Salubrious

–Once again yields fell and the curve flattened to new lows, in spite of slightly better than expected data.  Core CPI yoy 1.8%.  Headline Retail Sales +0.2 vs 0.0 expected…previous month revised slightly higher.  Decline in stocks seemed to give some support to fixed income.  Early weakness in Junk but etfs came back to close nearly unchanged.   New lows in 2/10 at 65 bps, and in 5/30 at 74.3 bps.  Tens fell 4.8 bps to 233.3.

–A BBG article notes that Fed insiders are pushing for a new possible framework as Powell takes the Chair.  “Alternative approaches could include allowing prices to overshoot for the same amount of time they undershot — commonly called price-level targeting — or even raising the desired inflation goal to 3 percent.”  Bond market calls bullsh-t with 30’s hovering at 2 3/4%.

https://www.bloomberg.com/news/articles/2017-11-16/fed-insiders-push-for-radical-policy-review-as-powell-era-dawns

–Ellington’s Vranos is concerned about a liquidity crisis (RTRS).  “Think of what salubrious environment corporate borrowers are in right now,” he said. “If they can’t roll (refinance) their debt, it’s going to cost them another 100 basis points, or worse than that, they just can’t lever as much. They put covenants in on that debt. That can crush corporations.” [Corp debt at nominal record high…almost all of which has gone to retire stock].  “Salubrious?”  What does that even mean?  I don’t know, but the last time I heard it tens were 6.5%. “You keep using that word.  I do not think it means what you think it means.

http://www.reuters.com/article/us-investment-summit-vranos/ellingtons-vranos-fears-corporate-liquidity-crisis-likes-fallen-angels-idUSKBN1DF33H

–Interesting late trade: +75k 0EM 9812c 8.5 vs -50k 2EM 9787.5c 13.0 (3×2) for 0.5 credit.  Ref 9794.5 in EDM9 and 9769.5 in EDM1.  So 25 bps between option strikes and futures spread as well.  Red/blue pack spread is on its low at 26.75 (as is nearly every other curve measure), so it’s a good fade of recent (relentless) flattening.  We’ve done similar trades: +3x 0EH 9837c vs -2x 2EH 9825c at flat (settled -0.5), and look at +0EH 9812/9825c strip (8.0s) vs -2x 2EH 9812c (4.25s), which could have been done flat.  A bit less risk with a one year spread…

Nov 15. China credit slowdown to reverberate?

–Another new high in the 2y yield at 168.7, up just 0.4 bp but the only yield on the treasury curve that was higher.  Ten year fell 1.7 bps to 238.1.  2/10 closed 69.4, right on top of the low of 68. 5/30 made a new low of 77.6 bps.  5/10 down to 31.8.  Dollar index hit yesterday, but base metals took a tumble as well, with copper (HGZ7) down to 306.5.  EUR soared, and erased the entire loss from the ECB meeting of 26-Oct.

–Interesting big late trade in dollars, a buy of 150k EDF 9837/9850 cs for 1.25 vs 9830.5.  Open interest in 9837.5c was up 99k, 1.50s and 0.25s.  EDH8 +2.5 this morning at 9832.5

–PPI was an upside surprise at +0.4, with yoy core +2.4.  Today CPI expected +0.1, Core +0.2 and Core yoy at 1.7%.  Retail Sales as well, expected 0.0, ex-auto and gas +0.3.

–While stocks fought back from an early swoon yesterday, ESZ is now slightly below yesterday’s low, portending a day of tough sledding.  The Sept/Oct seasonal sell-off is coming late this year.

–There are a few stories about China’s credit growth slowing, just as the ten year pushed above 4%.  Many commentators suggested a period of calm going into the National Congress meeting, but with that event now in the rearview mirror, we appear to be in the early stages of unwinding, which could get ugly in a hurry.
http://www.zerohedge.com/news/2017-11-14/chinas-credit-growth-grinding-halt-worst-possible-time

Nov 14. Strange Correlations

Nov 13. Junk Jitters

–The broad story is shifting to the idea that capital is being less accommodating.  Fraying starts at the edges and stories about deterioration in the high-yield market are becoming more common.  At the end of 2015 going into 2016, it was all about energy companies as the price of oil plunged.  Now spreads are widening on retail, healthcare and telecom.  Ambrose Evans Pritchard features a story calling high-yield the canary in the coal mine.  According to people that have seen the report, JPM also highlighted the rout in junk bond pricing last week.

http://www.telegraph.co.uk/business/2017/11/12/time-investors-leave-party-latest-bond-market-wobbles/

I mentioned over the weekend that junk ETF’s HYG and JNK closed at their lowest levels since March.  According to St Louis Fed, the BAML Hi-Yld option adjusted spread has rallied 40 bps since late October, though from the absolute low of 340 bps.  The last time the spread was that low was in the summer of 2014, and it took a year and a half to reach a high of 864 bps in Feb 2016.  Leveraged loans have displaced a large % of hi-yld issuance so signals may be a bit more opaque, but there are other indications that capital is being more selective in funding the capital burners, for example TSLA and SNAP.

–A couple of stories about a large seller of Gold futures on Friday, which caused a quick $10 drop.  I have no idea if this is related, but the Saudi freeze of $800 billion in assets automatically makes me think of forced sales and front-runners.

–PPI Tuesday.  CPI and Retail Sales Wednesday. Several Fed speakers during the week, but Brainard on Thursday afternoon may be most important as she is one of the fed continuing Fed Board members and has generally been cautious regarding inflation and rate hikes.

Turning points -weekly comment

On Friday, I attended the funeral for my uncle Constantine (Gus), a veteran of WWII, who served in the South Pacific as a naval officer.  I have always respected the tribute of Veteran’s Day, but I must say that this was an especially poignant and fitting occasion, as it was a full military funeral held at Jefferson Barracks National Cemetery, just to the south of St Louis on the west bank of the Mississippi River.   This is a massive plot of land, and it’s stunning to actually see and drive along the unending rows of uniform white marble grave markers over gently rolling terrain.  There were three fully uniformed military personnel who stood at attention throughout the service, followed by a three-volley rifle salute and playing of Taps.  Finally two of the three Honor Guard members slowly marched to the casket and at either end lifted the flag draped over it, and went through the slow and somber precision ritual of folding it in a triangle and presenting it to the family with the grateful thanks of a nation.  It’s one thing to see in a movie, and quite another to actually observe, and I was honored to have been present.

The drive to St Louis down I-55 takes one past the industrial factory corridor of southwest Chicago, followed by the Exxon Mobil refinery in Joliet, which we passed pre-dawn, a huge complex of steel lattice towers and cylinders, whose staggered lights dotting the structures are shrouded in steam and smoke like a science fiction movie.  Along one side of the highway was a miles long freight train.  Further south there are giant windmills looming over now barren cornfields, and a few hours later we reached the historic backbone of the US transportation system, the Mississippi.

It’s a pretty sharp contrast to the flashing lights of our trading screens which represent the values at any given moment of this aggregation of labor and transport and physical product.  Comments about markets will be fairly short this week though there were some interesting reversals, perhaps signaling some longer term changes.

Most of the commentary in the US about market movements last week was related to dimming prospects for a sweeping tax reform program.  US stock indices eased modestly, as did the US dollar index.

There were a few high profile reversals.  Most notable was bitcoin, which soared to 7879 before posting a low of 5507 and ending at 6160.  A range of about 30% on an asset with $100 billion market value is astonishing.  The Nikkei also made a new high on Thursday, having rallied 20% since the start of September, but had a big outside day and closed lower on both Thursday and Friday.  The US index which seems most closely tied with US tax reform is the Russell (small caps).  It has been in a slow decline since the beginning of October and this week gave up about 1.4%.  Both the DAX and CAC40 made new highs on Tuesday but then slid for the remainder of the week (-2.9% and -2.5%).  There seems to be an undertow of concern related to even a modest deceleration in Central Bank and fiscal stimulus with the latter being currently defined by tax policy.

However, fixed income markets were not a beneficiary of these worries.  Yields ended higher, with US twos and fives at new highs of 1.654% and 2.051%, while tens rose 5.7 bps to 2.397%.  The VIX closed at 11.29, up from 9.14 on the previous Friday.  Treasury vol firmed modestly on Friday’s price decline.

Most people are aware of Time and other magazine covers as contrary market indicators.  When the mainstream press glaringly informs the public of a given trend, it generally means that trend is ripe for reversal.  The most famous is probably Business Week’s ‘Death of Equities’ from 1979 which explained ‘How inflation is destroying the stock market”.  There was an additional feature: ‘Indexing bonds to oil and gold.’  Another one of my all-time favorites in the ‘bad-timing’ category was when Merrill briefly changed its famous bull logo into a swirling neon outline representing fiber optics of the tech boom right before the Nasdaq crash of 2000.  It’s much different than today’s environment, with sage commentators knowingly assuring us that inflation can’t go up due to technology, demographics, etc.

While magazine covers no longer hold the same cachet as they once did, it makes me wonder whether Powell’s recent announcement as Fed Chair will mark the low of the Central-Bank-inspired decline in volatility.  I would also note that the ICE exchange launched FANG futures this week.  Could it possibly signal the top of the mega-cap tech darlings that have single handedly powered passive portfolios to new highs?

One other note.  High yield junk bond ETFs HYG and JNK had their lowest closes since March.  While spreads are pushing a bit higher, I would hesitate to focus too strongly on these products.  Janus posted a rather interesting piece last week authored by Jenna Barnard, about the decline in supply of high yield bonds, noting a couple of factors.  For example: “While the number of credit rating downgrades has exceeded the number of upgrades in the high-yield universe, the volume of debt being upgraded to investment grade has far outweighed that being downgraded to the high yield index.”  She also notes the resurgence of leveraged loans, where “…over 75% of loans outstanding are classified as ‘cov-lite’.”  Further: “Since the end of 2014, the U.S. high yield market has shrunk by 3.7% while the loan market has grown by 12.7%.”

https://blog.janushenderson.com/most-unusual-cycle-shrinking-high-yield-market/

While there have been consistent warnings in some outlets about Chinese debts in the shadow banking system, it’s not always clear when marginal debts coalesce into something more ominous.  In this regard, I would mention in passing the 17% stock drop that LC (Lending Club, a peer-to-peer lender) encountered as it announced plans to tighten lending standards.  It closed at 4.30, less than 1/5^th of its IPO price in the beginning of 2015.

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November 9. random thoughts on everything (but rates)

–Now let’s get to the treasury mkt.  The yield rose NEARLY 2 bps in the ten year to 232.4.  It’s like the video of Canadian rioting https://www.youtube.com/watch?v=YTVKSyX3yXs

Manchester Riots 2011: Man knocks over bin www.youtube.com Guy knocks over bin… he seems very tough. Orginal video: http://www.youtube.com/watch?v=0cbVW_QS2eE&feature=feedf

Raucous social unrest everywhere else in the world and yet the treasury market has found zen-like stability.  Which is nice.

“Hey, Lama, hey how about a little something, you know, for the effort, you know.”  And he says, “Oh, uh, there won’t be any money, but when you die, on your deathbed, you will receive total consciousness.”  So I got that goin’ for me, which is nice.

–In eurodollars, there’s just not much to talk about.  However, there was relatively heavy volume of 30k EDZ8/EDZ9 spread at 18.0.  Appears to have been exit seller, as OI was down 8100 in EDZ8 (but only 700 in EDZ9).  Settled 18 and was bid there late in the day.  One other note of interest is that high yield junk bond etf’s had decent pullbacks yesterday, testing lows from August.  I read an article yesterday about the Retail Apocalypse (thanks BC) and some of the related debt burdens, so perhaps that’s filtering through. “Retail bondholders, there won’t be any money….”

–I’ve added a chart of the NYFANG index and its relative performance to the S&P since the FANG future made its debut yesterday.  NYFANG +59% ytd.  Makes you wonder what it might have been without the hostile relationship between big tech and Trump.

—Remember that sometimes not getting what you want is a wonderful stroke of luck.  The Dalai Lama (big hitter)

Nov 8. But are you SURE the Fed hikes?

–The front end of the market continues to press lower, with hike odds for December over 90%. January’18 Fed Funds (FFF8) were offered at 9861.5 during the day, but closed at 9862. There are 2 month-end dates in this contract which typically are associated with a lower Fed effective print; my assumption is that a hike would take FedEff to 141 bps, and given the year-end and month-end, I’d peg the final settle for FFF8 at 9859.6 or 59.7. (Last year-end the Fed Eff was 15 bps below target). The point is that downside is limited to a couple of bps, but if Fed’s hand is stayed then 22.5 of upside. It’s not quite as clear with EDZ7 due to lib/ois, but the basic equation is the same. (EDZ7 9846.5s).

–Extending a bit further, the two-year future settled at 107-20.25, which equals the low settle for this contract. Late in the day it was 20 offer with the 2yr yield at 1.629. I checked TUZ7 107-24 calls which were 1/1.5. DV01 is $40 so the calls cost around 1 bp for 2 weeks (Nov 24 settle), around 6.25 bps otm. Disaster insurance.

–The Nikkei has surged 20% in the past two months. Trump reckons that was purely in anticipation of his trip to Asia as he seems to take credit for capital gains everywhere… but a small crack opened yesterday with the Russell, which fell 1.25%. Small caps appear most sensitive to the tax plan (Russell surged 11% from its low in August), but the postcard-size return that Ryan and Trump wave around looks like it’s getting larger and more complex.

–Big consumer credit number yesterday $20.8B, a 6.6% pace. This sort of data (JOLTS as well) supports the expected Dec hike, but the long end sees growth as transitory. The curve continues to flatten with 2/10 at a new low of 68, 5/10 at a new low of 32 and 5/30 at 78.7. While deferred euro$ calendars aren’t quite making new lows, they are awfully compressed. For example, since 2011, the spread between the 6th and 10th quarterly has posted a low of 11 bps. EDH19/EDH20 corresponds currently to 6th/10th and settled at 15.5. EDM9/EDM0 settled 13.5. Not exactly reflecting economic vibrancy.
–Hey ML …it’s the ten year auction today… maybe that’ll limit the loss in the TY straddle to only 2/64’s…

Nov 7 . Flatter Curve…a few debt notes

Curve continued flattening trend. I marked 2/10 at 70.3 on futures close. Volume was light. Notable new buyer of 25k TYF 124/123ps for 11; settled 10 ref 125-025.

–Large mover on the day was oil, with CLZ settling +1.71 at 57.35. It’s just slightly lower this morning as Saudis face both internal and external threats.

–Decent volume yesterday in EDZ18/Z19 which settled 18.5 (-1.5), 6.5 off the high set a couple of weeks ago at 25. Back spreads remain relatively flat, with EDZ18 heavily influenced by large remaining open interest in midcurves. November midcurves expire Friday, but there are still 650k open in 0EZ 9800p which settled 2.5 ref 9807.0.

–Peak spread is still EDZ7/EDZ8 at 40.5 bps, while FFF8/FFF9 settled 33.5. These spreads forecast only 1.5 hikes over 2018, a year in which we’ll have a substantially different FOMC composition.

–Attached is chart of market cap to GDP [ycharts and Daily Reckoning]. There’s nothing that says this measure can’t make a new high, but it certainly suggests that total earnings can’t grow much faster than GDP itself, especially given total business debt at a record $13.9T (Q2 2017). By the way, consumer credit is released this afternoon. Though there are occasional warnings on HH debt, the fact is that at $14.9T, it’s really not much larger than the peak in 2007 of $14.175T. There’s just been a substitution of student debt for mortgage debt. Total mortgage debt in 2007 was 10.6, now 9.9, and Consumer Credit (includes student debt now >$1T) was $2.6T and now 3.7T.

Nov 6. Markets shrugged

–Warning from China’s Central Bank Chief:  (BBG) Latent risks are accumulating, including some that are “hidden, complex, sudden, contagious and hazardous,” even as the overall health of the financial system remains good, Zhou wrote…

“High leverage is the ultimate origin of macro financial vulnerability.” “In sectors of the real economy, this is reflected as excessive debt, and in the financial system, this is reflected as credit that has been expanding too quickly.”

–Zhou is expected to retire soon, and the head of the NY Fed, William Dudley, also announced plans to leave the US central bank.  The composition of the FOMC is changing, with Brainard the lone (dovish) holdout on the Fed’s Board.  It’s likely that a more hawkish tilt will result.

–The Saudis are in the midst of a power struggle, with arrests of elites including al-Walled bin Talal. The Saudis also intercepted a missile, warning Iran that it could be considered an act of war.  Oil has had a reaction, with CLZ now trading near $56/bbl, building on new yearly highs set last week.

–Another mass shooting in the US this weekend in Texas, killing at least 26.  As opposed to run of the mill Chicago stats: ytd 557 shot and killed, 2639 shot and wounded.

http://heyjackass.com/

–Global warnings are met with a shrug in US financial markets, unless of course one considers that flocking to the safe haven of AAPL is the logical outcome.  Implied vol across interest rate products was hammered last week as Powell was named Fed Chair.  Concurrently, the curve flattened to new lows, with 2/10 down over ten bps on the week (82.7 to 71.9) and 5/30 down 8, from 89.5 to 81.6.

Art and Crime

“They don’t understand the difference between art and crime.” –J S G Boggs

“I take them out into the real world and try to spend them, not as counterfeits, but as real works of art that ask us about the nature of money.”

“It’s all an act of faith.  Nobody knows what a dollar is, what the word means, what holds the thing up, what it stands for.  And that’s what my work is about.  Look at these things, I try to say.  They’re beautiful.  But what the hell are they?  What do they do? How do they do it?”

J.S.G. Boggs died in January of this year.  He was an artist who drew currency on fine paper on just one side, identical in size to the actual bill, with whimsical notations, like ‘In Fun We Trust’, or ‘JSG Boggs, Secret of the Treasury’.

He would spend his currency for goods and services.  For example, he would have an expensive meal in a restaurant, produce a nearly finished bill, take out his pens and ink the final flourishes, and then offer it as payment.  If there was hesitant concern, he would produce actual currency and say:

“It took me many hours to do it, and it’s certainly worth something.  I’m assigning it an arbitrary price that just happens to coincide with its face value- one hundred dollars.  That means, if you decide to accept it as full payment for our meal, you’re going to have to give me thirteen dollars in change.  So you have to make up your mind whether you think this piece of art is worth more or less than this regular one-hundred-dollar bill.  It’s entirely up to you.”

Perhaps Mr Bogg’s passing coincides with a turning point of sorts, as bitcoin has exploded this year, a ‘currency’ that is purely electronic blockchain.  At the time of his death in late January, Bitcoin was a little over $900.  On Friday it hit another new high, ending above $7300. The CME further legitimized Bitcoin by announcing plans to list a contract in Q4.

As an aside that is somewhat surprising, one would think in this era of plastic and electronic payments, that actual currency in circulation would have declined.  Not so.  According to the Fed website, there was around $1 trillion in outstanding currency in 2011.  Five years later, at the end of 2016, it was nearly 50% higher, at $1.463T.  Why?  Gresham’s law says that bad money (with the same face value but lower intrinsic value in the form of metal), drives good money out of circulation.  Will the value of the technology behind bitcoin, blockchain, lead to hoarding such that only the derivative trades?

The Federal Reserve’s goal is to depreciate the value of USD by 2% a year, that is, to attain 2% inflation.  The age old acronym for wealth preservation over time was SWAG.  Silver, Wine, Art and Gold.  All of limited supply which hold value relative to depreciating fiat currencies.  Of course, real estate would also be one of the key ingredients (perhaps SWAGGER?).  The point is that the wealth of our world now rests on a cloud-like edifice of electronic pulses.

It’s an act of faith.  What holds this thing up?

SP500 made a new all-time high this week.  As numerous articles have pointed out, the fundamentals are somewhat dubious.  For example, a piece titled ‘The Roach Motel’ [link at bottom] notes that 141 companies, about 30% of the S&P 500, had annualized 5-yr sales growth rates of 1% or less.  Of those, the average stock price gain was 68%. 106 companies had a stock price increase of >25% concurrent with FALLING revenue.  Avg amount of debt outstanding increased 70%. Etc. Of course, these stocks are all in the non-discriminatory basket of passive investing.  Everyone gets a trophy.

As the MacroTourist points out, it’s a lot like the late 1990’s.  He cites David Einhorn of Greenlight Capital: “What if equity value has nothing to do with current or future profits and is instead derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss? It’s clear that a number of companies provide products and services to customers that come with a subsidy from equity holders.” [and I would add, from debt holders].   As Mark Cuban said in an interview with Kyle Bass, his biggest public holding is AMZN, because it’s like one big constant start-up, but with the added benefit of infrastructure and scale.  [Like shot after shot of dopamine].  He says that AI will be deflationary, displacing jobs and real estate, to which Kyle Bass replies “That’s not good.”  It’s as if Cuban ignores the secondary effects of disruptive changes while Bass harbors the negative undertow of potential societal stress.

Did a crack in the electronic AI armor come in the form of TSLA, which was over 375 in mid-Sept, and closed nearly 20% lower at 306 Friday?  Could equity holders begin to question whether today’s economic subsidy will be transformed by alchemy into honest bitcoin profits?

By the way, Boggs was arrested for counterfeiting, and much of his art (even though it was only drawn on one side and clearly different from actual currency) was confiscated.  How do you think the authorities are going to respond to the mathematical elegance of bitcoin?

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Market Notes

This week we finally had the announcement of the new Federal Reserve Chair, Jerome Powell (pictured below).  I couldn’t resist ‘borrowing’ the caption from my friend Art.

I often have said the markets test a new Fed Chair.  Has a nice ring to it, but Yellen never really faced a crisis.  Powell is coming in at a time of historic lows in volatility.  Can the suppression continue?

There was an absolute implosion of implied volatility associated with Powell’s announcement.  It’s as if the market, in some respects, has drastic and outsized reactions when low-probability economic events DON’T occur, and subdued reaction to geopolitical events that DO occur.   For example, it’s understandable that Powell would be associated with continuation of a low volatility, nauseatingly transparent Fed.  But was the unraveling of premium a puke of heavy bets that had been placed on Taylor? (Taylor’s odds were never that great).  N Korea’s nuclear test mountain is also on the verge of imploding and spewing contaminated waste into the atmosphere.  Yawn.

Let me just cite a couple of Friday to Friday ED straddle comparisons:  EDU8 9812^ from 29.5 (9815) to 26.5 (9814).  Longer dated straddles were down 4.5 to 5 bps.  EDU9 from 58.0 (9788) to 53.5 (9791.5).  EDU0 84.0 (9772.0) to 79.0 (9778.5).  0EH9 9800^ from 26.0 to 22.5.  2EZ9 9787.5^ from 20.0 (9782.0) to 15.0 (9786.5).  Implied vol in treasuries also crashed to new lows.  For example I marked FVZ7 117.25^ at just 1.9 vol even after taking out weekend decay, from a high of 2.7 in the middle of the previous week.

Ever see one of those PBS documentaries where an iron smith recreates a medieval sword using ancient methods?  He pulls out a glowing ingot from the furnace and through brute strength slowly pounds it flatter and flatter with a sledge hammer as orange fireworks of slag spark off.  That’s what they did to the treasury curve.  It’s like Hephaestus himself was overseeing the job.  Week over week change in 2/10, 82.7 to 71.9.  5/30 from 89.5 to 81.6.  Both at the lowest levels since 2007.  Dipped in water and back into the oven for Monday.

While Core PCE Prices yoy remain mired at 1.3, and Avg Hourly Earnings in Friday’s report were weak, there are a couple of rays of inflationary light.  Oil closed at a new high for the year with CLZ7 at 55.64, +1.74 on the week.  In spite of the beat down in silver Friday, the BBG Base Metals Index is back at the high of 2014, ending Friday at 206, vs the start of the year below 170.  Data like Consumer Confidence is at the highest since the year 2000.  ‘Underemployment’ is supposedly at the lowest level since 2006.

Going back to the image of the Bogg bill at the top, the script in the upper left, which normally says ‘This note is legal tender for all debts public and private’ instead says ‘Do you hear anything being said here, or am I empty now?  Is anybody home? Hello?’

Central banks of the world are trying to lessen the value of their currencies so that “debts, public and private” can be nominally serviced.  Is anybody home?

• 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.