Jan 30…quick TY option open interest note

Yesterday the TYH 120.5 were sold in size; ended up settling 9 vs 121-26.  According to prelim open int sheets, 40k added yesterday…new shorts.  This is now largest TYH put open interest at 114k, outside of 122p with 145k.  Not much vs 3.5 million futures but worth a mention…

With TYH 121-23+ and GT10 270.7%, the 120.5 strike is about 16 bps away, or 2.87.  The high ten year yield in 2014 was 3.03%.  In TYH, that should equate to around 119-30…

Jan 30, 2018. Stocks start to notice bonds

–The US day started with rate futures at new lows across the board.  Ten year yield hit 272.5 but came back to close 269.2.  Futures contracts still closed at new lows, however there was quite a bit of put selling on the day, for example, before the floor open, a sale of 24k TYH 120.5 at 15 covered 121-20.  To give an indication of the vol clubbing, those puts settled at 9, unchanged on the day, even as the contract fell 8/32’s to 121-260. Another example:  USH 148 straddle was 2’57 early vs 147-27, but closed 2’39 mid-market vs 148-04.  In euro$’s the premium bid was more stubborn, with green midcurve straddles again higher on the day by 1-1.5 bps.  Futures calendar spreads remained pinned to the highs, with some posting new highs, for example EDM8/EDM9 +0.5 to 44.5.  Large buying of EDU19/EDU20 also sparked a new high in that spread, to 13 bps.

–Treasury released borrowing estimates…expects to borrow $441 billion in Jan-March quarter, the largest in 8 years.  That used to be the entire ANNUAL deficit.  In skimming the news this morning virtually every financial site mentions the bond sell off taking the wind out of stocks…but no one alludes to Dalio’s point that present values discounted by increased rates means lower asset prices…as a friend used to say, “that dog won’t hunt.”

–As mentioned yesterday, the US savings rate decline was on display with yesterday’s data…12 year low at 2.4%.  I have also attached the Atlanta Fed wage tracker chart, which appears to have an ominous decline going into the end of last year. (Hit a peak in late 2016 and has been down ever since). Some stories are suggesting that wage growth is now more important than NFP in Friday’s employment report; not sure if the latest data will capture bonuses and raises announced by various companies in response to the tax bill.  This report is less important than usual.

–State of the Union tonight.

Jan 29, 2018. America first…in a race to higher yields

–Rate futures closed with significant weakness on Friday, and the trend is continuing this morning.  All rate futures at new lows even as stocks indicate a lower open.  Goldman is cited this morning expressing the view that Wednesday’s FOMC may tilt to the hawkish side, with risks being balanced as opposed to “roughly balanced”.  As I mentioned over the weekend, the ten year tip/treasury breakeven was around 1.87% in the week leading up to the December FOMC and it’s now 20 bps higher at 2.07%.  Oil has, of course, rallied from about $57 before the last FOMC to $66 now.

–Near one-year calendars made new highs in eurodollars on Friday, with EDH8/EDH9 closing at 57 bps.  The area from 65 to 66 should be key resistance in this spread.  FFF8/FFF9 closed 66.75, so the 2018 Fed projection of 70 bps tightening in 2018 has now been blessed by the market.

–Today’s news includes Personal Income and Spending, expected +0.3 and +0.5, and there is likely to be additional hand-wringing post-data bemoaning the low and falling savings rate.  However, Core PCE yoy is perhaps more important, expected +1.6 from +1.5.  FOMC and treasury refunding announcement on Wednesday.  The treasury is set to ramp up borrowing to pay for Amazon’s new hub…oops, I mean to pay for the initial shortfall in revenues due to the tax program.  This occurs as Central banks around the world are shifting ever so slightly into a less accommodative stance.  This morning for example, there’s an article on Reuters saying the PBoC is going to increase macro-prudential review of shadow lending.  By the way, Illinois is weighing in with consideration of a $107 billion bond offering in an attempt to plug the pension gap.  It wasn’t that long ago that the entire US annual budget shortfall was only $400 billion….

–Vols had a strong close Friday.  Uncertainty this week is almost sure to be on display this week by a reach for puts.

Jan 28, 2018. “Why, he stumped his TOE”

A body might stump his toe, and take poison, and fall down the well, and break his neck, and bust his brains out, and somebody come along and ask what killed him, and some numskull up and say, ‘Why, he stumped his TOE.’ Would ther’ be any sense in that? NO. And ther’ ain’t no sense in THIS, nuther.

–The Adventures of Huckleberry Finn, by Mark Twain

CNBC had a 15 minute interview with Ray Dalio in Davos.  [Link at bottom]  Here are a few quotes from that segment:

If you’re holding cash, you’re going to feel pretty stupid

We’re going to have a jolt of stimulation

Classically, this is late cycle behavior

All assets trade at the present value of the future cash flows…interest rates affect all assets

It just takes a little change in interest rates to have a bear market

Now which of those quotes got all the airtime, breathlessly repeated on subsequent shows?  That’s right, “If you’re holding cash you’re going to feel pretty stupid.”  Becky Quick responded to that line with a stifled giggle, and the whole interview was summarized by, “Why, he stumped his TOE!”

I understand.  It’s tv.  Hahahaha….he said ‘stupid’ did you hear that?  He said stocks are going to be ‘jolted’ higher.  Hooray!  We have our scoop!

In the initial quote, ‘stumped’ means stubbed.  But ‘stumped’ in its present meaning can also be related back to the CNBC interview.  Because the most important things that Dalio mentioned seemed to have left the panel baffled. (Image of South Park’s Cartman silently blinking his uncomprehending eyes).   This is what he said, and he said it twice: “All assets trade at the present value of future cash flows…so interest rates affect all assets.” And he went on “…because duration of bonds and debt has lengthened, it just takes a little change in interest rates to have a bear market”.  With respect to monetary policy, “Will it be tighter than is discounted by the curve? We have a very small amount of tightening built into the curve. If it is greater…that can upset all asset prices.”  Here, Becky Quick interjected an inane comment about the number of hikes this year, at which point Ray tried to slow it down a little, in a vain attempt to bring the level back down to his audience.  He pounded it home again, “…you can’t have a significant rise in interest rates without knocking over the whole asset markets – all markets. Everything… is trading at cap rates or yields that are very low; if all of a sudden you raise the discount rate on that, they’re all going to go down.”

Now, Dalio didn’t suggest a crash was imminent. He said the key factor was how the Fed and other Central Banks respond to the current environment.  In the short term, he indicated that things are fine, but added that monetary policy is in a delicate area due to increased leverage in some parts of the economy, and noted that we now have more sensitivity to rates than ever.  He also mentioned increased bond supply as a potential issue.  When Andrew Ross Sorkin said, (as if he’d discovered a previously unknown gem of modern finance) ‘If this is the last leg, then you as an investor need to know when to get out”, Dalio just threw up his hands and said “THAT’S MY GAME!”

Dalio did not seem to be concerned that this jolt of stimulation would spark increased inflation, but I would say that the Fed may have to contend with just that possibility.

So, to bring it all back to the US rates market, where do we stand? Twos, fives and tens closed at new high yields. The Eurodollar strip out to the greens (the first three years) closed at new lows.  While the back end curve isn’t moving all that much, front euro$ calendar spreads closed at new highs.  For example, EDH18/EDH19 settled 57.0 (up 3 on the week), and Jan’18/Jan’19 Fed Fund spread settled 66.75.  This latter spread is a reasonable proxy for the amount of tightening priced for 2018, and it’s approaching the 70 bps projected by the Fed dots.  It’s true that the curve doesn’t have much priced in; indeed the red to green (2^nd to 3^rd year) ED pack spread is still below 14 bps, and 5/30 treasury spread closed at its ten year low of just 44 bps. However, direction and sentiment, especially notable this week, suggest that the market MAY begin to reflect a more aggressive Fed, and there are additional influences that could upset the asset apple cart.  These factors include new lows in the dollar, heightened sensitivity to bond issuance, and a parabolic rise in stocks.

With respect to the dollar, there was a bit of a dust-up this week when it was reported that Treasury Sec’y Mnuchin said the US welcomed a weaker dollar.  I didn’t see that particular clip.  I did see that both he and Trump indicated the comment was misconstrued. I always recall a remark by Richard Dennis, who said it’s critical to observe how the markets react to news.  For example, if a bearish piece of news comes out and the market doesn’t go down, or indeed goes up, that’s bullish.  Well here’s what I will say about Mnuchin’s comment.  It was bearish for the dollar.  The dollar went down.  And closed at a new three-year low in spite of the ‘misconstrued’ stuff.  Along the same lines, Draghi was expected to talk down the euro at the ECB press conference.  It closed at a three year high. I believe the dollar index is nearing important support (DXY 88.42 vs 89.02 currently).  But the trend is lower.

The risk going forward is that the interest rate curve will begin to indicate MORE tightening into the future.  That concern was on full display Friday, with large amounts of put buying in Eurodollars.  For example, EDG 9812p were bought in size of 80k, settling 1.0 ref 9813.0 with 3 weeks to go.   In midcurves, most straddles ROSE week over week.  For example, 2EM 9737.5 straddle settled on Jan 19 at 29.0 vs 9737 in EDM0, and 31.5 on Friday vs 9733.0.  3EM 9725 straddle went from 32.0 vs 9729.0 in EDM1 to 35.0 vs 9726.5.  Not particularly pleasant for the market making community, but also indicative of less certainty regarding the forward path of rates (perhaps accentuated by the passing of the torch to a Fed board with a much different composition).

On Tuesday we’ll have Trump’s State of the Union speech.  (An echo of Collidge’s “The chief business of the American people is business” from 1925?).  On Wednesday, the last day of the month, it’s the last Yellen FOMC meeting.  The end of month has also been associated with portfolio rebalancing, perhaps particularly important this time due to the runaway rally in stocks.  On Friday it’s the employment report. I believe the Treasury will also announce borrowing estimates this week.

With regard to the Fed meeting, there’s not likely to be much change in the statement, though there could be mention of increased market measures of inflation.  For example, in the first week of December, prior to the last meeting, the ten year tip/treasury breakeven was holding around 1.87%.  This past week it averaged 2.07%, a rise of 20 bps.  Note also that the CRB made a new 2 year high this week.

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Apologies to Becky, Joe, and Andrew.  I didn’t really mean to say you looked stumped.  Sometimes it just comes out that way.

Pray for me! I reckoned if she knowed me she’d take a job that was more nearer her size. — Huck Finn, responding in his head to Miss Mary Jane saying she’d pray for him.

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https://www.cnbc.com/video/2018/01/23/ray-dalio-us-markets-in-beautiful-goldilocks-period.html

Jan 26, 2018. Unbalanced?

January 25, 2018. Draghi to address EUR strength (as the US does its best to weaken USD)

–Going into today’s ECB meeting, Draghi faces the euro at a new high (with gold and oil also at new highs this morning).  Though the trade-weighted rise in the euro hasn’t been as pronounced, strength in the currency could undermine recent gains and stall already low inflation, so Draghi needs to gently talk it down.  On a related note, the chart below shows the dollar index, which closed at a new low following Mnuchin’s comments yesterday.  As is shown, the 50% retrace from the 2014 low to post-election high was an initial level of support (91.36) and I would expect the 61.8% level of 88.42 to act as support now.

–US yields pushed higher again yesterday, with tens up 3 bps to 265.  Seven year auction today.  Treasuries found some support yesterday as talk of month-end rebalancing following January’s spectacular gains pushed stocks lower.  However, those concerns were brushed away by the end of the day and ESH is again higher this morning.  (Talk of $70 billion rebalance).

–With Trump in Davos, trade frictions are heightened.  China’s Commerce Ministry says it will take appropriate actions against unilateral moves, but hopes to handle frictions with the US in a proper manner.  Worth a mention is a decline in S Korea Q4 GDP, mostly as a result of weak exports.  N Korea has been on the back burner recently, but a new flare up may be closer than it currently appears.  US news includes New Home Sales and LEI, expected +0.5.

Jan 24, 2018. The Mnuchin Show

–What the Fed hasn’t been able to accomplish for years, namely, generate 2% inflation, Mnuchin is going to do this year, by giving the green light to currency devaluation.  In Davos, Mnuchin indicated he welcomed a weaker dollar, which immediately fell to a new low.  It used to be that a Treasury Sec’y could ONLY say, “A strong dollar is in the best interests of the United States.”  In was in 1987, when then Treasury Sec’y James Baker threatened the Germans with USD devaluation, that stocks tumbled (with many commentators specifically pointing the finger at Baker).  In today’s environment, a weaker USD is embraced by the stock market, however, the bond market (if there is any sanity left) should run like hell to higher rates.  Gold is at a new high this morning, with Feb Gold +13.30 to 1350.  GBP, which had rebounded all the way back to pre-Brexit levels, is higher yet this morning.

–Two year notes were well rec’d yesterday.   Yields over 2% are obviously attractive for relatively short end paper.  But that won’t be the case if a drop in the underlying ccy value ensues.  What if the Fed is eventually forced to respond to the effects of a weaker dollar?  I’m not really supposed to make trade recommendations in this note, but THE TREASURY SEC’Y OF THE US IS SENDING AN ENGRAVED INVITATION TO SELL BONDS. *Disclaimer* Past performance is no guarantee of future profits (or losses).

–Yesterday was indeed a turnaround Tuesday, but the trend and sentiment is still bearish.  Feb treasury options expire Friday.  I would simply mention the USG 147p closed at 2/64’s.

Jan 23, 2018. Snow Job

–Hey here’s an idea, let’s buy some puts!  Massive put spread buying yesterday in euro$’s, which was the equivalent of at least -80k futures, mostly in reds.  Below I detail some of the trades, but the rise in futures open interest tells the story:  Total ED open interest +75k.  In reds (where almost all downside took place), +87k.  EDH9 +24k, EDM9 +25k, EDU9 +13k, EDZ9 +25k.  Unsurprisingly, yields pushed to new highs, with tens +2.4 to 266.3.  All near one-year euro$ calendars again made new highs, with EDH18/EDH19 +2.5 on the day to 56.5.  Large buying in EDH8 appears to have been short cover, with OI -16k.  Reds to greens edged up 0.75 bp to 15.25.

–Inescapable analogy:  Davos has been hit with huge amounts of snow and is under avalanche alerts.  Helicopters have been deployed to start controlled avalanches to lessen the instability, but only 2 of 10 efforts were successful.  It’s that last flake of snow that starts the slide.  What if the edifice of global wealth, embodied by the elite Davos attendants at the World Economic Forum, all comes crashing down?  ZH reports that 1% made 82% of global wealth last year.  The Central Bankers are trying to engineer a controlled retreat from helicopter stimulus, but the snow keeps falling…

https://www.bloomberg.com/news/articles/2018-01-22/davos-disrupted-as-executives-gather-amid-snowiest-ever-meeting

The town, where Donald Trump makes his debut later this week, was put on the second-highest avalanche warning level by the Davos-based Institute for Snow and Avalanche Research.

–“Gotta hunch, bet a bunch!”  Here’s a representative chart of market mentality, embodied by, well, a casino stock (WYNN).  Put it all on black.

–In my weekend piece I suggested conditions were in place for turnaround Tuesday.  Not a change in bearish sentiment, but perhaps a retracing pause. The big guns placed their bets yesterday in ED options.  Two year auction today, late yesterday the w/i was 2.09%.  Pretty juicy parking spot.

–Yesterday:

+170k EDH9 9725/9737ps vs 9800c for 0.5.  PS settled 4.75, 12d and call 4.0, 17d vs 9758.5

+60k 0EM 9725/9737ps with 2EM 9700/9712ps. 0EM settled 3.25, 14d and 2EM 2.75 10d   vs 9750.5 and 9734

+17.5k 0EZ 9712/9750ps vs 9775c.  PS settled 16.5, 30d and call 7.0, 23d  vs 9738.0

with

+17.5k EDZ9 9712/9750ps vs 9775c. PS settled 17.75, 23d and call 12.0, 29d (short and red dec pkg over 100 delta total)

+40k 2EJ 9712/9700ps settled 2.0.

Jan 22. Quick notes from Friday

–Ten year yield pushed through old high, closing 2.639, up 3 on the day and 9 on the week.  Implied vol firming on the move to lower prices, providing confirmation for bearish price action.  The bond yield rose 2.5 on Friday to 291.3.  (Not even 300 bps over a year, when stocks have already returned >5% this month).  In eurodollars, all near one-year calendars made new highs.  Notable buy was a clip of 60k EDH19/EDH20 that went through at 19.5, sparking a squeeze into the close with a settle at 21.5.  Peak one-yr spread is still EDH8/EDH9 which settled 54.  Perhaps this spread is still undervalued given recent Dudley comments that near term economic risks are to the upside, and Williams comments that the pace of hikes could be a little bit faster.  Further back, red to green pack spread rose 2.625 on Friday, but the level is still only 14.5 bps.

–A hike in March is substantially priced.  The June meeting is isolated by the May/July FF spread, which settled 16.5, indicating 2 in 3 chance of a hike then.

–Dollar index is lower this morning, with little on the horizon to suggest a change in trend.  Gov’t shutdown is probably net negative for the dollar, though there’s probably little reason to hope for a bounce when the gov’t reopens

–Feb treasury options expire Friday.  Late scramble to buy premium on Friday after the floor closed.  For example, 3EH 9737^ settled 20, but was immediately 21 bid late without much offered at 21.5.

January 21, 2018. RED DECEMBER

As I sometimes do, I’m starting this note with a walk down the historical market lane of my youth. (Oh no, not again!  Yes.  Again).  And it concerns millennials.  Wait, don’t stop reading yet, it’s not a social study about retail buying habits, it concerns the euro$ curve.  It was early 1999.

Back in those days, a normal trade in summer was the sale of Dec/March Eurodollars.  The spread would often decline due to the ‘turn’, related to funding demand at the end of the year, referred to as ‘balance sheet window dressing’.  Through rudimentary studies of my early years, I determined that pressure for year-end often peaked in October, reflected by pressure on front December contracts versus the rest of the curve.

Now I’m going to skip back to the year 1999.  At that time, someone began to amass a position in the Sept’99, Dec’99, March’00 butterfly.  He quietly hoovered up whatever he could, from about 13 to 20.  Think about THAT for a second.  For those that aren’t familiar with butterflies, it means that the three month calendar spread of Sept/Dec was 20 HIGHER than the three month spread of Dec/March.  Incredible, especially in the context of the past few years.  Of course, we were in a tightening cycle in 1999, so that was a factor.  Currently, Sept/Dec is 12.0 and Dec/March is 7.0, so the butterfly is 5.0  (Prices: EDU8 9779.5, EDZ8 9767.5 and EDH9 9760.5).  Back in 1999, it’s 21, and the pit community is short and uncomfortable.  I remember locals coming up to me and asking what was going on.  I didn’t know myself at first, but when it got up into the upper teens, I got wind of what should have been obvious.  And there are a couple of lessons from THAT for another time, which for now I’ll just crystallize with the locals’ mantra: “They KNOW something”.

In the latter half of the last century, when computers were just being adopted, programmers typically coded dates using only the last two digits of the year.  This was widely referred to as the Y2K issue.  Obviously, with the turn of the century, there would be a problem distinguishing between 00 for 1900 or 2000.  It was a huge race and expense to re-code all of these computers, and there were dire warnings about catastrophic consequences across all aspects of life, especially with respect to the financial system.

It’s here that I’ll insert a couple of asides, one an obscure movie reference relating to computer manipulation (just for you JC).  This was the 1995 thriller, The Net, starring Sandra Bullock -complete with slowly loading floppy disks for added suspense- a movie with a theme that one can extrapolate to system-wide computer malfunctions (as was the worry with Y2K).   The other is a Jeopardy question I just happened to see: “Embracing the future and new technology in 1962, Purdue established the first college department in the U.S. for this two–word discipline.” The answer, “What is Computer Sciences?”

Sandra Bullock as Angela Bennett in The Net

Anyway, worries for year-end funding over Y2K reached fever pitch in 1999, embodied of course, by the “millennial fly”, which exploded up to something like 70 bps.  The Fed, realizing the problem, said it would make liquidity plentifully available over year-end, and the turn hasn’t been much of an issue since then (except for a wee bit last year).

Now let’s fast forward to today. *Disc whirring*

On Jan 2, 2018, Aggregate Open Interest in Euro$’s was 12,745,080.   On Friday, it was 14,367,308, an increase of 12.7%.  Obviously, as yields have risen, the demand for hedging has increased substantially.  A particularly large change has been in the EDZ19 contract.  As shown on the chart below, open interest in that contract alone has surged from around 1m at the end of the year, to over 1.56 million now.  This accounts for over 1/3 of the total rise in open interest.

On 5-January, about 125k EDZ8/Z9/Z0 butterflies were sold at 15 to 14.5. (This position is LONG EDZ9).  That was obviously a new position, a sale against the high settle of 16.5 in the fly (16.5 settle on 4-Jan).  Since that time there has been heavy trade in many ED one-year calendar spreads, but especially buyers of EDZ18/EDZ19.  I had heard speculation that the butterfly short was covering the front spread (buying back EDZ8/9), but given the open interest increase, it appears more likely that there are several large players on opposite sides of the market.  In one of my old technical analysis classes, I was taught that the increase in open interest in a given contract was viewed as “tinder” for the next big move; i.e. someone loses the battle and needs to fire exit.  From the recent rise in rates, it appears that shorts have the upper hand.

EDZ8/EDZ9 is now at a new high of 27.0 (highest since early July).  EDZ8/EDZ9/EDZ0 is now 17.0/17.5 (17.5s), the highest in this fly over the past year, with curve roll providing a hefty tailwind (H8/H9/H0 is 32.5). On Friday, there was a new buyer of 60k EDH19/EDH20 for 19.5, causing a squeeze up to 21.5 settle.

According to prelim open interest data from Friday, EDZ8 and EDZ9 have the largest OI of any contracts, Z8 with 1.804m and Z9 1.564m.  Next closest is EDH8 with 1.374m. On Friday EDH9 OI rose 46.6k and EDH0 +56.7k (due to the spread buyer). EDZ8 rose 26k and EDZ9 +40.8k.  Total OI Friday +180k. These are big numbers.

The only conclusion I draw here for now is that large positions can create increased volatility upon exit.  I will note that EDZ9 9737.5 straddle settled 51.0, and the midcurve 0EZ9 settled 39.0.  Probably will be some scalping opportunities regarding 0EZ options.

A couple of final notes.  If Dec 31 is a Thursday or Friday, the end-of-year financing window needs to cover the weekend, exaggerating the pricing influence of the turn.  Dec 31, 2018 is a Monday and Dec 31, 2019 is Tuesday.  Also, some trading strategies regarding December contracts likely relate to the Fed’s SEP year-end FF projections.  As I have previously noted, the Fed’s 2018 year-end FF projection is 2.1%, and EDZ18 at a yield of 2.325% (9767.5) is now more or less consistent with that forecast.  For 2019, the Fed projects year-end FF at 2.7%.  EDZ9 is 2.59% or 9741.0, obviously a much lower yield than consistent with the Fed forecast.

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News is fairly sparse this week though Trump’s visit to Davos should be entertaining.  Treasury auctions 2, 5 and 7 year notes.  Friday sees the initial release of Q4 GDP, expected 2.9.  The Atlanta Fed’s GDP Now has it at 3.4% and the NY Fed Nowcast stands at 3.9%.  I’m going out on a limb here and saying the risk is probably to the upside.

Late Friday the government shutdown went into effect.  Earlier on Friday, a BBG article (linked below) noted the Fed was working on proposals to ease bank leverage constraints. (That’s what we need! A bit more stimulus).  Finally, Dadong rating agency in Beijing cut the US rating and put on negative outlook due to “political ecology”, also citing tax cuts. “Massive tax cuts directly reduce the federal government’s sources of debt repayment, therefore further weakens the base of government’s debt repayment.”

UPCOMING EVENTS TO BE AWARE OF

23-26 Jan.  President Trump goes to Davos.  Negative implications for global trade?

End of Jan (29^th?) Treasury forward borrowing estimates, likely at the end of the month. ** Important with respect to increased borrowing needs

31-Jan.  FOMC meeting.  Coincidentally, the same date will have a blue moon, a super moon and a total lunar eclipse.  Last time it happened was in 1866.

9-25 Feb. Winter Olympics in South Korea

4-March Italian elections

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https://www.bloomberg.com/news/articles/2018-01-19/fed-said-to-be-finishing-proposal-to-ease-up-on-bank-leverage

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• 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.