Jan 11. Maybe gold’s trying to tell us something…
–Once again Powell used the words ‘patient’ and ‘flexible’ to describe the Fed’s policy stance. The market is accepting that characterization with a current bias towards ease over the next couple of years. Jan’20 Fed Funds settled 9758.5 (or 2.415% vs current FedEff 2.40%), but all other contracts in 2020 are above 9760, culminating in the Dec’20 contract at 9772.0. Having wrapped up auctions with yesterday’s 30 year, treasuries are edging higher this morning with a current price 121-29. In the latter part of yesterday’s session there was some notable buying of TY week-2 and week-3 122 calls. The week-2 expire today and week-3 of course, are next Friday. Settles were 3 and 12 vs 121-23; at least 10k each bought.
–It’s also January midcurve expiration. EDH21 is now printing 9750, with the straddle having settled 4 vs 9748. Not enough open interest there to be concerned about; news today includes CPI, expected -0.1 headline and +0.2 Core, with yoy core 2.2.
–The hucksters that hawk gold and silver as a safe haven to threats to the financial system are having a day in the sun. Since mid-Nov silver has gone from nearly 14 to 16, and gold from 1200 to almost 1300. Think of the 1300 area as a wall, which may be vaulted as soon as Trump declares emergency funding for the wall on the southern border.
–Reuters reports that China is lowering this year’s growth forecast to 6.0-6.5%. Overt recognition of slowing conditions.
Jan 10, 2019. Powell up again
Analysts noted a disconnect between fairly dovish Fed minutes, released yesterday, and the FOMC press conference. What’s clear from Fed officials’ comments over the last couple of days is that the word ‘patient’ is repeatedly used, a signal for a pause. Powell speaks today at 12:00 EST. Yesterday’s session was quiet, with the curve edging steeper. The 2y note fell 2.2 bps to 2.561, while tens rose 1.3 to 272.8 and bonds rose back above 3%, gaining 3.1 bps to 3.025. Every Fed Fund contract out to April ’20 settled within 5 bps on either side of the current Fed Effective of 2.40%, so for this minute the market is comfortable with an idle Fed for the next year-plus. The decline in implied vol confirms the view of a hand-cuffed Fed and plodding economy. It seems from Powell’s comments last week that he’s content to continue to let the balance-sheet normalization run unimpeded; any change to that outlook would likely boost stocks.
–Lack of progress on a deal to end the gov’t shutdown contributed to late weakness in equities, as did a blurb that China and the US were ‘far apart’ on the issue of subsidies to state run companies. This morning there has been modest downside follow-through.
–January midcurve options expire tomorrow. Large buyer yesterday of EDH9 9737.5/9750cs vs 9728.5, 1 paid for 60k, covering the short call spread of the 9725/9737/9750 ratio fly.
Jan 9. We … sit around a lot
–Markets continue to rebound from the year-end plunge as the Fed softened and a deal with China draws closer. Oil back above $50/bbl. While one-year euro$ spreads remain inverted, calendar spreads over the first year of the Fed funds curve are flat to positive. Against a Fed Effective of 2.40% which is exactly where the Jan’19 contract sits at 9760, April FF settled 9758.5 (leaning ever so slightly towards a March hike) and Jan’20 FF settled 9757.5. Today the Fed releases minutes from the last meeting.
–In the two months starting November, EDH21 had a range (rally) of 100 bps. With a little over two months to go, March midcurve atm straddles are under 25 bps, except for Green March (EDH21) with settled 26.0. The market is settling back into a comfortable armchair sentiment where the biggest movement is a reach for the channel changer.
–In the early part of the session trade flows were mixed, though there was a notable buyer of EDU21 99.00/100.00 c spread for 9 to 9.5 (looking for a return to zero rates over next couple of years; settled 8.0). Late in the day there were some large risk reversals in blues: 40k 3EM 9712/9775 vs 9742.5 the call was sold for 1 credit. Same strikes in 3EU vs 41/41.5 20k sold at 1.0 (sold call). Calls have been better bid, especially in the panic rally; these trades are a new fade of that move. And if, for some reason, inflation expectations leap up, a bid for puts could easily develop in that part of the curve.
–As Softbank cut a planned $16 billion investment in WeWork to just $2 billion (as some of Softbank’s sponsors didn’t like the idea of throwing money at a cash-burner), the company changed its name to The We Company. Apparently the connotation of “Work” was harsh and off-putting. In the world of social media and public appearances, the loss of sponsorship quickly leads to a loss in ‘work’ and money. Perhaps negative implications for valuations in general (and that includes corporate real estate).
Jan 8, 2019. The thrill is gone
–Rate futures continued to deflate as stocks added to Friday’s gains. Bostic said he favors raising rates only once in 2019. FFF0 (January 2020 Fed Funds) settled 9764.5, a rate just 4.5 bps below the current Fed Effective of 2.40%, so the market has, in the last month, shifted from a strong stance of probable rate hikes, to a panicked fear of rate cuts, and is now more or less on the fence. The ten year rose 2.5 bps yesterday to 2.682%.
–A couple of innocuous clips from the news: first, unsurprisingly, Ocasio-Cortez wants to raise the highest marginal tax rate to 70%. Second, a headline from the FT says Softbank is cutting a planned investment in WeWork to $2 billion from $16 billion. WeWork is one of the largest lessors of commercial real estate in the nation. My initial thought is: higher taxes as the commercial real estate market deteriorates. That’s just great. Sort of the opposite of the Trump tax and repatriation surge that kicked off 2018. This idea isn’t quantified, just sort of a qualitative snap conclusion… but let me try to tie it into euro$ futures. In the last three quarters of 2017, total open interest in euro$ contracts averaged around 13.5 million. In Q1 2018 it surged to nearly 18 million, as expected growth prospects spurred a need to hedge. As of yesterday total euro$ OI has fallen all the way back to 12.8m. One might conclude that there is no longer much demand to hedge forward rate risks. I wonder how that might impact CME shares (I will do a bit more work on this; as a point of disclosure I am long a few puts).
–In any case, much of the surge in OI at the start of 2018 was specific to the EDZ’19 contract, which on its own hit a record 2.2 million in April. As of yesterday it has lost over 450k, with OI of 1.76 million. However, there are still large option trades going thru, which mostly appear to be rolling up long put structures. For example, a buyer of 50k EDZ9 9712.5/9700/9687.5 p fly for just under 1.5 (with a delta hedge) settled 1.25. Also a buyer of 45k EDZ9 9737.5/9712.5/9662.5p fly for 3.0. I suppose one could say that the latter looks for one hike and the former for one with a widening of lib/ois.–One other thought about the market being on the fence: euro$ option vol continues to seep out. Straddles down 1.5 to 2 bps yesterday. As BB King might say: ‘The thrill is gone. The thrill is gone away.” Play it Lucille.
Powell and NFP save the day
–Yields rebounded strongly from Thursday’s plunge as the Employment report showed continued strength and Powell re-assured the markets that the Fed would act flexibly. Stocks surged. NFP was +312k with yoy hourly earnings +3.2%. The ten year rose 10.4 bps to end at 265.7. Red through gold euro$’s were down 13-15 bps, though prices are still a shade higher than Wednesday’s close. Implied vol was hit on the pullback as longs pared back positions in both futures and premium. Open interest in virtually all interest rate contracts was down significantly, except for bonds and ultras which saw modest increases. Two-year fell 135k, five-yr -52k and tens -17k.
–Near euro$ calendars rebounded as well. EDH9/EDH0 closed -19.5 (+7.5 on day) and EDM9/M0 -23.5 (+4.5). Both were -27 or lower on Thursday.
–This week brings auctions of 3, 10, 30 years, with Fed minutes on Wednesday afternoon. There are a bunch of Fed speakers, starting with Bostic today, and including Powell and Clarida on Thursday. The Fed’s balance sheet is becoming a much larger topic of discussion. While the Fed prefers to let the run-off occur in the background, the financial press has belatedly brought issue into the foreground, as the move to shed $50 billion per month beginning in October exactly coincided with the slide in stocks. There’s a fair amount of economic jargon regarding the effects of balance sheet reduction but I would say this: QE and QT work primarily on stocks, not bonds. Stocks like liquidity. The removal of liquidity is a headwind to equities which tends to support bond prices.
–Probably worth noting that the US Navy has sent a ship into the Black Sea to heighten tensions with Russia, while at the same time sailing warships in the disputed waters of the South Sea. (How many of these boats do we have?) The issue of border patrol apparently goes way beyond the wall. Gold has no boundaries and is once again staging an assault on 1300.
Jan 6, 2019. FLEXIBILITY
To start this note I am listing a few bullet points of important events, in reverse chronological order. It was a pretty extraordinary week.
BIG EVENTS in the week 12/31/2018 to 1/4/2019
- Powell soothes markets at Friday’s AEA Conference; Fed will act flexibly
- Blockbuster US employment report. NFP 312k. Wages increase 3.2% yoy.
- China cuts RRR by 100 bps and signals additional support for the economy
- Weak US ISM Manufacturing report at 54.1 (expected 57.9)
- Yen surges in ‘flash crash’
- AAPL warns about forward weakness, mainly due to China
- Weak Mfg PMI for China at 49.4, followed by Caixin Mfg PMI of 49.7
There’s a link below to the Credit Bubble Bulletin which does a superb job of summarizing these events.
At the American Economic Association Conference on Friday, Powell described policy-making in times of uncertainty as a function of ‘risk management’ specifically citing 2016. If you recall, the end of 2015 going into 2016, featured a continuing slide in the price of crude oil and an explosion of credit spreads, though mostly in energy names. Powell said that the Fed had initially forecast four rate hikes in 2016 (which can be seen on the table below). In December 2015 the Fed had initiated its first hike to 0.25/0.50, or to 0.4 on the table, and at that meeting the FF projection for the end of 2016 was 1.4%. (Shaded red on the table, a forecast of 4 hikes over the year). Powell said that as financial conditions tightened, the Fed ‘flexibly’ adjusted the expected rate path, but eventually ended the year with one hike in December. Then he said, “No one knows whether this year will be like 2016, but what I do know is that we will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy…” He also said the Fed will listen carefully to markets and incoming data. In other words, even though we have two hikes penciled in for 2019, we might stay on hold. He said the market is “pricing in risks” to which the Fed is highly attuned.
On the other hand, he was somewhat dismissive of possible negative effects from balance sheet reduction. “We don’t believe that our issuance is an important part of the story of the market turbulence that began in the fourth quarter of last year. But, I’ll say it again, if we reached a different conclusion, we wouldn’t hesitate to make a change.” On Saturday, Bernanke also said he didn’t think the balance sheet was responsible for market turbulence. It’s oddly coincidental that the increase in balance sheet run-off to $50 billion per month at the start of Q4 almost exactly marked the peak of stock index prices. But the Fed has certainly bought time until the January FOMC to determine if changes need to be made. My guess is that they WILL tweak the balance sheet schedule at the January meeting unless there is concrete progress made in China trade negotiations. Trump continues to insist that the US is negotiating from a position of economic strength, while XI has ordered his military to improve combat readiness and prepare for the possibility of war, warning of “unprecedented risks and challenges.”
TABLE BELOW SHOWS CHANGES OVER TIME IN THE FOMC’S FF PROJECTIONS (source Federal Reserve)
Powell has simply acknowledged what the interest rate markets have already proclaimed. No hikes in 2019. On Thursday, euro$ and Fed Fund calendar spreads plunged to new lows, indicating increased odds for an EASE in 2019. In euro$’s, March’19 to March’20 settled MINUS 27 and June’19/’20 settled minus 28. In Fed Funds, January’19/’20 settled -18 on Thursday but rallied back to -8 on Friday. The point is, that in spite of a powerful bounce in stocks and a huge payroll report, forward contracts are still signaling lower rates ahead. EDH9/H0 settled -19.5 Friday and EDM9/M0 settled -23.5.
Consider TYH9 contract. On Thursday prior to ISM, the contract was trading around 122-06. By the end of the day it had topped at 123-08. After Friday’s massive payroll report, the settle was 122-095.
The fact that what used to be the most important economic data release of the month couldn’t more than reverse a rally from Manufacturing ISM reflects a continued underlying bid. Perhaps a strong Service ISM number on Monday will build on Friday’s price reversal. I would also note this week’s auction schedule of $78 billion in 3’s ($38b), 10’s ($24b) and 30’s ($16b) which will raise $39 billion in new cash. In any case, I continue to watch the area from 2.49-2.52% as key resistance. Last week I noted that a long term trendline off the 2016 low had been breached, and added: “The 38.2 retrace is 2.52%, which would approximately equate to TYH9 123-08.” The actual low yield was a couple of bps above 2.52%, but the high of the week/move, was exactly 123-08.
There are a lot of Fed speakers this week, primarily on Wednesday and Thursday. Wednesday features Bostic, Evans and Rosengren, while Thursday Powell speaks during the day and Clarida in the evening, with additional appearances by Bullard, Barkin and Evans (again). FOMC minutes are released on Wednesday afternoon. I would expect a generally dovish tilt to officials’ comments, with the word ‘flexibility’ being emphasized. One other quick thought. AAPL has lost $400 billion of market cap since the high in October. It’s just one company, but that loss of wealth represents 2% of GDP in a $20 trillion economy. The reverse ‘wealth effect’ may become a topic of increasing importance.
OTHER MARKET/TRADE THOUGHTS
As mentioned above, near STIR calendars lean towards Fed ease. I will just highlight here the FF contracts which bracket the next three quarterly FOMC meetings: Feb/April, May/July and Aug/Oct. Spread settlements Friday were -0.5, +1.0 and -1.5. On Thursday they settled -2.0, -2.0 and -2.5. Spreads which barely moved for weeks are now bouncing around easily. Once again I will mention the week over week change in January’19/January’20 FF spread, from -1 to -8. Odds for an ease have increased, and moved forward in time. Every FF contract is higher in price (lower in yield) than the current Fed Effective rate of 2.4% except July 2019 which is 0.5 bp higher at 97.595. On Thursday both the 2 and 5 year note traded at a yield below the Fed effective. On Friday the March SOFR contract settled 97.58 or 2.42%, with 2’s and 5’s just barely above 2.48%. Carry has vanished.
On Friday, it’s notable that open interest declined in nearly all treasury contracts. The closer contracts which represent ‘disaster insurance’ lost the most: 2y -135.3k, 5y -52.6k, 10y -17k. Ultra 10y -2.2k. The 30y and Ultra showed small increases of +1.7k and +3.3k. The euro$ strip open interest fell by 101k. Longs pared back. What does it mean? Fear of a stock market melt-down is very powerful, and Powell was able to squelch that risk for the time being. But even if the monetary authorities in the US recognize their role in the risk landscape, it doesn’t mean that all the global players do.
| 12/28/2018 | 1/4/2019 | chg | |
| UST 2Y | 253.4 | 248.4 | -5.0 |
| UST 5Y | 257.0 | 248.1 | -8.9 |
| UST 10Y | 273.4 | 265.7 | -7.7 |
| UST 30Y | 304.1 | 297.4 | -6.7 |
| GERM 2Y | -60.9 | -59.5 | 1.4 |
| GERM 10Y | 24.2 | 20.8 | -3.4 |
| JPN 30Y | 70.4 | 65.2 | -5.2 |
| EURO$ H9/H0 | -13.5 | -19.5 | -6.0 |
| EURO$ H0/H1 | -9.0 | -11.0 | -2.0 |
| EUR | 114.43 | 113.98 | -0.45 |
| CRUDE (1st cont) | 45.33 | 47.96 | 2.63 |
| SPX | 2485.74 | 2531.94 | 46.20 |
| VIX | 28.34 | 21.38 | -6.96 |
Jan 4. Plop plop fizz fizz. Searching for relief.
–Astounding rally in fixed income with the red euro$ pack (2nd year) +18.375 bps. 5-yr treasury down 13.6 bps and 10-yr down 11 bps to 2.553% at futures settle. Yields dissipated like the tiny bubbles racing upward from Alka Seltzer dropped in water, but indigestion relief isn’t quite at hand for market volatility, even though there’s a stock bounce this morning. They used to say. “When America sneezes, the world catches a cold” but now, as has been mentioned by others, it’s China. AAPL citing the slowdown in China is, of course, a case in point.
–There are now all sorts of responses to ‘fix’ the problems. Last week Williams said in an interview that the Fed could end balance sheet reduction. Kaplan said yesterday he’s open to adjusting balance sheet run-off if needed. El-Erian was also talking about an end to QT yesterday morning. Today of course (at 10:15 EST) Powell, Yellen and Bernanke are being interviewed on a panel at the American Economic Assn. Expect more hints of an end to balance sheet ‘normalization’, along the lines of, ‘we’re now at the lower band of neutral’, that is, trying to gracefully step back. There are also talks between US and China scheduled next week to address the trade impasse. China is already taking steps to boost liquidity, cutting RRR by 100 bps, in part to cover needs over the lunar new year. The powers that be aren’t in panic mode yet, but are throwing out trial bubbles to sooth markets.
–So what happens if Powell forcefully hints at an end to QT? Ironically, it would probably be more of a relief to stocks and lead to selling in fixed income. Adherence to ‘auto-pilot’ continuation will cause stocks to plummet, though that would put more pressure on Trump to solve the trade issue asap.
–Employment data are also released today, but almost as an afterthought. NFP expected 184k following a strong ADP number yesterday, with a rate of 3.7%. YOY average hourly earnings expected 3.0 from 3.1 last
–All near term interest rate calendars now show odds leaning toward ease, and the market is pushing the timetable aggressively forward. Feb/April FF spread closed MINUS 2 bps, meaning an ease is more likely than a hike at the March FOMC. Jan/Jan FF spread settled -18 and April/April at -24, so the market is feeling comfortable with the idea of one FF rate cut sometime this year. In euro$’s, the EDZ9/EDZ0 spread had been the lowest one-year spread a week ago; this has now pushed forward to June’19/June’20 which settled minus 28, now the lowest on the board and down 8.5 on the day. March’19/March’20 dropped 13 bps to -27!!!! One spread which notched a new high is 5/30 treasury spread, which hit 54, highest since last February.
Jan 3, 2019. AAPL and FX turmoil
–Yesterday I mentioned new lows in EUR/JPY as an indication of ‘risk-off’. Early this morning the cross crashed to 118.96 and is now around around 122.50, having been around 126 last week. The catalyst seems to have been AAPL’s lowered Q1 guidance based on weakness in China. Who could have seen that coming? AAPL immediately dropped 8% after hours. I can’t help but also feel that Taiwan’s rejection of Xi’s call for reunification also factors into global uncertainty. This morning finds US equity futures on their heels with ESH -40 and Nasdaq -172, but both are above lows set early yesterday morning.
–Unrelenting bid in treasuries yesterday even as stocks bounced from the lows (prior to AAPL news). Ten year yield fell 3 bps to 266.3. New lows in near one-year euro$ calendars again, with EDU19/EDU20 the nadir at -21.5 (-1.0 on the day). This has been the low for any one-yr spread in the cycle.
–Despite underlying warning signs, implied vol fell across the curve. As an example, 2EM 9725p/9800c strangle settled 17.75 on Monday ref 9756, versus just 16.0 yesterday with the contract up 0.5 to 56.5. The 50 delta risk reversal settled 0.5 for the put from 0.25 for the put on Monday. 2EM9 9800c settled 7.75, 23d and 9725p 8.25, 26d. By the way, the underlying contract, EDM21, has rallied over 85 bps from the low settle of 9674.5 on 8-Nov. (9760 this morning).
–What’s the more powerful signal? FX turbulence and the treasury bid, suggesting further risk off? Or lower interest rate vol on the eve of the unemployment report? I have to lean toward the former. Note that Friday morning Powell, Yellen and Bernanke speak at an economic conference. Hints of balance sheet changes?
Jan 2, 2019. Weak start
Stocks off to a rocky start. Hang Seng fell nearly 2.8% with Kospi near a new low -1.5%. ESH9 currently down 40 at 2465.25. A double top separated by one day typically provides powerful resistance, and that’s how ESH9 is setting up. Thursday’s high was 2523 followed by an inside day Friday and this morning’s high of 2521. End of year considerations may play a part but this area just above 2520 will likely be hard to pierce.
–Monday featured new lows in near eurodollar calendars. March’19/March’20 fell 2 to -15.5, and Sept’19/Sept’20 which is the lowest one-yr spread also fell 2 to -20.5. The ten year inflation index treasury vs 10-yr note spread also fell to a new low just under 175 bps. Market measures of forward inflation continue to slip. However, new recent high in 5/30 at 52.5 bps.
–EUR/JPY starting 2019 at a new low from 2018, now at 124.76 in a sign of ‘risk-off’. The low in 2017 was 115. Gold up $8 to a new high for the move of 1289, another signal of concern. –Markit Mfg PMI expected 53.9 with prices 58.0. ISM Mfg expected 57.9.
‘Big progress’ Happy New Year!
–Trump’s weekend tweet that good progress toward a trade deal was made on a phone call with Xi is helping stocks continue to rebound, with ESH9 up 20 to 2506. In other news relating to China, Manufacturing PMI showed a contraction to 49.4, the weakest since Feb 2016. FT has a headline ‘China ending the year as the worst performing stock market’. Incentives to make a deal on both sides…
–Despite relative strength in stocks, rate futures are more or less holding gains from Friday. The ten year yield declined 1 bp Friday to 273.4. There were a couple of large new call spread buys Friday: FVG9 114.25/115.25 c spread bought from 20.5 to 22 in 40k; settled 22 vs 114-14 with 40 delta, the equivalent of about 16k futures. Open interest in FVH gained 13.5k. In tens, +50k TYG9 121.5/123.5 cs up to 33; settled 33 vs 121-20 with 42 delta, or around 21k futures. Open interest in TYH was up 13.8k.
–New lows Friday in euro$ calendar spreads. Both March/June and June/Sept (EDH9/M9 and EDM9/U9) closed at minus 2. In year spreads, EDH9/EDH0 closed at -13.5 and EDM9/EDM0 at -17.0. The next one-year spread didn’t close at a new low, but it’s the most negative on the board at -18.5. Euro$ spreads are more pessimistic than FF spreads, where Jan’19/Jan’20 settled -1.0. Curves flattened in Short Sterling and Euribor over last week as well. In sterling March’19/March’20 closed at 18.5 from 22 the previous Friday and in Euribor H9/H0 fell to 7.5 from 10.5. While hikes in the eurozone are expected further out the curve, even deferred spreads compressed. For example, ERH21/ERH22 eased to 32.5 from 33.5 week over week
