July 30. Weaker USD as Inflation Spark?
There’s a lot going on these days, Trump shake-ups, N Korea missile threats, Russian sanctions. But I write mostly about the markets. And, on that particular topic, there’s not a heck of a lot of interesting things to comment about. Sure, stocks continue to press record highs; the dollar closed at the low of the week; crude oil had a strong resurgence and copper is breaking out to the upside. But overall, SPX was nearly unch’d on the week, and the ten year note yield rose less than 6 bps. Volatility, as everyone knows, is in the dirt.
I also read other market summaries. A lot of them have useful information, but can be numbingly boring. Especially when there’s not a lot to say, people tend to fall back on the old industry standards of ‘mean-reversion’ and ‘relative value trades’. Now it’s all about passive vs active. Time for a nap.
I was once invited to an insurance company presentation, an asset-gathering hunt, where the enthusiastic ‘wealth management’ presenter was going through the magical mechanics of compounding. As I said, I was invited by a friend, but I still was tempted to get up and say, “How does all of that work out in a sub-2% ten year note environment? Maybe you should be running the Chicago Teachers Pension if you can consistently compound at 7-8%.”
Above is what we might loosely call a relative value idea that clearly shows stocks in a wicked bear market. Huh? Oh, it’s SPX priced in bitcoin. Perhaps it’s more appropriate to show Nasdaq in terms of bitcoin, since the crypto-currencies rely on cutting edge technology. Looks the same.
Reversion to the mean? I guess that means we keep buying volatility because we’re way below the long term average. I guess it means we keep selling Eurodollars because over the long term the FF target is more like 3%. As we know, it’s all a matter of timing and time frames. We may be seeing some clues of change currently.
Where we did see a breakout of sorts this week is in copper, which closed at the highest level in two years. Post-election, copper broke through a long term downward sloping trendline. It made new highs in Feb, only to sputter back lower. However, it is now above highs from the early part of the year and poised to test the high of 2015. This move corresponds with the weaker dollar and perhaps a relaxation of China’s shadow banking clampdown into the National Congress.
In many ways, the broad strokes of exchange rates are likely a key determinant of markets now. In late 2012-2013, Japan embarked on its yen devaluation. By 2014, it was europe’s turn, with EUR falling from 140 to 105 in a year. Finally, two years ago, in August of 2015, China devalued and has allowed the yuan to trade lower ever since. That is, until Q2 2017. As the yuan weakened, China could be thought of as ‘exporting deflation’. This year, it has been the dollar’s turn to weaken. The yuan has firmed, and is through long term moving averages (CNY hadn’t been below the 200 day since late 2014, but broke below in June of this year. Chart below). As mentioned earlier, DXY is at the low of the year.
From RTRS: “The euro has risen nearly 3 percent against the dollar so far this month and more than 11.5 percent this year. It is on track for its third straight weekly gain and the fourth in five weeks.” And on Saturday: “The European Central Bank should start thinking about how it wants to return to normal monetary policy and when it wants to wind down it bond purchases, governing council member Sabine Lautenschlaeger said…” Does USD weakness continue? For now, the lower trend is in place.
The dovish interpretation of this week’s FOMC actually sparked steepening in the US curve, with 5/30 closing at 106.4, near the week’s high of 108.4, and well off the low of 93 made after the June hike. The red/gold pack spread closed 62.375, up 5 on the week. If the dollar continues to weaken and yuan strengthen, the implications are a steeper US curve, a slowing or reversal of flows into US equities, and perhaps, a catalyst in the Fed’s elusive search for inflation.
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This week’s main event is the employment report on Friday. NFP expected 180k with avg hourly earnings +0.3. ISM and Personal Income / Spending Tuesday. Core yoy change in PCE price index expected +1.4.
The FCA announced the phasing out of LIBOR as a benchmark by 2021. A market maker informed me that their group would no longer be making markets in Gold Midcurves after the September expiration. There are nearly 700k open positions on the dollar strip from EDH21 on back. Perhaps we can expect a bit more looseness along the entire back end of the curve.
July 28. Winners and losers
–Might as well start off with the failure of Obamacare repeal. I don’t usually write about politics, but many market moves were defined by the election and have since deflated, including the dollar. It was two years ago in July 2015 that Trump said of McCain “He’s not a war hero”…because he was captured. He followed up those remarks in an interview talking about McCain’s 2008 presidential campaign: “I never liked him as much after that because I don’t like losers.” McCain’s vote yesterday killed the bill in a huge defeat for Trump. US equities, which soared post-election and are repeatedly cited by Trump as a symbol of his success, are seeing a bit of profit taking…
–Clearly, the political landscape may only be a footnote markets. Yesterday was about AMZN, which soared to a new high of 1083 in the morning, and proceeded to fall to 1040 in an outside day. Earnings were reported post-close and missed. Another factor that some pointed to was a note by JPM’s quant Marko Kolanovic, who echoed previous warnings about low volatility. Nothing really new there, many finance luminaries have warned of low vol, but the kid smoking weed, living in his mom’s basement, is still printing money by shorting near VIX for the ‘inevitable’ roll-down.
–The curve steepened with notable selling in the long end. 2/10 rose 2.3 bps to 95.4. 5/30 was only up a bit over 1 bp at 108.3, but seems to have clearly rejected the low made after the June FOMC hike (93.4) and now has legs to advance. Part of the weakness in the long end may have been spurred by AT&T’s huge bond sale. There were also some decent size shorts in dollars, for example, 2EV 9775/9750ps 2.5 paid for 15k. Settled 2.25 ref 9802.5 in EDZ9.
–Interesting clip on FT regarding Japan: “Permanent job vacancies outnumber applicants for the first time.” If THAT situation doesn’t lead to wage increases what will? On the other hand, I saw another clip this morning where Amazon is holding a competition for the use of robotics to replace workers in warehouses. Oh, if we could only get back to the good old days. The Rolls Royce CEO, in an interview coinciding with the release of the new Phantom VIII, when asked about self-driving vehicles said. “Our customers have access to chaffeurs.”
–Q2 initial GDP today expected +2.6. Atlanta Fed forecasts 2.8, and some are saying there’s a chance of a 3 handle. A ‘win’ for Trump to close out the week?
July 27. FOMC fizzle…except for gold
–USD continued to decline as another FOMC announcement came and went. “The Committee expects to begin implementing its balance sheet normalization program relatively soon…” I would peg “soon” as September. While the Fed wrings its hands over lack of inflation, the commodity complex is perking up a bit. The Bbg Commodity Index BCOM was as low as 79.4 in late June and is now 83.7, mostly due to oil of course. However, gold also jumped over $10/oz after the Fed announcement. EUR highest in two years having traded as high as 117.40. And of course, inflation in financial assets is well entrenched.
–Amusing story in Reuters: “The U.S. Federal Reserve’s plan to reduce its $4.5 trillion balance sheet could exert the same squeeze on emerging markets next year as three interest rate hikes, an Institute of International Finance (IIF) study shows.” Um, the Fed’s interest rate increases thus far have only seen EEM rally (the emerging mkt etf). So, last December EEM traded as low as 34. Now, after three hikes it’s up to 44. Does that mean when the Fed starts to reduce the balance sheet it will ‘squeeze’ up another 30%? EEM is the mirror image of DXY, and as everybody knows, rate hikes haven’t done much for the dollar this year; financial conditions in general have eased.
–Implied vol lost its mojo on yesterday’s rally, with TY rejecting 4%. TYU 126 straddle settled 1’01 from yesterday’s atm of 1’09. Pre-Fed there was once again buying in 2EZ 9800 straddle for 32.5, settled 32.0. Despite the lackluster environment we currently have, plenty can happen going into year end. It’s all going to turn around on the eclipse! August 21.
–Today’s news includes Jobless Claims 240k. Durables expected +3.7 with non-def, ex-air expected +0.3. AMZN reports earning today.
http://www.reuters.com/article/us-emerging-markets-flows-fed-idUSKBN1AC191https://
www.space.com/33797-total-solar-eclipse-2017-guide.html
July 26. Long end leads rates higher
–Longer dated treasuries led the fixed income market lower Tuesday, in front of today’s FOMC meeting. Tens finished up 7.1 bps to 232.3 and 30y +7.5 bps to 290.7. The curve steepened, with red/gold pack spread gaining an impressive 4.25 bps to 62.25, as the gold pack (5th year) fell nearly 9 bps. While no rate change is expected at today’s FOMC, there could be hints that balance sheet reduction will begin in September. The ease in general financial conditions will certainly be a factor as USD weakens, long end yields remain low, stocks press to new highs, corporate spreads tighten. (Junk bond etf’s, like everything else except for GE and IBM, are making new highs). It’s little wonder that consumer confidence posted its second best reading since 2001.
–I mentioned the strengthening of the copper/gold ratio yesterday that Gundlach often refers to as an indicator for treasury yields. It’s higher again this morning with copper building on gains after yesterday’s upside breakout and gold down this morning. On yesterday’s sell off in bonds, implied vol firmed, with TY vol again approaching 4%. USU 153 straddle settled 2’46 ref 152-20. Two days ago the atm straddle was just above 2’30. One last thing arguing for higher rates at the long end was this Trump quote in a WSJ interview about who might be in the running for the Fed Chair, “I’d like to see rates stay low.”
–Apart from the FOMC meeting, New Home Sales are released this morning expected 611k and 5’s are auctioned.
Copper/gold ratio
July 25. Copper surge; implied treasury vol edges up
–Last week it was noted that Merrill’s MOVE index of treasury volatility had hit an all time low; yesterday in an otherwise uneventful day premium selling appeared to have been shut off and some buyers emerged. Most notably, there was a new buyer of 20k USU 155c for 1’01 to 1’03 as futures traded around 154-13 to 15. Open interest doubled in the strike to 27.6k. The early quote in the 155 straddle was 2’32/2’34 (6.8 ref 154-17); with the call buying it popped up to 2’40/2’43 and USU 154 straddle settled 2’40 or 7.2. There was also a large amount of wing buys: TYU 130.75 and 131calls 1 paid in each for total 20k. On the put side a total of 80k FVU 114.75 and 115 puts for 0.5 each. Late in the session there was a buyer of 1k red pack atm straddle strips for 171.5. The point is, that there was finally premium buying. The second somewhat odd note is that bonds slid even as the call buying was taking place; it seems as if the call buys must have been a hedge against much larger selling pressure elsewhere. Typically large delta option trades can push the bond future pretty easily, but in this case USU settled down 17/32’s and is continuing a slide this morning. (Ten year cash yield +2.0 yesterday to 225.2 and 30y bond +2.9 bps to 283.2).
–Copper is simply exploding higher this morning and is within shouting distance of the infrastructure inspired highs of February. Not sure of the reasons for this, but again, China seems to have relaxed some of the more stringent monetary reforms… maybe that has taken a weight off copper and perhaps we’re even seeing some treasury selling by China. Oil is also adding to yesterday’s bounce, currently +50 cents at 46.85 (CLU7). Nasdaq closed at a new record high.
–Yesterday we looked at 2EU 9800/9775/9750 put fly which traded small at 3 during the day. Settled 2.75 ref 9811 in EDU9. Not a bad short in front of tomorrow’s FOMC. Language on inflation not expected to change much “running somewhat below 2%”… market measures little changed.
July 23. Central Banks Retreat
What if Trump and Yellen are working hand in hand? Trump: “I’ll throw outlandish claims on my Twitter account. Janet, you make sure nothing takes stocks down….together we’ll work to weaken the dollar. That will help (or at least give the appearance of helping) US manufacturers. It will also keep oil somewhat stable so that US shale producers can continue to displace supply from the MidEast. I’ll be the volatile one, you keep market volatility low. I’ve found that the best form of manipulation is to make patently false claims, and then walk them back over time. Often the secondary reaction is even greater than the initial misdirection. For example, your initial threat to remove accommodation in the name of financial stability was a nice touch. The way you ignored that theme at your testimony was huge. New highs in financial markets and a weaker dollar. Keep up the good work.”
Clearly I am jesting in the above paragraph, however, the dollar closed at its low, stocks are at new all-time highs, and the MOVE (volatility) index closed at an all-time low. Draghi helped, by leaning against his Sintra comments: “the last thing that the Governing Council may want is actually an unwanted tightening of the financing conditions that either slows down this [recovery] process or may even jeopardise it; and that’s why we retain the second bias, or let’s call it, reaction function” The German bund fell 10 bps this week to 50.6 and the US 10y treasury dropped 8.5 to 223.2. VIX closed at 9.36.
In Eurodollars, calendar spreads tightened. The EDZ17/EDZ18 spread closed at 28.5, down 4 on the week. The white/red pack spread (1st year to 2nd year) closed just above ¼% at 27.375, while red/green closed less than a bp above the year’s low at 21.0. (Post-election high was in mid-40’s; we’re right back to the one-hike a year mantra). There was a large, 60k, buyer of EDZ18/EDH19 three-month spread on Friday for 5 bps which appeared to be a new position. The spread in front, EDU8/EDZ8 settled 8.0, but most 3-month spreads are between 4 and 6. Several trades recently have faded year-end money market pressures embedded in December contracts, and that’s the theme here, to fade relative weakness in EDZ8, capture roll and squeeze out year-end premium.
The central banks dampen risk. At the same time, the nano-second trading algos keep the bid/ask tight across correlated markets. Why no volatility? That’s why. The price of risk dwindles away in the face of excessive stability. As they say on the black-and-white mystery movies while piping in ‘smoke’ from dry ice, “It’s almost TOO quiet.”
So what could change things? The Fed meeting for July is Wednesday, with possible hints of balance sheet adjustment implementation. (No press conference). On Thursday, the Senate holds hearings on Randal Quarles as a new Fed board member.* Recall that he leans more towards models as the basis for central bank decision making, rather than the discretionary approach favored by the current Fed. Questioning along those lines at the hearing would not be surprising. Perhaps it wouldn’t much matter, except that Yellen’s term is up in half a year, and there’s speculation that Fischer could resign before next summer. In other words, the composition of the Fed could change, and with labor markets tight, it might tilt the balance towards the more hawkish posture suggested by, for example, the Taylor Rule. Not much in early August, but the Jackson Hole symposium is August 24-26. (Sept treasury options expire August 25). Then in September, the FOMC is on the 20th, and the debt ceiling fight should be in full swing. The kink in the bill curve in mid-October already is testament to this issue (mid Oct bills are 5-6 bps higher than Sept and 3 higher than Nov). Another event to keep in mind is the 19th Nat’l Congress of the Communist Party of China, which is in autumn. Any chance that China’s data takes a turn for the worse into the end of the year? From a Bloomberg article July 12: “President Xi Jinping told the politburo in April that ‘financial security’ was a top policy priority for the year. That led the central bank to tighten liquidity, while the ambitious new banking regulator unleashed a ‘regulatory windstorm’ that sent shockwaves through the banking system. The storm appears to be passing, as the People’s Bank of China has become more generous with cash injections while the China Banking Regulatory Commission has delayed implementation of a significant new directive.” Both the Shanghai Composite and Copper have been in uptrends since early May. Kospi is up 20% since the beginning of the year and Hang Seng is up nearly 25%. Loose monetary conditions to keep the economy humming into the Nat’l Congress may reverse in its wake.
Here’s a guy with a view that things may change: On Friday there was a buyer of 262k October VIX 15/25 call 1×2 vs 12 put. (Sold the put to finance the call spread). I am not sure of actual premium, but mid-markets were 15c 1.40, 25c 0.40 and 12p 0.80. These prices suggest a small credit; the link below suggests the trade was entered at flat premium. (Thanks Andy O’Kelly for the tip).
http://www.businessinsider.com/vix-mystery-trader-massive-bet-stock-market-volatility-2017-7
Given that spot VIX is 9.36, the 12 put appears to be the risky leg, though a quick move above 25 would also be problematic. (Oct 35c could cap upside risk for 0.20). The point is, this is a huge trade that would benefit by an upside move in vol, and as noted above there are several possible catalysts.
The Fed, the ECB and China have all pulled back from hinting that less accommodation is on the horizon. Stability sows the seeds of instability. We just haven’t had any rain yet.
Selected option expiration dates:
TYU7 August 25 corresponds to Jackson Hole
Oct ED Midcurves October 13 Debt ceiling fight
Oct VIX October 18
TYX7 October 27
Nov ED midcurves November 10
July 21, 2017. On the MOVE….lower
–Both the MOVE index and DXY closed at a new low. The former (ML Volatility Estimate, yield curve weighted avg of normalized vol on one-month treasury options) closed at an ALL TIME low of 48.25. As a point of reference, the high in 2008 was 264.0.
–EUR was trading late at 116.30, highest since August of 2015.
–Euro$ spreads in general continued to compress. EDZ7/EDZ8 settled 30.5 but was 29/29.5 late in the electronic day. Jan’18/Jan’19 FF spread settled 25.5. One hike a year…but is that going to be the case with a potential new Fed composition?
–Jobless Claims at 233k yesterday and continue to trend lower (that part of the Fed’s mandate is fixed). No economic news today, but August treasury options expire. TYQ 126c still have 91k open interest. The peak strike in TYU is the 127c with 161k open. FOMC next week on July 26. Just a reminder, there are now TY options that expire on that day, week-4 July Wednesday…the 126^ settled 28/64’s ref 126-02. About 1k open.
–It was in the year of Q1 2014 to Q1 2015 when the eur/usd adjusted lower, from 140 to 105 as the ECB poured on the gas. Perhaps the fx move was the true stimulant for the eurozone. What happens now, on a new bout of EUR strength?
July 20. ECB is the main event today
–Same story as yesterday. Implied vol under pressure, stocks new highs. USD edged slightly higher, rates nearly unchanged. TYU 126 straddle opened 112/113 but was being sold at 1’11 at the end of the day (3.7 vol). August treasury options expire Friday. All one-year ED calendar spreads from reds back are around 20 bps. Red/green pack spread 21.75, Green/blue 19.0, Blue/gold 18.5. Not much premium built in anywhere for the idea of Fed balance sheet reduction.
July 16, 2017. Third Mandate of Financial Conditions Recedes
“It’s almost an embarrassment be an American citizen traveling around the world and listening to the stupid sh-t we have to deal with in this country…” Could be worse Jamie. Could be Greek. Oh… Nevermind. Sorry about that Mr Papademetriou.
I had thought the curve would steepen after the June FOMC because I thought it was going to be a dovish hike given mushy economic data. Instead, the curve flattened. The dovish stuff is coming out now. First Brainard on Tuesday: “In my view, the neutral level of the federal funds rate is likely to remain close to zero in real terms over the medium term,” Brainard said. “If that is the case, we would not have much more additional work to do on moving to a neutral stance.” Then Yellen in her comments on Wednesday: “…our view that the federal funds rate remains somewhat below its neutral level. …Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance.” Then on Friday, Kaplan with “we want evidence of inflation progress before hiking again.” Inflation measures have fallen off again, with YOY CPI just 1.6% Friday (Core was 1.7). Retail Sales were -0.2%. The odds of a Sept hike fell to 10% and a hike before year end is now priced only at about 50/50. Below is a chart of the FF target and a couple of market measures of inflation, the ten yr note/tip spread and 5y5y forward inflation swap.
But what about the Fed’s dots? Well, those are just a loose guideline. Anyway, now it’s all about financial conditions and risks to stability, right? Some analysts even termed ‘financial conditions’ a third mandate. Well, as the Fed de-emphasized that point over the past week and rather, chose to highlight soft inflation, it was an engraved invitation to sell the dollar and buy equities. Stocks made new highs. VIX sank to 9.51. Especially perky was the Emerging Markets etf EEM, which soared nearly 6% from the previous Friday’s low on almost daily gap opens. Of course, Dimon’s subtle reference to the political circus which is short on substantive policy progress is another USD negative. (DXY lowest close since August of last year).
Now I want to focus on a different part of Yellen’s testimony. She said “We think that our purchases of assets during the QE years around the financial crisis did have some positive effect in depressing longer term interest rates. And, so over many years, as our balance sheet shrinks, we would expect to see some increase in long term interest rates relative to short term interest rates. But of course, we will take that into effect, namely the steepening of the yield curve, in how we set the fed funds rate, which will become, is now, and I hope will remain, our primary tool for adjusting the stance of monetary policy.”
A comment from Ben Hunt of Epsilon Theory is more succinct, and more rooted in reality: “My point is a simple one. In exactly the same way that QE was deflationary in practice when it was inflationary in theory, so will the end of QE be inflationary in practice when it is deflationary in theory.” *
Both of these snippets get to the same core. QE depressed long term rates because it siphoned off investment in capital equipment for leveraged ‘investment’ in stocks and other financial assets. It removed the inflation premium. It removed risk premium. In a closed textbook world, the marginal buyer, the Fed, drives up price and lowers yields and spurs borrowing and capital investment. In the real world corporates got the message on borrowing at low rates, but never saw true economic opportunities. ‘How ya left?’ With record corporate debt as a % of GDP and diluted balance sheets (outside of cash-rich tech titans). Yellen wants to gingerly wind down QE in a way that will be almost unnoticeable. However, by embracing the FF rate as the primary Fed tool, she’s sending a much more opaque invitation to sell bonds. Back to Dimon again, “When that [unwinding of QE] happens of size or substance, it could be a little more disruptive than people think.”
I was gently heckled after last week’s comments calling for higher rates at the long end. But, I’m doubling down this week. Although on Friday USU traded to a new high on the week of 153-16, by the end of the day it was trading a point lower at 152-13, less than a point away from the recent low of 151-18. When Yellen started her testimony on Wednesday, USU was around 152-08. All interest rate futures rallied from there, but the bond is near that initial level even with the soft inflation and retail sales data. At the futures settlement time (USU7 152-20s), I marked 5/30 spread at 105 bps. This had been a long term support area. [Chart below] On June 13, the day before the last FOMC, 5/30 was 108.5. By the end of June it had sunk as low as 92, but as of Friday it’s more or less testing the breakout level. It’s either a great sell level here or an indication that the flattening after the Fed was the final capitulation.
I’ll end with a quote from another Greek, this one being 12 years old but amusing nonetheless, from George Economou, CEO of DryShips, as noted in FT Alphaville: “Because Americans are the dumbest investors around, and there’s lots of liquidity in this market.” The FT mentioned DryShips because of an interesting piece in the Wall Street Journal detailing new financial gymnastics by Economou. ‘Plus ça change, plus c’est la même chose.’ Good read; this guy’s almost as creative as the central banks in building false value.
http://m2m-vn.com/shipping-companys-bizarre-stock-maneuvers-create-high-seas-intrigue-spencer-jakab/
* http://wolfstreet.com/2017/07/13/what-will-the-fed-do-jobs-productivity-inflation-qe-tighten/
