Aug 6. Quien es mas macho? Chuck Norris o Steven Seagal?

Aug 5. Weekly rate comment – “Good luck bro!”

(Reuters, July 6).  Tracking the journey of the vessel, Peak Pegasus, as it motored toward the northern Chinese port of Dalian was the 34th-highest trending topic on [China’s] Twitter-like Weibo on Friday, beating out the World Cup, showbiz gossip and Beijing’s escalating trade war with Washington.

https://www.reuters.com/article/us-usa-trade-china-soybeans/go-ship-go-china-roots-for-last-u-s-soybean-cargo-to-land-before-tariffs-kick-in-idUSKBN1JW1IZ

The snippet above was one of several stories about Peak Pegasus, a US cargo ship with a hold of soybeans that was racing to the Chinese port of Dalian in an effort to beat implementation of tariffs on July 6; the ship had left Seattle on June 8.  Weibo users were rooting for the ship to make it: “Good luck bro!” “Go, ship go!”  It reminds me of the movie The Gauntlet, where Clint Eastwood plays a washed-up cop tasked with delivering a prostitute across the desert from Las Vegas to Phoenix so that she can testify in a mob trial.  Of course there are many attempts to kill them on the way, and a side-show of wagers on whether they can actually make it alive.  Peak Pegasus fell just a few hours short, incurring a 25% surcharge.  Clint, of course, delivers.  Hey, you make YOUR comparisons, I’ll make mine.

The overarching plot of US vs China trade wars is taking center stage, outlined by Larry Kudlow last week on CNBC.  “…it looks to me like the China economy is declining in growth. It’s weakening almost across the board. And it looks like the People’s Bank of China is trying to pump it up by adding high-powered money and new credit.  …Some of the currency fall, though, I think is just money leaving China because it’s a lousy investment. And if that continues that will really damage the Chinese economy. If money leaves China – and the currency could be a leading indicator – they’re going to be in a heap of trouble. And so I’m going to make the case that they are in a weak economic position – that’s not a good place for them to be vis-à-vis the trade negotiations – first point. Second point, they better not underestimate President Trump’s determination to follow through on our asks…”

Perhaps one finer point of the above quote is this:  If the US continues to ratchet up pressure, and if that DOES accelerate the Chinese economy to “heap of trouble” status, will the US not also suffer negative consequences?  Danielle DiMartino Booth in her newsletter the Daily Feather, highlights some interesting notes with respect to trade effects on California.  “CA has the highest exposure to China and the largest trade gap with China of any US state.  In 2017 CA accounted for nearly 40% of the merchandise trade deficit with China or $143b of the total $375b.   …CA’s $159b in 2017 Chinese imports was almost 4 times as large as the next closest state, Texas, which imported $43b in good from China last year.”

She adds: “The ports of Los Angeles and Long Beach comprise the largest port complex in the US….Together they handle a fourth of all container cargo traffic in the US.”

When looking at the Port websites (links at bottom), it appears as if cargo volumes have surged, likely to beat trade measures, with a lot of Peak Pegasus runs.  The Port of Long Beach had a record June 2018, with loaded inbound containers totaling 384095.  “Container cargo volumes reached record heights at the Port of Long Beach last month, surging past the previous mark and distinguishing June 2018 as the Port’s best month ever.”  The Port of LA had a small yoy dip in June, however, “It is the second fiscal year the Port has surpassed the 9.1 million TEU mark, with 24 months of record breaking cargo movement.”

We’ve already seen the wholesale price of lemons double due to California wildfires.   How much more can the state handle if Chinese trade abruptly declines?  The US continues to talk up the fight against a powerful adversary.  A little like Muhammad Ali.  But sometimes, there’s an unexpected response:  “His mouth made him [feel] like he was gonna win. Not his hands, I had my hand. He had his lips.”  –Joe Frazier, who beat Ali March 8, 1971.

https://www.irishexaminer.com/sport/other-sports/muhammad-alis-five-losses-403427.html

If the yuan reflects weakness in the Chinese economy, then the Chinese can sell reserves to stem that decline, and that means US treasuries.  However, the treasury market just doesn’t seem to be that sensitive to supply and demand sometimes.  From the Credit Bubble Bulletin. “An analyst on BBG tv made the important point that global QE is today in the neighborhood of $25 billion monthly, down from $125b one year ago.”  This week’s treasury auctions of $34b three-year notes, $26b tens and $18b of thirty year bonds will raise $39.78 billion in new cash.  It seems as if yields should conceivably be higher than they are.  However, the ten year note pulled back from the 3% brink last week, closing at 2.95% as non-farm payrolls came in on the soft side at 170k.  On the other hand, 30-yr JGB’s tacked on another few bps to 84.2, up from 68.5 two weeks ago.  Perhaps also worth a mention is that the spread between Italy and Germany tens increased on the week, closing at a five-week high of 252 bps, nearing the 290 bps set at the end of May.

There are a lot of geopolitical stresses and uncertainties across the globe.  Trump keeps pushing.  Domestically, it necessarily puts the Fed in a response mode.  That is, hold to a steady course until the data actually begins to change.  Although Mick Mulvaney, head of the OMB, insists that the US economy is not in a “sugar high”,  the market is projecting a slowdown into the end of next year and 2020, with the Eurodollar curve completely flat between September 2019 and September 2021 (all prices in that 2-yr period between 97.005 and 9695.0).  The only thing that’s absolutely 100% certain is that the terminal rate can never get back above 4%.  That is, if the guy that keeps adding long dated Eurodollar put ratios is correct.  Last week these traded: EDZ0 and EDM1 9625/9575 p 1×3’s at a 0.0 and a credit of 1.0, selling the 9575 (4.25%) puts.

One last point regarding sugar highs.  US equities surged into February on the President’s tax plan.  There was tremendous coverage last week regarding Apple’s trillion dollar market cap.  However, leadership is narrow, and much hope rides on the idea of continued buybacks.  Fourteen of the 30 Dow Jones Industrial components are lower ytd.  Not every horse has wings.  https://money.cnn.com/data/markets/dow/?page=2

Treasury auctions this week.  PPI and CPI released Thursday and Friday.

http://www.polb.com/economics/stats/teus_ytd.asp

http://www.polb.com/news/displaynews.asp?NewsID=1742&TargetID=1

August 3. Fear of downside (in bonds) is limited in front of payrolls

August 2. TTT trade fears spilling over

Slowdown Signals????????

The Daily Shot apparently had a note on U of M Consumer Expectations vs Current Conditions.  As can be seen on the top chart, everyone’s happy with ‘Current Conditions’ but there’s not as much enthusiasm for future expectations.  On the lower chart, the white line is the SPREAD between the UofM current conditions vs expectations; it becomes more negative as future expectations lag.  Sort of a grasshopper and ant fable…having fun now but borrowing from the future.  I have overlaid the 2/10 yield curve spread (in amber) on the confidence spread.  Perhaps unsurprisingly, these two roughly move together directionally.  Makes sense, the flatter curve typically results from the Fed hiking rates which slows the economy.  Recently there has been spirited debate about whether or not a flattening curve signals slower growth and a possible recession, with some, including Bernanke, indicating that the curve now has less predictive power.  However, the “social science” spread of current conditions to expectations is also near its low.  Corroborating evidence???

August 1. FOMC meeting. Accommodative for now.

–The main influence Tuesday was the Bank of Japan non-event.  Treasury vol had been bid going into the meeting, but deflated afterwards. An example of how it fizzled can be seen in USU8 145 calls.  On Monday, these calls settled 16, versus 142-20.  On Tuesday, the underlying contract settled +11/32’s at 142-31.  And the 20 delta 145 calls?  Unchanged at 16.  Expire 3 weeks from Friday.   However, Japan’s yields have rebounded this morning with the ten year at 12 bps and 30 year at  80 bps; it appears the BOJ is being tested, with possible spillover implications for US bonds (and vol).

–The wage component of Q2 ECI (for private industry) was up 2.9% yoy.  The Atlanta Fed wage tracker for June is 3.2%.  While Core PCE prices yoy were a shade under the Fed’s target of 2%, (actual was 1.9%), the last piece of the Fed’s inflationary puzzle was wage growth, and it appears to be strengthening.  FOMC meeting this afternoon isn’t expected to result in a rate change, but there’s talk of language modification… “the stance of monetary policy remains accommodative”… FOR NOW.

–Stocks rallied after AAPL’s results, but gains have reversed as the US threatens increased tariffs on China.  TSLA reports today after the close.

–Vol eased in eurodollars as well with straddles down 0.5 to 1.0.  Notable selling in EDV 9737 straddle at 11.0 and in 0EZ 9700 straddle at 29.5.  Late buy of 5k EDM20 9600 put for 3.0 ref 9694.0.  Hey! that was my idea…  In any case that’s one of the strikes that had been heavily shorted due to put ratio trades, with open interest of 132k.  EDM0 9625/9600p 1×3 settled 2.5, 6.5 and 3.0.  We paid 1 for 3 legs a few sessions ago.  Worth considering some long bond puts given depressed vol levels.  For example USU 140p settled 11.  If the long end of Japan can’t be contained, all bond markets will be vulnerable in the short term.

–Interesting tweet from Holger Zschaepitz, “ECB balance sheet has hit another all time high…. ECB balance sheet now equates to 41.3% of EZ GDP, while the Fed’s shrank to < 31% of US GDP.

Eurostoxx vol

A friend mentioned the Daily Shot had a chart showing that SX5E (Eurostoxx 50) implied vol is on the low.
Below are 2 charts of the same thing, 1 year above and 5 year below….  SX5E vol (white)  and US VIX (amber).

Some divergence here…the main takeaway is that eurostoxx vol is low.

July 31. BoJ fears fizzle

–Yields in the US edged higher yesterday (led by weakness in European Govt bonds) and the curve steepened in front of the BOJ meeting.  That move has reversed as the BOJ kept ultra-easy policy, vowing to keep rates low for an extended period and hold the ten year around 0.  Ten year JGB fell 4 bps to 5bp and the 30 yr fell 8 bps to 74.

July 30. Sugar high?

July 29. ACRONYMS. BOJ, PBOC, FAANG

On the trading floors, exchange members wore large badges, with 2 to 4 letter acronyms.  In some cases they were simple initials, or they might be like vanity license plates.   For example, my friend Art Nolan just told the membership department to use their imagination and give him an acronym with some style, so they came up with (duh) STYL.  Of course, human nature, or perhaps just trading floor nature, is to come up with alternative monikers for badge initials.  Let’s just say that having an ‘F’ in one’s acronym invited a specific word.  So PMF, who was using his initials, was known by a different name.  BWR sparked a spontaneously funny (but not exactly flattering) nickname as well.  It’s not really politically correct to go into specifics, but I did have a favorite acronym story.  There was a tall sandy-blond woman that was a market maker in Eurodollar options, named Mary Ohno.  She was pretty, in a wholesome girl-next-door way, the type that would have gladly played in a pick-up game of softball with her brothers.   Her badge was OHNO.  There was a long aisle leading from the back month area of the Eurodollar pit, near the main floor entrance, to the option pit.  On one side were the tiered booths of various brokerage firms, and on the other were cat-calling pit clerks facing out toward the desks   I have no idea when this started, but one day Mary was walking down the aisle and a bunch of clerks in unison shouted, “Oh, No…” and after a second or two they all came back with “Ohhhhhh, YES!”  She just gave a half smile and looked straight ahead as she walked to the pit.

I’ve titled this note with a few acronyms that refer to central banks and stocks.  The Bank of Japan, or BOJ, is perhaps going to elicit the ‘OH, NO’ fear of reduced accommodation and liquidity, with the complimentary pit rejoinder conspicuously absent.  The other themes are China and the PBOC, and FAANGs, stock market darlings that are looking long in the tooth.

One of the standout moves in rates this past week was the 30 year Japanese Government Bond, which rose nearly 13 bps from 68.5 to 81.3 bps.  From BBG (July 26) “The BOJ’s steps to buy fewer bonds has seen the annual increase in its debt holdings slow to 44.1 trillion yen ($397 billion) versus its guidance of 80 trillion yen. Last quarter the reductions were entirely focused on so-called super-long bonds, which are the most attractive to insurers. What happens next in the world’s second-largest bond market has the potential to cascade globally given Japanese investors hold $2.4 trillion of overseas debt.”

At this week’s policy meeting, the BOJ is expected to “tweak” its policy, perhaps raising the yield target on the ten-year by 20 bps, and changing its yield curve control policy regarding super long bonds.  According to the Bbg article, many Japanese insurers would consider switching their purchases from foreign bonds to  longer dated JGBs as the yield hits 1%.  Doug Noland of Credit Bubble Bulletin added, “the BOJ may also adjust its ETF purchase program, viewed as distorting the Japanese equities market.”

Some of the spillover was seen in US rates, as the ten year yield rose 7 bps to 2.96%.  However the 30 yr only rose 5.7 bps to 308.7 and the 5/30 spread declined a couple of bps on the week to 24.1.  Implied vols firmed slightly at the end of the week, but I still marked TYZ8 at just 3.8 and USZ8 at 7.3.  Is it possible that a change by the BOJ could spark a “taper tantrum” type move of mid-2013 when US 10y yields surged over 120 bps?  I’ll tell you who better hope not, and that’s the relentless seller of long dated puts in Eurodollar options.  I’ve written a few notes about this seller over the past 2 weeks (if you want further details email me at amanzara@rjobrien.com) so for now I will just note a few representative sales.   EDU20 9637/9600p 1×3 sold lower strike at 0.5 credit, EDZ20 9637/9587p 2×7, sold the lower strike flat.  EDZ20 9600/9550p 1×4 sold lower strike flat.  EDH21 9625/9575 p 2×7 sold lower strike at 1 credit.  From Friday’s open interest sheets it’s pretty easy to identify top shorts: EDM20 9600p 130k, EDU0 9600p 339k, EDZ21 9587p 249k, 9550p 168k, EDH21 9587p 169k, 9575p 38k.  Various reports note that this player is short “millions” of puts, which I believe is a stretch.  A Bbg article by Edward Bolingbroke notes that the positions reflect the view that terminal rates are capped.  What is indisputable is that long-dated puts have been sold at very cheap levels in size.  Could a “tweak” turn into a global “tantrum”?  Not too likely, but insurance is cheap.  BOJ meeting Monday/Tuesday.

By the way, US supply remains an issue.  Even the White House Office of Management and Budget is ratcheting up deficit estimates to levels more in line with other forecasters.  From Friday: OMB estimated that new legislation enacted since the release of its February budget — alongside new projections on other spending and receipts — would add $101 billion more to the 2019 deficit, pushing it above $1 trillion. “That figure would amount to 5.1% of the US’s gross domestic product…”

http://thehill.com/homenews/administration/397445-white-house-budget-projects-1-trillion-deficit-in-2019

The next topic concerns China.  While there were signs of a thaw in EU/US trade frictions last week, the situation in China continues to deteriorate.  The Chinese yuan prints new lows vs USD almost every day, having moved from 6.3 in late March to 6.81 on Friday.  Whether due to massive amounts of China debt and malinvestment, or concerns about trade wars, evidence is mounting that serious problems are growing.  The government has taken several steps to loosen policy and make it easier for small firms to borrow.  So we potentially have the BOJ tightening and the PBOC easing.  Both can be considered as a negative on the US long end (China selling US reserves).  Of course, China’s devaluation could also be considered to be deflationary, but an inflation ‘premium’ in the US long end is pretty much non-existent anyway.  I add here a chart and idea from The MacroTourist, gold priced in yuan.    http://www.themacrotourist.com/posts/2018/07/25/gold/

In August 2015, China devalued.  It’s clear on the chart above, as gold in yuan made its high at the end of 2015.  Over the past year there seems to be a pretty solid peg between CNY and gold.  There are some who say that protectionist measures will inevitably be inflationary.  The price of gold and other commodities argue differently.  In any case, recent easing by China has helped to steady the plunge in the Shanghai Composite.  Does the gold peg help bring a measure of stability?  Or does the debate hearken back to William Jennings Bryan, “You shall not crucify mankind upon a cross of gold.”  My bias is that trade tensions with China will continue to worsen.  Probably negative for commodities; perhaps positive for bitcoin.

The last topic is FAANG stocks.  There have now been a couple of high profile, high tech, thrashings, notably FB and TWTR this week.  In some ways, these stocks have acted as safe havens, must-own assets, with many like AAPL sporting huge cash reserves.  After the FB disaster, I saw an analyst on CNBC making the case to buy the stock (or to average in, as he had already been touting it).  He said that FB knows more about every individual than any other organization, and can therefore be extremely specific in targeting sales pitches.

Recall in the late 1990’s, the valuation of tech companies was all about ‘clicks’ and ‘eyeball views’.  Now, the goal for tech companies like FB and other social media firms is to capture more of your time.  The mega companies either drive mega-trends (AAPL, NFLX), or drill down with intimate knowledge for sales targeting (FB, GOOGL).  But Facebook’s Zuckerberg, on the quarterly conference call, alluded to the wall that these companies must now hurdle:  “Looking ahead, we will continue to invest heavily in security and privacy because we have a responsibility to keep people safe.  But as I’ve said on past calls, we’re investing so much in security that it will significantly impact our profitability.  We’re starting to see that this quarter.”  Translation: the value of our company is based on intimate knowledge of our users.  There is a privacy backlash that is risking our core asset.  We are spending what we must to make sure that this asset doesn’t seriously depreciate, and to change the perception of the public regarding our use of this core asset.  Boom.  It’s not just FB that has data–mining as the core value.

Will the sell-off of last week turn into something more meaningful?  I add a couple of charts below.  The leadership has been big-cap big tech defined by FAANGs.  The chart at the top is Nasdaq, which sort of looks like a normal pullback in the context of a bull market.  The chart below is the NYFANG index.  While Nasdaq surpassed the mid-June high, NYFANG did not.  While Nasdaq remains well above the late June low, NYFANG closed below that level.  This is a pretty significant divergence given huge capital weightings of FAANG.  Will it resolve in a broader based rally, or a leadership inspired retreat?

NY FANG Components: FB, AAPL, AMZN, NFLX, GOOGL, BABA, BIDU, NVDA. TSLA, TWTR

NASDAQ

NYFANG INDEX

On the domestic front, US news this week includes Personal Income and Spending on Tuesday, with the Core PCE Price Index expected 2.0%, right at the Fed’s target, also ECI.  ISM Mfg Wednesday along with ADP, followed by the August FOMC.  Factory Orders on Thursday.  Payrolls Friday.

MARKET THOUGHTS AND POSITIONING

There’s been consistent buying of EDU8 calls and spreads, with the contract settling at 9757 on Friday.  The one-year EDU8/EDU9 calendar spread closed at a new high of 59, up 8.5 bps on the week and just a few bps shy of the peak for the constant maturity one-year which was 63.75 set in May.   There was buying last week of EDZ8 9750/9762 c 1×2 for 0.25, a roll-up trade if the Fed feels compelled to halt the tightening cycle after Sept’s FOMC.

Long dated puts are very cheap as noted above.  EDZ0 9587p settled 4.5 with 11 delta.

There was a buyer last week of TYU 120/121c spread for 11, 30k.  There is a LARGE long position in the 120 call strike, with open interest 323k.  Position primarily related to long 120/122 call spread.  Settlements and call OI as follow: TYU8 119-14s, 120c 14s, 30 delta, OI 323k.  121c 3s, 8d, OI 199k.  122c 1s, 2d, OI 259k.

Way back in mid-April, USU bond option trading was kick-started by a seller of USU 143 puts at premium of 1’37 to 1’21 in size of 36 to 40k.  There was never much evidence that the position was pared back; it’s still the peak open interest put with 47k; settled 1’04 with USU 142-30s.  Talk about pegging a strike.  There are 4 weeks left in Sept treasury options.

http://creditbubblebulletin.blogspot.com/

https://www.bloomberg.com/news/articles/2018-07-26/boj-policy-tweak-that-matters-for-global-bonds-already-underway

https://www.zerohedge.com/news/2018-07-27/what-weve-seen-unprecedented-mysterious-new-whale-emerges-market

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

  The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.