a warning about MMT, for the first time:  “Having the Treasury sell securities directly to the Fed could do this [make the Fed’s liabilities legal tender]; the Treasury’s deposits would be credited and then the Treasury would write checks against these deposits.  If this change is enacted, rising inflation would ensue and the entire international monetary system would be severely destabilized and the US banking system would be irrelevant.” 

“Evolutionary theory suggests that populations with low genetic variation are more vulnerable to changing environmental conditions than are diverse populations.”

Concentration giving way to diffusion.  Commoditization morphing into diversity.  Supply retrenching from global to local.  Higher price pressures. 

OTHER MARKET/TRADE THOUGHTS

Three month libor plunged 30 bps this week, from just over 84 bps on April 24 to just over 54 on Friday.  However, EDM0 net change was from 9960 a week ago to 9963 on Friday, with the intervening high at 9968.  The market is now signaling that libor compression has run its course.  Interest rate volume eased as the week progressed and implied vol in treasuries declined, with implied vol on TY around 4%, lower than the level of early Feb before stocks peaked. VIX has also declined, but popped off the lows on Thursday into Friday as stocks resumed a sell off.  VIX ended at 37.19, up 1.26 on the week. Importantly treasury vol did NOT respond positively to equity weakness; a signal that perhaps treasury yields have bottomed.

	4/24/2020	5/1/2020	chg
UST 2Y	21.2	20.0	-1.2
UST 5Y	36.1	36.7	0.6
UST 10Y	59.1	63.9	4.8
UST 30Y	117.1	127.7	10.6
GERM 2Y	-70.6	-76.0	-5.4
GERM 10Y	-47.3	-58.6	-11.3
JPN 30Y	43.4	42.7	-0.7
EURO$ M0/M1	-13.0	-9.0	4.0
EURO$ M1/M2	5.5	4.0	-1.5
EUR	108.21	109.81	1.60
CRUDE (1st cont)	16.94	19.78	2.84
SPX	2836.74	2830.71	-6.03	-0.2%
VIX	35.93	37.19	1.26

https://www.history.com/news/after-168-years-potato-famine-mystery-solved

https://millefiorifavoriti.blogspot.com/2010/03/irish-hunger-memorial-new-york-city.html

https://evolution.berkeley.edu/evolibrary/article/0_0_0/agriculture_02

bloomberg.com/news/articles/2020-05-03/sum-of-all-fears-still-can-t-dispel-speculation-about-inflation

https://economics21.org/html/open-letter-ben-bernanke-287.html

May Day

May 1, 2020

–May Day, a sign of spring but also a commemoration of workers initially relating to the Haymarket Square affair in Chicago in 1886 where a rally of peacefully striking workers turned into a riot as a bomb was thrown. I didn’t realize the location was Randolph and Desplaines, just a few blocks northwest of the old CME floor.   https://en.wikipedia.org/wiki/Haymarket_affair

–Markets were fairly quiet yesterday, though post-close earnings reports from AMZN and AAPL led to a sell off in stock futures.  Last in ESM is 2845.50, down 57.0.  Interestingly, that’s below the initial short that Gundlach mentioned he had placed earlier in the week at 2863.  Boeing launched a $25 billion 7 part bond offering yesterday, with the 40 year maturity yielding 4 5/8% above treasuries vs initial talk of a 5 1/2% spread.  Debt issuance continues to be massive over the government and corporate sectors in an effort to plug revenue gaps. At some point, and perhaps we’ve reached it, yields will refrain from probing lower levels given the flood of paper.   

–3 month libor set at a new low yesterday of 55.6 bps, but EDM0 closed -1.5 at 9965.5 leaving a relatively narrow 20 bps of convergence.  Ten year treasury yield eased half a bp to 61.7 with TYM hugging the 139 strike.  There hasn’t been a lot of trade in Sept treasury options but what I did see yesterday was a seller of the TYU 139 straddle from 2’35 to 2’35.  Settled 2’30, just above 4% vol.  General bias was steeper, though red/green pack spread in dollars closed at a new recent low of just 8.25 bps. 

–War of words between US and China continues with implications of a further decline in global trade no matter how soon the virus threat ends.   

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.