Tipping points
May 9, 2019
–Stocks under renewed pressure this morning with Trump turning up the rhetoric saying China broke its deal. Treasuries have reversed yesterday’s weakness going into today’s 30 year auction. News today includes PPI expected +0.2, with yoy Core 2.5%. Trade deficit $50.1b. Jobless Claims 220k.
–Yesterday’s 3 month libor setting was 2.545, the lowest since last October and just shy of 29 bps below the high print set just after the December FOMC hike. While this supported the very near contracts, reds through golds fell 3 to 4 bps. After an initial push to new highs in TYM9 to 124-06, the market faded going into the ten year auction and declined further in its wake to settle 123-24. The auction was poorly received with bid to cover of just 2.17, the lowest in a decade, with a tail of 1.4 bps to come in at 2.479 (3:00pm marked 2.482). Most commentary surrounding this auction expressed concern with lack of foreign demand, with some suggesting that perhaps the prospect of increasing supply had reached a tipping point. A BBG piece fretted about lack of Chinese participation. Should that be a surprise? After the 2008 crisis, the US/China relationship was often referred to as ‘vendor financing’ with China selling the US manufactured goods and recycling those dollars into treasuries. From the start of 2008 to the middle of 2014, China’s reserves grew from $1.5T to a peak of $4T. Since 2016 they’ve leveled off just above $3T. But with less being shipped to the US, there are fewer dollars to recycle into UST. Who is going to plug the gap? You guessed it: The Fed.
–Interesting to note that in this regard, BOJ’s Kuroda dismissed the idea that Japan was a real-life example of MMT. It seems as if Kuroda equated MMT with the idea of hyper-inflation, but according to Stephanie Kelton, MMT’s main proponent, the point of MMT is to bring down employment and create/repair infrastructure, with an increase in inflation being the limiting factor, rather than a fixed dollar amount of debt. That is precisely the Japanese story, and it hasn’t sparked inflation. It’s also ironic that the Fed’s Lael Brainard in a speech yesterday brought up the (Japanese) idea of targeting yields slightly further out the curve. Yes, the Fed will be on its way to monetizing the debt.https://www.federalreserve.gov/newsevents/speech/brainard20190508a.htm
–Some notable new sales yesterday of TYN 126c at 13 and 14; open interest +11k, settled 9. Fears of a meltdown associated with a complete breakdown in trade talks just isn’t reflected in markets. However, it’s also worth keeping an eye on TRY, new low today of 6.23.
China, Iran and US banks altering agreements
May 8, 2019
–Yields fell as stocks declined. Tens shaved 5 bps off to end at 2.446% in front of today’s 10y auction. The red eurodollar pack closed +5.125, with greens, blues and golds +5.5. SPX fell 1.65% with Nasdaq down 2% as the showdown on a US/China trade deal moved into a more precarious stage. Vol up in both stocks and fixed income with the VIX nearing 20 and many eurodollar straddles adding 1-1.5 bps, but there seemed to be some call profit-taking in treasuries as well.
–Odds for Fed rate cuts increased slightly, but are not particularly close to more extreme measures seen at the end of March. For example, the lowest one-year ED calendar spread is now EDU9/EDU0 at -29.5, while the lowest in March hit -42.0. Aug/Oct Fed Fund spread is -6.0, indicating a 25% chance of ease in Sept (that had traded below -8.5 in March). Jan 2020 funds settled 9781.5, which, given changes in IOER, is somewhere around 75-85% chance of a cut by year-end.
–It’s not only about China. The Turkish lira today is edging to a new low of 6.17 and apparently Iran is also stepping back from earlier agreements, leading to increased internat’l tension. The Italy bank index has erased April’s gain and is nearing levels from late March.
–On a more mundane domestic note, Consumer Credit yesterday for March was up much less than expected at $10.4b vs $16b exp. Revolving credit (credit cards) actually declined on the month. In my mind, there are only two explanations: one, banks are tightening conditions as delinquencies edge up or two, households are trying to load up on student loan debt for the upcoming jubilee. Non-revolving credit (student and car) increased nearly $12b from $2.983 to $2.995t. A drop in revolving credit is a red flag.
Employment Day
May 3, 2019
–Yields continued to rise as a result of Powell’s more hawkish than expected press conference Wednesday, with red euro$’s down 6.75 bps. Tens were up 4.5 to 2.55%. EDU9, which had been solidly bid based on the possibility of a rate cut at the Sept FOMC, fell 3 bps to 9748.0 as calls came under heavy liquidation pressure. EDU is now only 5 bps above the front May contract. August/Oct FF spread settled -4, now around 1 in 6 odds of a cut in Sept. EDZ9/EDZ0 settled -24, up 3 on the day and is still the lowest one-year spread. The market has gone from the idea of a string of cuts to maybe one over any given year, or maybe nothing. The withdrawal of Steven Moore as a candidate for the Fed is another loss for those looking for an easy money Fed.
–Employment data today with payrolls expected 190k. Average Hourly Earnings yoy expected 3.3%. Also Service ISM expected 57.0 from 56.1 last. Prices were 58.7 last and I would expect a lower reading this time.
–Nancy Davis of Quadratic was on CNBC yesterday, a guest whose commentary is generally more sophisticated and nuanced than other guests. Yesterday she was pretty straightforward. I am paraphrasing here, but she said ‘the theme in 2019 has been carry, whether that means bonds, credit or selling of premium. The result has been that volatility has been compressed. And it’s a concern for the market.’ When yields and spreads continue to compress, there’s much less of a cushion for the market to absorb shocks. I think the 2018 Powell was trying to re-inject the idea of risk into markets, which leads to higher real rates and actually elevates the neutral rate. The end of 2018 transformed him in the 2019 Powell: let’s give the party what it wants. Wednesday he was perhaps trying to get some of the old mojo back…but inflation is not going to cooperate with him.
What in the Wide Wide World of Sports is going on here?
May 2, 2019
-Back in the 1970’s, a sports show aired on TV called The Wide World of Sports. It featured the memorable tagline voiced over grainy images:
The thrill of victory. The agony of defeat.
Here’s an intro clip.
–Yesterday, for the bulls it was exactly that. A brief grasp of victory, followed by an agonizing sell off.
–It was an interesting session from the start, with Mfg ISM coming out lower than expected at 52.8, with Prices Paid at just 50.0 (vs 55.0 expected). Rate futures remained well bid in the wake of this data. I recall back in 2015 saying that the Fed had never hiked with Mfg ISM sub-50, but of course that’s exactly what they did in Dec 2015 (the first hike in this now officially ended cycle; officially in my opinion anyway). Now with ISM holding over 50, should they ease? Well, that’s not exactly what they did, but for a spontaneous moment the market took the 5 bp cut in IOER to 2.35% from 2.40% as a broader policy signal rather than a technical modification. Red eurodollars traded to +5.5 bps! However, the elation in both stocks and bonds was fleeting, with hard reversals into the end of the day. Red eurodollars settled -4.625 on the day and were -6.0 late. Stocks also had a reversal with ESM9 making a new contract high before dumping 40 points from that level into the close. Stick a fork in it…sell in May and go away.
–The Fed fund calendars revealed the extent of hopes for ease: FFN/FFQ spread traded as low as -5.5/-5.0 post announcement before being lifted at 5 in 4k and settling at -3.5. This spread targets the July 31 FOMC. The spread that isolates the Sept FOMC, FFQ9/FFV9, got down to -8.5/-8.0 (1 in 3 odds of an ease) before coming back to settle -5.0. As near term easing hopes surged and then deflated, the curve flattened. Reds -4.625, greens -2.75, blues -1.375, golds -1.0. In treasuries, 2/10 gave back 2.8 bps to close 21.1. Powell didn’t express much concern about the decline in inflation, citing transitory factors.
–However, worrying signs emerged. For example, copper took a large tumble (HGN9) with a 3.5% decline on the day, breaking out to the downside from a two month range. Gold is down $12 this morning testing the recent low, and oil is likewise closing in on last Friday’s low.
–In eurodollars as in Fed Funds, calendar spreads ultimately pared back easing expectations. EDM9/EDM0 traded as low as -34 before coming back to settle -25.5. The low settle at the end of March was -42.0. Once again, EDZ9/EDZ0 takes the crown as cheapest one-year spread on the board, settling -27.5. We’re now in a ‘position adjustment’ trading environment of gradually paring back the froth associated with hopes for a near term ease. Tomorrow’s wage data will be important in this context. expected yoy 3.3% vs 3.2 last.
By the way… googling the “Wide wide world of sports” takes you back to another 1970’s anachronistic throwback….Blazing Saddles.
Mfg Prices Paid, EVERYBODY PANIC
EVERYONE SHOULD PANIC!!!! CUT RATES!!!!
(of course the Fed’s FIRST rate hike was in Dec 2015, with Price Paid SUB-40)
The Merry Month of May
May 1, 2019
FOMC meeting today with the possibility of a cut in IOER. Rates eased yesterday in spite of a record high in SPX, further supported by AAPL’s earnings report. Tens fell 2.7 bps to 2.507%. Reds through golds were up 2.5 to 3 bps. New low posted in EDM9/EDM0 which has moved into the slot of the lowest one-year spread at -30.5; it fell 2 bps yesterday. EDZ9/EDZ0 fell 1.5 to -28.0. On the longer end, 2/10 and 5/30 both edged to new highs, 23.9 and 66.0 respectively.
–As an aside, when looking at the DV01 on the five year and bond contracts (June) and comparing that with implied vol levels, it appears that US vol is extraordinarily cheap to FV. DV01 ratio is nearly 3.9, while US vol is just 2.4x as high as FV. I think the ratio between the two is about as low as I have seen it,which doesn’t really make sense (to me anyway) in a steepening curve environment.
–USM Mfg ISM expected 55.0 vs 55.3 last. Prices paid expected to firm to 55 vs 54.3 last. For a bit of context, prices paid topped out in mid-2018 just under 80 and have declined since then. The readings this year: Jan 49.6, Feb 49.4 (the recent low) and March 54.3. By the way, this area around 50 is where ‘prices paid’ were in mid-2016, when global bonds posted their lowest yields.
2-YR NOTE OPEN INTEREST
April 30, 2019
Chart below shows rolling TU contract (white bar) and aggregate open interest in green. OI has nearly doubled in past year from 2 to 4 million contracts. Nearly one million new positions since the last FOMC meeting!!
Steepening…can we call it a trend?
April 30, 2019
–Once again the curve steepened to new highs, with 2/10 up 2.2 bps to 23.8, a new ytd high and more convincingly through a two year downward sloping trendline (chart below). Red/gold euro$ pack spread rose a similar amount to a new high just above 26 bps. There was some notable new buying of EDZ20/EDZ21 spread which settled at a new high of +2.5, though there was also a seller of EDZ0 through a buyer of 25k EDU0/Z0/H1 3-month fly for 1.5 (which settled 2.0). For now it’s just worth noting that EDZ19/EDZ20 is -10.5 and EDZ20/EDH21 is -3.0. Open interest in EDZ20 rose 40k to become the red with the most OI.
–Yesterday’s data showed prices softening with Core PCE yoy at just 1.6%. The savings rate also took a tumble. That’s like the story of the wife, who *saved* $200 on a dress that was marked down from $500 to $300. Actual savings down, prices lower. Is that sexist and wrong? Might be…I’m not sure how much dresses figure into core PCE.
–China PMI numbers were lower than expected this morning with focus on mfg, which was 50.1 vs 50.5 expected, clinging tenuously to ‘expanding’ vs ‘contracting’. US news today includes Chicago PMI expected 58.5. The lowest level over the past year was in Jan at 56.7, followed by Feb at 64.7. Last was 58.7 so this series is pretty noisy. Consumer confidence 126.7.
–New buying yesterday in EDQ 9775/9800c 1×2, 1.25 paid 30k vs 9753, 40d. EDQ 9775c alone settled 2.25. A July 31 FOMC ease would make the case for this trade.
–Alphabet/GOOGL ad sales had faltering growth sending that stock down $40 after the close. AAPL today. Maybe the top will be marked by the IPO of WeWork, the classic lend long/borrow short mismatch that is going public with astonishing losses. (In this case take long term lease commitments and carve them up into smaller short term leases). Anyone remember the savings and loan crisis of the 1990’s? It’s capital transformation. Or evaporation
GDP strong, prices weak
April 29, 2019
–Friday’s 3.2% Q1 GDP print sparked brief sales in rate contracts, followed by new highs, as some of the details in the report portend future weakness. An inventory build, soft prices, and a 5th quarterly decline in residential construction (-2.8%) put a cloud over the strong headline number. The ten year note fell 3.2 bps on the day to 2.502%. Reds were the strongest part of the euro$ strip, closing +4.625 on a bull steepening move. New highs in 2/10 at 21.6 bps and 5/30 at 63.2. Jan 2020 Fed funds settled 97.82, indicating near certainty of at least one rate cut by the end of the year.
–The highest contract on the ED strip is March’21, the last red, which settled 9785.5. The high print in this contract at the end of March was 9809 with a high settle of 9800.
–Little change this morning, though oil is down another 70 cents to 62.60 after plunging nearly $2 Friday as Trump said he wanted to see lower prices. Oil posted an outside range week and lower close, a technical reversal signal.
–This morning Personal Income and Spending are released, expected 0.4% and 0.7% with Core PCE prices expected 1.8%, identical to the last report. AAPL reports tomorrow. FOMC on Wednesday, May Day.
Short, and not so sweet, for the shorts
April 28. 2019 – Weekly comment
Last week I cited a WSJ headline, ‘Fed Officials Contemplate Thresholds for Rate Cuts’ which had been planted posted on the WSJ site on Saturday 4/20. (Sure, I’ll have a hit of that). The Fed’s continued shift to dovishness, crystallized by the above article, sparked a flurry of buying in eurodollar calls in the early part of the week. The yield on the 2 year note plunged 9.6 bps on the week to 2.286%.
This week’s note isn’t about technicalities in money markets and central bank policies. It’s more about what we can see with our own eyes with respect to interest rate futures and options flows. I’ve read a million times that the “investing public” doesn’t believe in this year’s stock market rally and is still stuck on the sidelines (being constantly chastised by tv investment professionals). In the rates markets, I sort of have the feeling that it’s the other way around. The tv investment professionals just don’t want to believe that rate cuts are on the way, even though market flows are unmistakably sending that signal – with a bit more urgency last week.
In short term interest rates, near one-year eurodollar calendar spreads trended more negative through the week. In the middle of the previous week, on April 16, spreads had hit their highs, with EDM19/M20 at negative 18.5, EDU19/U20 -20.5 and EDZ19/Z20 (the lowest one-yr on the curve), at -23.0. Seven sessions later on Friday, April 26, the levels are M19/M20 -29.5, U19/U20 -28.0 and Z19/Z20 -27.5. The lowest one-year spread is now the front M9/M0 which fell 11 bps in 7 sessions. This collapse indicates a couple of things: first, that the market is moving the idea of rate cuts slightly forward in time, and second, that there is some additional funding pressure on the very near part of the curve. In more deferred contracts, the curve has actually steepened, which is another reflection of eases on the horizon (and perhaps recognition that the Fed is serious about letting inflation run a little warm, if indeed that’s in the Fed’s power). For example, reds/golds (2nd year to 5th year forward on the euro$ curve) settled at 23.5, +4.25 on the week, at a new recent high. and close to the ytd high set in late March just above 25 bps. The green/gold pack spread did close at a new ytd high of 25.125. In treasuries, 2/10 spread closed at 21.6, the highest since late last November, and 2/5 was finally able to close above 0.
With respect to flows in the aftermath of the WSJ headline, there was a surge of eurodollar call and call spread buying over the week. Open interest in both regular ED quarterly calls and in one-year midcurves (0E) were up 6% on the week. In quarterly long-dated EDZ20 calls, open interest swelled by over 20% as there was a big buyer of call spreads vs puts. (Bought 9775/9812cs and sold 9737 puts and bought 9800/9850cs and sold 9737 puts). The total EDZ20 call open interest increase was acounted for by these trades, from a total of 668k to 814k. One-year midcurve total call open interest went from 3.929 million to 4.174m. Again, the point is that these flows are helping to further invert near one-year calendars, in order to capture coming eases. Consider that the EDZ20 put being sold in above cited structures, the 9737.5 strike, which is 45 bps out of the money, settled 11.25, while the EDZ20 9837.5 call, which is 55 out of the money, settled 14.25. Skew is leaning to calls for a reason.
Once again, it’s clear from the Fed funds curve that the market is raising odds of a cut specifically at the September FOMC. Actually, both the August/October calendar spread, and the Nov/Jan settled -6.5, projecting 1 in 4 odds of an ease at either the Sept or Dec FOMC meetings. January 2020 FF settled 9782.0 or 2.18%, 26 bps under the *new* Fed Effective of 2.44%, fully pricing at least ONE 25 bp cut by year end. In touching upon the topic of the Fed Effective rate at 2.44, the natural progression is to discuss this week’s upcoming FOMC meeting and a possible tweak to IOER. At 2.44, the EFFR is 4 bps above IEOR, leading some to speculate that a reduction in IOER is in the cards as early as Wednesday. A ZH article over the weekend cites JPM as saying “liquidity conditions in the US banking system are perhaps close to their tightest in a decade.” This claim is made on the basis of the ratio of bank reserves at the Fed divided by total assets of US banks, having fallen below 9%. (Link to article at bottom). Again, it’s hard to comprehend that reserves are ‘tight’ but that’s what the market is saying. I recall a previous speech by Simon Potter, head of the NY Fed’s Market desk, noting the importance of the Fed being able to keep EFFR within target. Of course, as recently as last September, he, like others on the Fed was advocating “further gradual increases in interest rates.” The point is, that the Fed will respond to EFFR above IOER, and the market on Friday timed that tweak for the July 31 FOMC, as the July/Aug FF spread closed at negative 3.5, down 1.5 on the day. I would also note that EDM19/EDU19 settled at -8.5 on Friday. Last week I recommended selling at -4.0 with a target of -9 to -10. With USD strength and near term funding demand, EDM9 should be held down relative to deferred contracts.
Another theme that has been cropping up is deteriorating credit quality at the margin. On the consumer side, several credit card issuers have noted increasing deliquency rates and have tightened terms. For example, Capital One said its Q1 US card charge-off rate rose to 5.04% from 4.64% in Q4 2018. Financial conditions are becoming mixed. Yields have fallen, stocks have continued to rise, corporate spreads remain tight. But the dollar is strengthening and weakness across several EM currencies is obvious, for example in Argentinian peso and Turkish lira. The South Korean won and Swedish krona are also breaking to new lows, not to mention the euro. The Fed appears to be more focused on USD with respect to downside risks for the US economy. “Normalization” is over.
OTHER MARKET/TRADE THOUGHTS
The market’s reaction to Friday’s Q1 GDP print of 3.2% says it all. An initial kneejerk sell off was instantly reversed with rates contracts making new highs as shorts scrambled to cover. “He who sells what isn’t his’n, must buy it back or go to pris’n.” The treasury market isn’t yours anymore. It’s the Fed’s. Weak price data and (unintentional) inventory building in Q1 were the focus, and of course Trump’s tweeting about wanting to see energy prices lower emboldened the DE-flationistas. CLM9 had an outside week and closed lower on a large weekly range. After having posted ytd new highs on Tuesday at 66.60, it settled 63.30.
Last week I said TYM was likely to settle between 123 and 124 due to positioning in expiring May TY options. TYM settled 123-215 Friday, and open interest in June TY calls is clustered around the 124 strike. Tens will probably probe under 2.5% this week (2.502 on Friday’s close).
Last week I suggested buying TUM9 106.375/106.625cs for 3.5 ref 106-09.25. Settled 6.5 ref 106-15. Likely more upside though there could be a pause early in the week.
In general I favor the theme of bull steepening.
| 4/18/2019 | 4/26/2019 | ||
| UST 2Y | 238.2 | 228.6 | -9.6 |
| UST 5Y | 236.8 | 229.3 | -7.5 |
| UST 10Y | 255.6 | 250.2 | -5.4 |
| UST 30Y | 295.9 | 292.5 | -3.4 |
| GERM 2Y | -57.4 | -59.5 | -2.1 |
| GERM 10Y | 2.5 | -2.2 | -4.7 |
| JPN 30Y | 55.5 | 55.8 | 0.3 |
| EURO$ Z9/Z0 | -26.0 | -27.5 | -1.5 |
| EURO$ Z0/Z1 | -0.5 | 1.0 | 1.5 |
| EUR | 112.34 | 111.49 | -0.85 |
| CRUDE (1st cont) | 64.07 | 63.30 | -0.77 |
| SPX | 2905.03 | 2939.88 | 34.85 |
| VIX | 12.09 | 12.73 | 0.64 |
https://www.newyorkfed.org/newsevents/speeches/2018/wil180928
