Stealth steepening
Feb 28, 2019
–Given what has been a low vol environment, price action was quite bearish in treasuries Wednesday, with a steeper curve. 5/30 closed at a new high of 58 bps, closing on the high of early 2018 which was 61.4. A paper from Credit Suisse a couple of weeks ago suggested a steeper curve would be necessary to clear treasury auctions. Tens closed 2.691%, up 5.4 bps. USM had the lowest settle since Feb 4. On the euro$ curve red/blue and red/gold pack spreads made new monthly highs, with red/gold +2.875 to 15 bps.
–A Merkel suggestion that Brexit could be delayed sent short sterling tumbling, with reds -6.0 and greens -8.5. (By comparison ED green pack was -4.75).
–Powell said the Fed was close to a new plan on the balance sheet; Goldman says an announcement to end to balance sheet reduction will come at the March FOMC. Powell originally seemed concerned that excessive financial speculation was creating potential instability. About a year ago there was talk of “financial stability” as a third Fed mandate. Not hearing much of that anymore… There was a Fed paper out yesterday that suggested wage growth might be understated. Um…so what? That only means that consumer spending has been even weaker than initially thought? Q4 GDP out today gives a clue as to whether the wealth effect or wages are a more important economic signal. Atlanta Fed estimates 1.8% for Q4. The market looks for 2.2 or a bit higher. China mfg PMI was disappointing at 49.2 vs 49.5 expected.
–Trump/Kim ended the summit without a deal. ESH down modestly and fixed income bouncing a bit.
Signs of recession lurk in forward euro$ curve
Feb 27, 2019
Yields fell yesterday with end-of-month buying and the conclusion of a slug of treasury issuance with the the seven-year auction. Tens fell 3.5 bps to 2.637%. Interestingly, the lowest one-year eurodollar calendar spread on the strip notched a new low as Dec’19/Dec’20 settled -20.0. While stocks have roared back from the turmoil of late December and early January, this particular spread is actually re-testing the low settle of Jan 3, which was -22.0. On that date, the nearer spreads were even more inverted, with EDM9/EDM0 settling at -28.0 (this has been the lowest of any one-yr spread). Currently, EDM9/EDM0 is -14.5. How to interpret it? Obviously the panic of early Jan has subsided, but forward recessionary fears are still lurking, and possibly increasing.
–EDZ9 remains the contract with the most open interest on the strip and trades by far the largest volume of any contract.
–With every quarterly option expiration, there is typical large buying of way-out-of-the-money calls and puts in treasuries. Often these buys are done just prior to the end of the expiration. However, March options expired Friday and there were sizable purchases yesterday. First, upside: TYK 128.5c 2 paid for 70k, and 127.5 and 128c also bought for 2 in smaller size. TYK 128c have 60k open and 128.5c 80k open. These strikes are around 3/4% away in terms of yield…around 1.9%. Huge buying as well in FV puts. FVJ 112p 0.5 paid 42k, FVK 112.25p 1 paid 113k and then shifted down a strike and paid 1 for 67k 112p, and also paid 2 for FVM 112p 70k. So about 300k FV otm puts bought; the 112 strike is approx 60 bps out which would be over 3%.
–We can look forward to the Maxine Waters show as Powell goes to the house for questioning. Bonus question from AOC? –CME apparently had major issues and had to close electronic markets last night. All seems to be functioning currently.
–ZeroHedge cites a paper by Lawrence Summers and Jason Furman about the opportunity for more gov’t spending due to low real yields. Not sure what the merits are, however, I would note that the ten-year inflation index note represents a “real” yield, which has been in decline from over 1% in Q4 to just over 70 bps now. Like low vols, low real yields don’t last forever, and don’t provide a cushion for when things change.
Rates stuck as Powell visits the Senate
–Yields had a slight tilt higher yesterday as the treasury auctioned 2’s and 5’s, with 7’s today. The ten year rose 1.8 bps to 2.672. Today Powell is in front of the Senate Committee on Banking, Housing and Urban Affairs for semiannual testimony.
–In rates, a couple of highlight trades: buying of EDM9 9737/9750 c 1×2 for 2.0 (settled there vs 9739.0). Also, a seller of about 25k TYK 121/124 strangles 24 to 25, settled 22 vs 122-11.5. TYM 122.5 straddle settled 1’39, at the lows of the recent vol range.
–Treasury rolls have been active with fives and tens about 2/3rds complete.
–Stocks gave back an initial surge to new highs on China/US tariff delay and are lower this morning. WTI crude is stable, having fallen about 1.80 yesterday as Trump complained about the high price. With the debt ceiling being reinstated by the end of the week, treasury has to draw down balances at the Fed; from what I’ve seen, this might cause flows into banks, driving libor a bit lower.
Feb 25. The bull equity case continues
–Yields fell Friday with tens down 3.2 bps to 2.654%. The bond fell 2.4 bps, remaining above 3% at 3.021. Reds through blues were up 4 to 5 bps.–This morning stocks are pressing new highs as Trump delayed implementation of tariffs on China. Shanghai and Shenzhen Comps both surged over 5%. So we’ve had an end to the government shutdown, an end to US rate hikes, a probable China deal, a likely end to balance sheet reduction (Powell could re-hint in his appearance at the House tomorrow), and a large increase in China Social Finance. The bullish case has unfolded, page by page. On top of that, a narrowing of libor/ois signals a slight ease in credit conditions, and inflation expectations are edging a bit higher from recent declines. Oh, and Clarida says a low neutral rate could last for years (leaving stocks as the only alternative). What can you do for me NOW?
–Today the treasury crams in a bunch of auctions, including, 3 & 6 month bills, and $40 billion 2’s, and $41 billion 5’s.
–On the eurodollar curve, EDZ9/EDZ0 is the most negative one-yr spread at -18.0, closing down 2 on Friday. Reds to geens (2nd to 3rd year) are -6.0 while greens to blues (3rd to 4th) are the same magnitude but opposite sign at +6.5. The news media continues to quote ‘experts’ who time the inevitable recession for 2020 to 2021. The market seems to put it a bit closer, more like late 2019 to 2020. If it even happens. By 2021 we could get a ‘normal’ curve again.
Dear Mr Fantasy
Feb 24, 2019
Dear Mr. Fantasy play us a tune
Something to make us all happy
Do anything, take us out of this gloom
Sing a song, play guitar, make it snappy
You
are the one who can make us all laugh
But doing that you break out in tears
Please don’t be sad if it was a straight mind you had
We wouldn’t have known you all these years
– TRAFFIC 1967
My mom told me to always have some cash on me. The reason is because she knew a guy in Chicago who was jumped, and, because he had no money with him, the thugs were mad enough to beat him to within a hair of death. It’s one of those little insurance policies. “Take some money with you honey. So you don’t get your ass kicked.” Nice.
JK sent me a link from the Fed about the Fed’s balance sheet and liabilities.
Now here’s something I am personally amazed by: “Since the start of the Financial Crisis, notes in circulation have more than doubled and, as of the end of 2018, stood at about $1.67T…about 8% of US GDP, implying that accommodating demand for currency alone requires a larger balance sheet than before the crash.” As a comparison, in the mid-1980s currency was about 5% of GDP. How can it be? The youth of today never have any currency on them, they just wave their phones around. A clue is in another sentence. “…with heavy usage of US currency overseas, changes in global growth as well as in financial and geopolitical stability, can also materially affect the rate of currency growth.” There you go. In other countries, they know having an easy, portable store of value can go a long way in case of instability. As they say, there are more $100 dollar bills circulating in Russia than in the US. The Fed’s discussion of balance sheet goes on to note that banks may have a higher demand for reserves for several reasons, including “an increased focus on liquidity risk management in the context of regulatory changes.” So, the banking system is following the Demetra Rule. Have a little extra on hand. Don’t get your ass kicked. Quarles essentially said the same thing Friday. He “favors sizable reserves as buffer against most shocks.” In this business we call it “Risk Management.”
Now I move loosely into the Mr Fantasy reference. I chose it right after I read the Clarida speech on revising the Fed’s policy framework. But I don’t really mean to single out Clarida. Mr Fantasy refers to Central Banking and Monetary Policy and the Green New Deal and… the list could go on and on.
Clarida first asserts that the neutral rate has fallen both here and abroad:
Perhaps most significantly, neutral interest rates appear to have fallen in the United States and abroad.2 Moreover, this global decline in r* is widely expected to persist for years. The decline in neutral policy rates likely reflects several factors, including aging populations, changes in risk-taking behavior, and a slowdown in technology growth.
Huh? Slowdown in tech growth? Why, I can go into McDonalds, order on a kiosk, and I don’t even have to TALK to anyone. And… I don’t need cash. Now that’s progress. On a more nuanced note, Lael Brainard had this to say as recently as September [‘What Do We Mean By Neutral’, Sept 12, 2018]
This year, the unemployment rate has fallen further, and job market gains have gathered strength, at the same time that the federal funds rate has increased. This combination suggests that the short-run neutral interest rate likely has also increased. If, instead, the neutral rate had remained constant as the federal funds rate increased, we would have expected to see labor market gains slow. That inference is consistent with the formal model estimates, which indicate that the shorter-run neutral rate has gone up as the expansion has advanced.
As I said in my note ‘Brainard the Bear’ 9/16/2018, “the neutral rate is a moving target and it’s going up”. The neutral rate RISES with the EXPANSION and with a higher FF rate. The end of Q3 2018, was a time of peak hawkishness, when even Chicago’s uber-dove Evans said he was comfortable with the inflation outlook and rate hikes.
So, Brainard had neutral moving up, just about perfectly top-ticking the peak of the rate cycle in late Oct/early Nov. Clarida now has neutral moving down. Does neutral go up as the Fed hikes and go down with an institutional flip to dovishness? Perhaps this comment is a little unfair; I think all Fed members would allow that, in the short term, neutral can move around.
Clarida continued Friday’s speech with 3 questions. First, should the Fed overshoot inflation to make up for past shortfalls (inflation averaging). Second, should the Fed’s tool kit be expanded to allow for BOJ style yield capping, for example. Third, can the Fed’s communication be improved.
On point number three, a variant of monetary rules listed below were posted in Friday’s Monetary Report to Congress. How much more communication could you ask for? Equations. They KNOW what they’re doing!
| Taylor rule: | RTt=rLRt+πt+0.5(πt−π∗)+0.5(yt−yPt)RtT=rtLR+πt+0.5(πt−π∗)+0.5(yt−ytP) |
| Balanced-approach rule: | RBAt=rLRt+πt+0.5(πt−π∗)+(yt−yPt)RtBA=rtLR+πt+0.5(πt−π∗)+(yt−ytP) |
| ELB-adjusted rule: | REadjt=maximum{RBAt−Zt,ELB}RtEadj=maximum{RtBA−Zt,ELB} |
| Inertial rule: | RIt=0.85Rt−1+0.15[rLRt+πt+0.5(πt−π∗)+(yt−yPt)]RtI=0.85Rt−1+0.15[rtLR+πt+0.5(πt−π∗)+(yt−ytP)] |
| First-difference rule: | RFDt=Rt−1+0.1(πt−π∗)+0.1(yt−yt−4) |
On points number one and two, Clarida notes that policy stances have to be CREDIBLE to the public. You know, like the EURCHF peg. Or like the equations above. For years, central banks have been hand-wringing about just hitting the 2% inflation target. Now we’re going to fine-tune over- and under- shoots? I, for one, enthusiastically support that (fantasy) policy choice. It almost certainly will lead to busy markets. Optimal policy? No. But busy. As my friend George used to say: Vote like a Democrat. Live like a Republican.
One last excerpt from Clarida’s speech:
As is well known from the research literature, makeup strategies, in general, are not time consistent because when the time comes to push inflation above 2 percent, conditions at that time will not warrant doing so. Because of this time inconsistency, any makeup strategy, to be successful, would have to be understood by the public to represent a credible commitment. That important real-world consideration is often neglected in the academic literature.
“Real-world.” Thanks Rich. Williams also sought to clarify Fed thinking: “We must be equally vigilant that inflation expectations do not get anchored at too low a level. This persistent undershoot of the Fed’s target risks undermining the 2 percent inflation anchor.” You can’t find neutral. Can’t quite hit 2%. Better keep a little cash in your pocket.
Conclusions from above: Balance sheet reduction will end later this year. The Fed won’t hike.
*******************
From a review of markets last week one would say there’s not much really going on. VIX slipping into quicksand again, stocks bid, treasury yields tightly coiling around mid-range with implied vol probing new lows. Dollar index pretty much sideways since last summer. Then you start to skim through the news, and, maybe it’s just me, but there appears to be an absolute flood of upcoming uncertainty. Fed policy. US debt limit. US/China trade issues. (These last two have Friday, March 1 ‘deadlines’). Brexit. Parliamentary elections in May in Europe. China’s monetary policies.
Regarding China, there was a story on Bloomberg that Qinghai Provincial Investment Group (Q-PIG), 2/3rds owned by the provincial gov’t, missed a USD coupon payment Friday. This struggling aluminum producer was seen as “a bellwether for assessing gov’t support” and may send tremors through other LGFVs (Local Gov’t Financing Vehicles). I don’t know how to assess ramifications, if any. It’s well known that defaults have been increasing in China (coming to a theatre near you in the USA), but this one also comes just after a huge surge in Total Social Financing in January. Are the PBOC’s efforts designed to mitigate increasing fall-out? On Friday, February 15, the South China Morning Post ran a story that Premier Li Keqiang warned the PBOC on credit expansion, “This will not only lead to arbitrage and inefficient circulation of capital, it will also bring new potential risks.” From the article: “Li’s unusual comments suggest concern among some policymakers that the recent modest easing in policy by the PBOC has allowed a resurgence in financial activity akin to speculation that does not benefit the real economy and creates unacceptable financial risks in the longer term.” That ALMOST sounds like the original Chairman Powell, before he submitted to the market’s pressure and turned tail. Now he wears running pants.
In any case, given looming uncertainties, I think the easiest call to make is that vols are too low in the US. Buy some cheap insurance. Might not need it, but It may prevent a true ass-kicking. VIX was 35 a couple of months ago and is now 13.5. April US 30-year bond vol is around 6% with the Fed talking about allowing an overshoot of inflation and a tsunami of treasury issuance. We don’t even know what the benchmark rate is going to be a few years from now, but Blue June Eurodollar 9750 straddle on EDM22 is just over ¼% at 27 bps with 109 days until expiration.
Finally
I’ll leave off with a quote from fashion designer Karl Lagerfeld, who passed
last week.
“Whoever wears running pants has lost
control over his life.”
Upcoming events (source Bloomberg)
Monday Clarida speaks in Dallas
Tuesday Powell testifies to Senate, followed by an appearance at the House on Wednesday (I hope Maxine Waters and AOC don’t disappoint us. Dear Mr Fantasy, play us a tune)
Thursday Fed speakers Clarida, Bostic, Harker, Kaplan, Mester
On Monday the Treasury borrows. A lot.
$48 B 3-month bills
$39 B 6-month bills
$40 B 2-year notes
$41 B 5-year notes
And
on Tuesday
$26 B 52-week bills
$32 B 7-year notes
Q4 GDP on Thursday
Friday: Personal Income/Spending and Core PCE. ISM Mfg.
OTHER MARKET/TRADE THOUGHTS
Here’s an update on libor/ois proxies. I use 3 month quarterly ED contracts vs the average of the next two FF contracts. On the week these spreads have compressed by 2.25 to 3.50 bps.
2/22/2019 2/15/2019
EDM9 9739.5 vs avg(FFN9+FFQ9) 9761.5 = 22.00 24.25
EDU9 9740.0 vs avg(FFV9+FFX9) 9762.0 = 22.00 24.50
EDZ9 9738.0 vs avg(FFF0+FFG0) 9765.75 = 27.75 31.00
EDH0 9746.0 vs avg(FFJ0+FFK0) 9770.0 = 24.00 27.50
EDM0 9751.5 vs avg(FFN0+FFQ0) 9776.0 = 24.50 27.25
EDU0 9756.0 vs avg(FFV0+FFX0) 9780.75 = 24.75 28.25
| 2/15/2019 | 2/22/2019 | ||
| UST 2Y | 251.8 | 248.9 | -2.9 |
| UST 5Y | 249.3 | 246.6 | -2.7 |
| UST 10Y | 266.4 | 265.4 | -1.0 |
| UST 30Y | 299.7 | 302.1 | 2.4 |
| GERM 2Y | -55.6 | -56.5 | -0.9 |
| GERM 10Y | 10.2 | 9.6 | -0.6 |
| JPN 30Y | 59.2 | 57.5 | -1.7 |
| EURO$ H9/H0 | -3.5 | -6.8 | -3.3 |
| EURO$ H0/H1 | -12.5 | -13.0 | -0.5 |
| EUR | 112.98 | 113.35 | 0.37 |
| CRUDE (1st cont) | 55.98 | 57.26 | 1.28 |
| SPX | 2775.60 | 2792.67 | 17.07 |
| VIX | 14.91 | 13.51 | -1.40 |
http://creditbubblebulletin.blogspot.com/
https://www.federalreserve.gov/monetarypolicy/2019-02-mpr-part2.htm#xsubsection-1553-1b5b0b6b
https://www.federalreserve.gov/newsevents/speech/clarida20190222a.htm
https://www.cnbc.com/2019/02/22/fed-should-be-vigilant-about-too-low-inflation-williams-says.html
https://www.federalreserve.gov/newsevents/speech/brainard20180912a.htm
Can stocks and bonds go down together? Inconceivable!
–Yields moved higher yesterday in spite of weak economic data and equity prices. The ten year rose 3.6 bps to 2.686% and the 30y bond closed decisively above 3% at 3.045%, up 4.7 bps. Curve slightly steeper; 2/30 rose 2 bps to 51.8. Atlanta Fed’s GDP Now was revised down another tenth to just 1.4% for Q4 2018 on soft durables. A couple of weeks ago (prior to retail sales) this forecast was over 2.6%. Philly Fed also disappointed at -4.1 vs expected +14.0. This morning stocks are buoyed by the prospect of progress on trade as Trump is slated to meet with China’s top negotiator. Bonds are steady.
–There’s a Reuters article this morning about the Fed’s ‘pivot’ and a ‘new economic reality’. Nothing really new there, I would only say that US markets remain dependent on juice from either the Fed or from the Federal Govt (tax stimulus plan of 2018). https://www.reuters.com/article/us-usa-fed-pivot-insight/a-fed-pivot-born-of-volatility-missteps-and-new-economic-reality-idUSKCN1QB0IK
Interestingly, the FT also has a Fed article, ‘Slow-inflation conundrum prompts rethink at the Fed.’ Are these Fed plants, indicating that the old models have less and less value? Or just news outlets belatedly catching up to the idea of an end to the hiking cycle? As an aside, note that the ten-year tip inflation breakeven notched a new recent high of 191 bps yesterday. Maybe inflation is simply stable…
–If there IS a big change, it might be signaled by yesterday’s weakness in both stocks and bonds. Volume was light, so probably not worth reading too much into it, but there appears to be uneasiness creeping in, that increased treasury supply may not be welcomed as eagerly. THAT would be a game changer.
–No news today. March treasury options expire. TYH 122 straddle settled 14/64’s yesterday vs 121-29.
–Attached chart is March’21/March’22 spreads in dollars, bor and sterling. In europe, this area of the curve has been the steepest as the ECB was expected to move toward a hiking cycle. However, since October that spread has nearly halved, from almost 40 to just above 20. In the US, the back end of the curve was flat as the US was, in fact, tightening. The end of December spike in the spread from -4 to +11 reflected a sharp increase in odds of an ease in response to turmoil. Interestingly, the back end of the euro$ curve isn’t falling back to previous levels. Risk/reward favors longs in back euro$ calendars…
Feb 20. Fed Minutes Today
–Yields eased Tuesday with tens -2.1 bps (from Friday) to 2.643. In euro$’s, EDU9 through the golds settled +3.0 to +4.0 with a modest bias toward flattening; red/gold pack spread edged to a new recent low of 9.25 bps.
–Option activity favored upside. For example, EDU9 9725/9712 put spreads were sold on exit at 2.5 over 100k, but there’s still likely 150k left to go. Settled 2.25 vs 9738.0. There were quite a few call structures, but I will just mention a few on EDZ9 since that contract still has the most interest on the futures side. First, the selling of straddles continues, with EDZ9 9737 straddle sold at 26.5, 5k (settled 26.5 vs 9735.0). There was a buyer of 20k EDZ9 9800/9900c spds with +40k 9850 calls for 4.0 covered 9735 and 9734. And then a buyer of another 20k EDZ9 9800c vs EDH0 9800/9850/9900 c fly for 0.75. In any case, EDZ9 9800c settled 2.25 vs 9735.0….the Fed dots last indicated 2 hikes in 2019…the market is leaning in the exact opposite direction as Fed minutes from January are released today. In fact, EDZ9 9700 puts, which are only 35 bps out of the money settled at 2.0, a quarter bp under the 9800 calls which are 65 out as the underlying futures trade just 5 bps away from the current Fed Funds Effective rate.
Reuters article notes the change in the stance of Central Banks:
Atomic number 46
–It would be wise to be long palladium, number 46 on the Periodic Table. See what I did there? Palladium is named after the Greek goddess of wisdom, Pallas. And it’s up over $50 this morning to new high of 1458! In early November, gold (GCJ) was about 1215/oz. PAH (March Palladium) was 1075. Now palladium is 1458 and gold is up $10.40 this morning to 1332.50, which is also a new high. Mostly used for pollution control in catalytic converters, but I don’t know what’s driving this move.
–Rates are about steady and stocks edging a bit lower this morning. Implied vol in rates was crushed at the end of last week. Tomorrow sees the release of the FOMC minutes, and there is an article on Bloomberg indicating that ECB officials are getting increasingly nervous about deceleration in the EU. The ECB releases its summary of January’s meeting on Thursday. “The backdrop is a recession in Italy, stagnation in Germany, and a sharply changed outlook for the 19-nation euro area.”https://www.bloomberg.com/news/articles/2019-02-19/ecb-heavy-hitters-are-laying-groundwork-for-response-to-slowdown?srnd=premium
–Praet said the ECB could change guidance if the outlook worsens; Kuroda said the BOJ could ease if a stronger yen hurts the price goal path; China is pledging more support for its bank perpetual bond swap scheme. They out there panickin’. I can feel it.
Feb 17. Heisenberg Uncertainty
The Heisenberg Uncertainty says that the position and velocity of an object cannot both be measured exactly, at the same time, even in theory. (Werner Heisenberg). The very concepts of exact position and exact velocity together, in fact, have no meaning in nature.(1) “Any attempt to measure precisely the velocity of a subatomic particle, such as an electron, will knock it about in an unpredictable way, so that a simultaneous measurement of its position has no validity.” Nor does position and velocity have meaning at the Federal Reserve.
Of course, Heisenberg was dealing with sub-atomic particles. (Yes, I watched a fascinating physics documentary on Nova, and now I am taking a topic that vastly exceeds my comprehension and trying to apply it to monetary policy and markets, which vastly….well, you know the rest). Anyway, the very act of observing and measuring these particles affects their behavior. Powell at the start of the year, changed course on monetary policy after being put under the microscope by Trump and becoming the subject of intense criticism. Now it’s hard to tell where the Fed is going, let alone how fast.
A couple of weeks ago in my note ‘Blue Sky’, I cited the TBAC (Treasury Borrowing Advisory Committee) minutes. One sentence is key: “The presenting member outlined the potential for a significant financing gap over the next ten years in the context of the potential need for domestic investors to participate more if foreign reserves were to grow at a slower pace.” Clearly, increased US deficits, projected to be $1 trillion this year, in the context of slower global trade that requires less official recycling of dollars into foreign reserves, is perceived as a possible problem.
At the end of last week Zoltan Pozsar of Credit Suisse released a note discussing, in part, this funding gap. According to people that saw the note, he said that as official foreign buyers are less of a demand factor, private foreign buyers will become more important at the margin. The difference? Private buyers hedge out fx risk through cross-currency swaps. The argument is that a couple of years ago, the US curve was the steepest globally (providing carry to both domestic and foreign buyers) and now is the flattest due to the Fed’s hiking regime. This creates a situation where cross ccy bases make it uneconomic to fund longer dated purchases of US treasuries. Indeed, USD three-month libor is around 2.69% and the ten year yield on Friday was 2.664%. This pulls the prospect of a “significant financing gap” quite a bit forward in terms of time.
One of the conclusions that Pozsar draws is that libor-ois will tighten significantly and may even go negative this year!! Xccy bases will go from negative to positive. In order to fill the ‘financing gap’, funding costs will need to drop on the front end, which may require the Fed to cut rates. These potential cuts aren’t to address falling inflation and growth expectations, they will be necessary to clear treasury supply. Of course, much higher yields on the long end relative to current funding costs would accomplish the same thing, but implications for stocks are very different.
Now we draw into the discussion recent activity and economic trends. After a weak Retail Sales report this past week, the Atlanta Fed GDP Now forecast for Q4 2018 was slashed from 2.7 to 1.5%. The NY Fed’s Nowcast fell to 2.23% for Q4 from 2.4%, and the estimate for Q1 2019 was cut in half to 1.08% from a previous stab of 2.17%. Also of note is the University of Michigan’s 5 to 10 year inflation expectations survey which came out last week. From BMO: the data “…declined 0.3% to tie an all-time record low at 2.3%. Although drops of similar magnitude have occurred in the past, this is only the third time we’d seen this size of a change this decade.” As mentioned during the week, the Baltic Dry Freight Index has crumbled by 2/3rds over the past year.
The ten year note to inflation-indexed breakeven is now 1.87%, down 20 bps from early November, and the 5y5y forward inflation swap is 2.19% having spent most of 2018 above 2.4%. These market-based indicators support the idea of a stagnant economy where inflation runs below target. But is that justification for Fed easing?
As discussed in previous notes, some of the trades going through Eurodollar options appear predicated on the idea that one or two eases take place by autumn. For example, there is a consistent buyer of EDU9 9775/9787.5 call spreads for just under 1 bp (ref EDU9 9735). On Friday there was a buyer of 50k EDZ9 9850c for 0.75. Of course, if position and velocity are uncertain due to what almost seems to be the mundane problem of treasury supply, then why is implied volatility being crushed to new lows? There is relentless selling of EDZ9 straddles, on Friday the 9725 line was sold at 26.5 and the 9737.5 line sold at 27.0, with settles of 26.0 and 27.0… with 300 days until expiration. EDZ9 settled down 1.5 bps at 9732.0; the 9725p settled DOWN 0.25 and the 9712.5p settled DOWN 0.5 at 5.0. Market maker ML noted it’s the earliest he’s seen the atm TY straddle below 1’00. With 5 weeks to go, TYJ 122.5^ settled 0’62. Here’s a visual:
So we have a flat curve sucking the air out of premium. Near one-year Eurodollar calendar spreads are all negative (the lowest being EDZ9/EDZ0 at -16.5) suggesting that the next Fed move will be an ease. The FF curve through 2019 is within 1 bp of the current Fed Effective of 2.40% with Jan 2020 at 97.62, a demure tilt toward a looser Fed. The euribor curve is flattening. Global ten year yields have all been declining. From the start of Q3 the US ten year has fallen from around 3.20 to 2.67. China from 3.60 to 3.07 (both just over 50 bps). Bunds from 55 to 10. Japan from 14 bps to -3. The rate environment again points to TINA… there is no alternative besides stocks, a theme further enhanced by the prospect of a US/China trade deal. The very scenario that Powell was supposedly leaning against is now settling over the financial landscape like a wet blanket: Financial speculation without cushion; a flimsy backdrop of growth; earnings that can only be juiced by buybacks which further erode corporate balance sheets. To layer it on even thicker is the emergence of Modern Monetary Theory (or debt monetization) and the left’s Pyrrhic victory of forcing Amazon’s withdrawal from NY.
https://www.themacrotourist.com/posts/2019/01/23/mmt/
https://www.mauldineconomics.com/frontlinethoughts/modern-monetary-madness
I’ll leave it with another profound physics comment, this one from Albert Einstein. “The difference between genius and stupidity is that genius has its limits.”
OTHER NOTES
FOMC minutes on Wednesday. Philly Fed, Durables and Existing Home Sales Thursday.
I don’t know how much I can buy into the idea of lib/ois going to zero or negative, but here’s the nearby forward proxies represented by futures. I use 3 month quarterly ED contracts vs the average of the next two FF contracts. All around 25 bps.
EDM9 9736.0 vs avg(FFN9+FFQ9) 9760.25 = 24.25
EDU9 9735.0 vs avg(FFV9+FFX9) 9759.5 = 24.50
EDZ9 9732.0 vs avg(FFF0+FFG0) 9763.0 = 31.00
EDH0 9739.5 vs avg(FFJ0+FFK0) 9767.0 = 27.50
EDM0 9745.0 vs avg(FFN0+FFQ0) 9772.25 = 27.25
EDU0 9749.0 vs avg(FFV0+FFX0) 9777.25 = 28.25
| 2/08/2019 | 2/15/2019 chg | ||
| UST 2Y | 246.1 | 251.8 | 5.7 |
| UST 5Y | 243.9 | 249.3 | 5.4 |
| UST 10Y | 263.0 | 266.4 | 3.4 |
| UST 30Y | 297.4 | 299.7 | 2.3 |
| GERM 2Y | -57.9 | -55.6 | 2.3 |
| GERM 10Y | 8.7 | 10.2 | 1.5 |
| JPN 30Y | 57.5 | 59.2 | 1.7 |
| EURO$ H9/H0 | -9.5 | -3.5 | 6.0 |
| EURO$ H0/H1 | -13.0 | -12.5 | 0.5 |
| EUR | 113.26 | 112.98 | -0.28 |
| CRUDE (1st cont) | 53.09 | 55.98 | 2.89 |
| SPX | 2707.88 | 2775.60 | 67.72 |
| VIX | 15.72 | 14.91 | -0.81 |
Feb 15. Taking downside risks ‘on board’
–Treasury yields fell Thursday, initially spurred by weak retail sales, which fell 1.2% on headline (broad-based weakness and worst since 2009). Fed Governor Lael Brainard mentioned the miss in retail in the context of increased downside risks, and noted weaker foreign growth and political uncertainty as well. She further said that she favored ending balance sheet run-off in late 2019. The ten year yield fell 5 bps to 265.7. On the euro$ strip reds thru blues were up 5 to 6 bps. Volume was light and implied vol continues to be smothered. About a month ago the green pack 9750 straddle strip traded as high as 372, but settled yesterday at 307.5. Sure, some of that is due to time decay, but not 17%!
–Stocks fell, but then shrugged off the retail sales number. However, by the end of the day domestic political uncertainty again crept in, with reports that Trump would declare an emergency to build the wall. Perhaps at the margin there was also a negative reaction to the decision by Amazon to pull out of plans for HQ2 in NY. The general move on the political spectrum to the left may be sharpening the edges between gov’t and business. After Trump was elected, the NFIB Small business optimism index surged and remained elevated…until recently. Perhaps some of THAT decline is due to dragging uncertainty related to China negotiations. But a harsher environment for big tech and business in general has to figure into the equity valuation equation.
–There is still upside accumulation of EDU9 9775/9787cs, bought for 0.75 yesterday only in 10k, but both strikes have over 215k in open interest. Also a new buyer of 30k EDZ9 9850c for 1.0. When Brainard repeatedly says the Fed is “taking on board” the idea of growing downside risks (in spite of solid domestic employment trends) it’s not that much of a leap to envision rate cuts in 2H.
