June 2. Surging stocks are no help to treasury shorts
–Fixed income settled only marginally lower despite record highs in stocks. Once again, the curve edged to new lows for the year. As ADP came out strong at 253k, July FF were immediately sold, and closed down 0.5 on the day at 9887.5. While a June hike is considered a lock, the market is loath to price in more hikes, even though the economy is running along at full employment. For example EDZ7/EDZ8 settled at just 31.5, down 1.5 on the day. EDH8/EDH9 settled 30…recall a sizable buyer early in the week at 33.5. All near one-year calendars settled at new lows.
–Illinois downgraded close to junk. Looks like another job for the Fed….but by promising not to disturb the long end of the market, it just makes the pension problem worse and worse.
–Oil getting crushed today with July Crude below $47. Stocks are building on yesterday’s record gains.
–NFP today expected 182k, but if ADP couldn’t dent the interest rate market, it’s hard to imagine that today’s data will. Treasury shorts dying by a million cuts.
June 1. Delinquencies edge higher
–Once again, the curve edged to a new low with 2/10 down 1 bp to 92.2 and red/gold euro$ pack spread 1.75 to 60.625. Stock indexes fought back from early weakness which was spurred in part by JPM’s warning that low volatility had contributed to a decline in Q2 trading revenue of 15%. Large financial shares closed lower, with JPM and WFC -2%, GS -3.3% and BAC -1.9%. There was an early seller of 70k EDU7 9862p at 4 bps ref 9867.0; the 9862 straddle settled 12.5. SF Fed’s Williams continues to say his baseline forecast is for 2 more rate hikes this year. While July FF are >90% priced for a hike in two weeks, January’18 FF are priced at a spread to July of only 14 bps. (9888 and 9874). The market’s baseline is substantially below Williams’.
–An article on Reuters says Small Business Borrowing has hit a six month low. “The Thomson Reuters/PayNet Small Business Lending Index dropped a third straight month in April to 123.1, down 5 percent from last April and the lowest level since October.” Additionally, “The share of loans more than 30 days past due was 1.7 percent in April, the highest rate in more than four years, PayNet data showed.” [Link below]. Delinquencies have been rising on credit cards and auto loans, and now small businesses as well.
–News today includes ADP expected 170k and ISM Mfg at 54.6. It appears that treasuries are going into tomorrow’s Payroll data at the top end of the range.
http://www.reuters.com/article/us-usa-economy-lending-idUSKBN18S4DC
May 31. Stocks near new highs, but no signs of inflation…
–Both Bullard and Brainard voiced worries about inflation not reaching target. Here’s a snippet from Brainard’s speech: “…I see some tension between signs that the economy is in the neighborhood of full employment and indications that the tentative progress we had seen on inflation may be slowing. ….it may lead me to reassess the expected path of the federal funds rate in the future.” Well, I have news for you Lael, the euro$ curve has already adjusted the path lower. This morning, the FT has this article: The Fed’s Conundrum: Stubbornly Low Inflation. And the WSJ includes this piece: Doubts Cloud the Fed’s Rate Increase Plans Beyond June. [Beige Book summary of conditions released this afternoon]. The curve continues to flatten and that’s contributing to weakness in financial stocks. For example, in a relatively flat broader market, GS fell 2% and JPM was down 1.7%.
–Early yesterday morning there was a buyer of about 40k EDH8/EDH9 one-year ED spreads for 33.5. Volume by 8 AM Chicago time was a bit over 55k. By the end of the day this spread had eroded to just 31/31.5, with volume just over 63k, as the curve generally flattened to new lows (H8/H9 settled 31.0, a new low). For example, 2/10 treasury spread closed at 93 and edged slightly lower after open outcry. The red/gold pack spread also closed at a new low of 62.375, almost exactly where it was on election day, though it had reached 100 in December.
–There was a large buyer of midcurve July 0EN 9850/9862c spds for 1.5. Appears to be a roll-up of a short as open interest fell 136k in 9850c and rose 148k in 9862c. The underlying contract, EDU8, closed at 9836.0. The pre-employment trade has typically been to buy near midcurve puts and put spreads and sell calls. It hasn’t really worked out and the open ended call risk is getting a little more uncomfortable.
–Oil and copper both lower this morning, adding to the disinflation story.
May 28. Wasted Words
Can you tell me, tell me, friend, just exactly where I’ve been?
Is that so much to ask I’ll pay you back no matter what the task
You seem really sure ’bout something, I don’t know. –Allman Bros Band, Wasted Words, 1973
Where have we been in 2017? The chart below summarizes part of the story. [Chart of 5y5y inflation forward swap, 2/10 treasury spread, and volatility on the TY contract]. For context, the chart goes back a decade, but what I am focused on is simply the last six months. TY implied volatility started the year high and it’s now near its low at around 4%. 2/10 yield curve spread got up to 135 in December and is now at its low for the year around 95. One market measure of inflation, noted on this chart as the 5y5y inflation forward swap, surged to around 260 post-election; it is now around 225 bps. Former Speaker of the House John Boehner has captured the mood. “I was a little more optimistic about [tax reform] early in the year; now my odds are 60/40.” He added, “Tax reform is just a bunch of happy talk.”
I was just going to end my note right here, and not waste any more words. The market seems really sure about the Fed hike in June. Economic data has softened. The curve has flattened and stocks have risen, with the 10 largest stocks accounting for 54% of the total return in past month.
Can you tell me, tell me, friend, just exactly where I’ve been?
Former Fed Chairman Ben Bernanke touches upon past history in his blog this week: Some Reflections on Japanese Monetary Policy.
https://www.brookings.edu/wp-content/uploads/2017/05/es_20170523_bernanke_boj_remarks.pdf
It’s this speech that really crystallizes the title of the Allman Brothers Song. Why does Bernanke bring up the topic of Japan? Is it that he believes all developed countries are moving in that direction (of persistently low growth and a failure to hit inflation goals)? It seems to me that the entire subtext of the speech is that debts need to be inflated away.
He starts… “Why ending deflation and escaping the effective lower bound has proved tougher than I once expected will be one of the themes of my talk today.” He owns up to some of his previous misconceptions: “In particular, in some of my early writings, I did not always demarcate sharply enough between what monetary policy can achieve on its own, and what requires some degree of coordination with fiscal policy.”
He notes that with the Abe-Kuroda combination, the BoJ’s balance sheet has grown to 88% of Japanese GDP, compared to the Fed at 24% and the ECB at 34%.
“In general, even at the effective lower bound, monetary policy can boost aggregate demand, employment, and inflation in one of two complementary ways – by easing financial conditions (for example, by lowering longer-term interest rates, depreciating the currency, or lifting the stock market) – which stimulates aggregate demand directly; or by raising the public’s expectations of inflation, thereby lowering real interest rates as well as increasing expectations of future growth.”
[This is an important passage as it relates to the US and every other developed economy, I return to it below].
Then he says, “In any case, in Japan both channels of monetary policy transmission seem to be approaching their limits.”
Here are a couple of other snippets:
“Inflation expectations in Japan did rise after the initial announcement of QQE, but overall they have been less responsive than hoped….”
“…understanding the links between central bank talk and the expectations of households, businesses and markets is an increasingly important challenge for monetary policymakers.”
He then mentions Japan’s high debt to GDP, which leads to a discussion of coordination between monetary and fiscal policy. If there is anywhere in the world where there is the possibility of strong coordination between the central bank and the government, it’s Japan. It’s certainly not the ECB and the US. Yet Bernanke insists upon going down this fantasy academic exercise. But what’s really stunning is the next turn. He talks about the central bank maintaining its independence as it embarks upon its stimulus with fiscal cooperation, and then says ”…the gov’t has to accept the risk that a future leadership of the bank would renege on the commitment.”
It’s an extraordinary thought process. Here’s my interpretation of BB’s speech: 1) I didn’t know how hard it would be to stop deflation, 2) Now I know: all we need to do is boost stocks and calibrate the public’s inflation expectations, 3) a strong independent central bank can accomplish the task, but it needs a subservient government.
That’s a perfect solution, concentrate power in the unelected central bankers. Wasted Words.
One more note on the embedded passage which I copy below:
“In general, even at the effective lower bound, monetary policy can boost aggregate demand, employment, and inflation in one of two complementary ways – by easing financial conditions (for example, by lowering longer-term interest rates, depreciating the currency, or lifting the stock market) – which stimulates aggregate demand directly; or by raising the public’s expectations of inflation, thereby lowering real interest rates as well as increasing expectations of future growth.”
Since the beginning of the year, US financial conditions have eased. It’s as if the Fed is trying to stimulate growth and the economy, in spite of saying that accommodation needs to be removed. Longer term rates have declined, USD has come off its highs, the stock market has risen. The public’s expectation of future growth should be higher due to possible tax reform. Yet inflation expectations appear to be declining. With Moody’s downgrades of China and Brazil last week, risks from overseas will again be on the radar.
May 25. I just can’t figure it out…
–One of my favorite Far Side cartoons is attached. The perplexed donut shop proprietor. “I’m moving over 500 donuts a day and I’m just barely squeakin’ by.” …as the bloated employee looking on innocently sweeps up.
–The owner is the Fed. The helper is the market. You keep making the donuts, I’ll keep eating them. So what did the Fed minutes say yesterday? “Maybe we should use a few less sprinkles on the iced donuts.” That’s not putting anyone on a diet. It’s telling the asset markets that the Fed is not going to stand in the way. Sure we’re going to hike in June, (which everybody knows already), but we’re going to trim the balance sheet in imperceptible steps. The Fed claims to have concerns about CRE and asset markets, but then can’t seem to understand why excesses develop as they watch, scratching their heads like innocent bystanders.
“Under the proposed approach, the Committee would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month. As the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve’s securities holdings would become larger. The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels. The final values of the caps would then be maintained until the size of the balance sheet was normalized.[in June of 2073]
Nearly all policymakers expressed a favorable view of this general approach”.
–OK. This really doesn’t sound like something that is a ‘substitute’ for changes in FF target. So, bonds and stocks rallied. Way to lean against easier financial conditions. The STAFF ACKNOWLEDGED the lax environment: “Prices of risky assets increased… Treasury yields declined, dollar depreciated. …decline in yields driven in part by expectations of a somewhat slower pace of rate increase following FOMC communications…and waning of investor optimism about prospects for more expansionary fiscal policies.”–It appears that even the guys on staff are saying WTF.
–Anyway, the ten year yield declined 2 bps to 226.4 at futures settle, and was down to 225.2 ref 126-05+ late in the session. Nasdaq’s at a new high, blah,blah, blah. Option premium remains offered. Slight new low in 2/10. Seven year auction today.
May 24. No cushion / no policy room for the Fed….
–China downgraded by Moody’s in part due to the explosion of debt, yet US stocks are slightly positive this morning. http://www.reuters.com/article/us-china-economy-rating-idUSKBN18K04Q The sell off relating to Trump’s misadventures has been erased.
–US rates rose yesterday with tens up 3 bps to 228.3. Auction pressure and buoyant stocks were factors; 5 year auction this afternoon. Fed releases minutes from the May FOMC meeting today, with possible clues regarding balance sheet reduction. Several officials have emphasized that the Fed will go slow in order to prevent any market disruption. In terms of odds for a June hike, FFN7 was trading 98.98 yesterday and settled 98.5, indicating 85%. The peak one-yr euro$ calendar is still EDZ7/EDZ8, which closed 36.5, up 1.5 on the day.
–Some early lifts in July TY calls yesterday mostly related to replacing expiring June exposure, however, the trend of overall pressure on premium continues. July atm (125.5) straddle settled at just 1’14 or 4.2.
–If missed yesterday, Moody’s warned on cov-lite loans in the US. Its “newly released report finds poorly structured covenant-lite loans making up a much larger proportion of the US leveraged loan market than before the credit crisis, portending lower investor recoveries during the next downturn.” The report notes that cov-lite loans made up 3/4’s of the new institutional loan issuance in 2016.
–Overall, credit spreads remain extremely tight, implied vol is low everywhere, stocks are at lofty levels and the Fed has warned on CRE. The Fed has been attempting to create some ‘policy room’ for the next potential downturn, but there is simply no cushion in current market pricing…which, of course, keeps the pressure on the Fed as the only game in town. (…so buy stocks)
May 22. 2/10 below 100 bps is NOT a sign of economic confidence
–Crude oil continues to rebound from the plunge in the early part of the month and CLN now trades above $51, having had a close below $46 earlier in May. Canada and Aussie are lagging the bounce, which is likely an indication that the oil run-up will falter.
–On Friday yields rose around 1 bp, tens were up 0.9 to 224.2. However, an underlying bid remains in place. June treasury options expire Friday, with the most open interest in 126, 127, and 128 calls; likely going to be buying to replace those deltas.
–2/10 treasury spread closed at a new low for the cycle just under 97 bps. Red/gold closed at 65, essentially at new lows as well. There is nothing to suggest a rebound in yields besides the fact that they are very low. Fed Governor Brainard speaks this evening, and she’s likely to pour cold water on the economic resurgence story in her own inimitable way. By the way, she is probably in the top 4 in terms of importance in the Fed’s thinking. There’s an interesting post on ZH detailing deterioration of lending….here’s a link
May 21 weekly – Economy Clouded Even Before Political Risks
Last week I quoted Ben Hunt of Epsilon Theory: “…how is it possible that our capital markets are not similarly gripped by volatility and stress? What is responsible for breaking the transmission mechanism from political risk to market risk?” It was a timely question.
Political uncertainties have now spilled over into markets, and the possibility of further volatility and stress has increased. This week potential Comey news will overshadow all else (with CNN reporting this weekend that Comey now believes Trump was trying to influence him). http://www.cnn.com/2017/05/19/politics/james-comey-trump-influence/
On Wednesday, the FOMC minutes from May will be released, which will perhaps contain information about Balance Sheet Adjustment plans. There are Fed speakers in the early part of the week, including Lael Brainard on Monday evening. Brainard doesn’t appear as frequently as some Fed officials, and had previously been a consistently eloquent voice for the dovish argument. However, in early March she was more upbeat, though still repeating that removal of accommodation should be gradual. She also said she favored a subordination strategy, “…that would prioritize the federal funds rate as the sole active tool away from the effective lower bound, effectively subordinating the balance sheet.”
Now I am just going to cite a couple of news stories and tie them into markets. This isn’t meant to be a comprehensive view of the news, however, the markets supposedly ARE comprehensive, incorporating all information, and I’ll follow up with a couple of market notes.
First, from Reuters: “U.S. states collected less personal income tax revenue in April than they did a year earlier, a Reuters analysis shows, and analysts said they believed high earners were shifting income to next year, hoping for tax cuts from the federal government. State personal income tax (PIT) revenue dropped an average of 6.6 percent in April from the same month last year in the 27 states for which Reuters has data.”
http://www.reuters.com/article/us-usa-states-tax-analysis-idUSKCN18F2GQ
A drop of 6.6% is large, even if the conclusion of an income shift into next year is correct.
Second, a Bloomberg article highlights declining real estate deals. “In New York City, first-quarter property sales plummeted 58 percent, to $4.3 billion, compared with a year earlier, according to data from brokerage Cushman & Wakefield Inc. It marked the lowest quarterly sales volume in six years. Nationwide, the picture wasn’t much better. Sales dropped 18 percent, research firm Real Capital Analytics Inc. found.”
https://www.bloomberg.com/news/features/2017-05-18/real-estate-deals-vanish-in-new-york
A drop of 18% across the country. Hard to ignore. When deals decline, prices follow. A ZeroHedge article attributes a part of this fall to Chinese capital controls which were instituted at the beginning of this year. I don’t know how to weigh this factor, but what I do know is that even without Trump’s issues, the goal of reaching 3% growth in the US appears to be a tall order, given some of the deterioration we’re seeing, if only on an anecdotal basis. If stocks slump, it will be impossible.
The political environment now looms much larger. The response of the Fed will also be key. Many markets obviously had huge moves after the November election, and have either stalled or else completely reversed those moves. The dollar index closed the week at the low of the calendar year. It has reversed the election rally, which topped at the very start of the year, and is now around the average level of 2015 and 2016. The Euro closed at its high, just above 112, having shaken off populism risks. The Daily Shot notes that the 3m 25 delta risk reversal in EURUSD now slightly favors calls!
The US curve has flattened to new lows, with 2/10 ending the week at just 97 bps. This is down nearly 40 bps from the high posted in December following the euphoria post-election. I have previously mentioned the round-trip of inflation measures such as the ten year treasury to tip spread, now around the year’s low of 180, having been holding above 2% for the first couple of months of the year. The 5y5y inflation forward swap tells the same story.
I include below a chart of China’s 5/10 gov’t bond spread, which has inverted. I suppose that the interesting thing to note here was that the aftermath of the US taper tantrum in 2013 led to a high in China’s rates as well as the US, but at that time China’s curve did not invert. Now, with Chinese rates at a much lower level, the China curve IS inverting as financial conditions have tightened. This fits the ZH Commercial RE story. Fed officials have warned about frothy valuations in US CRE. Perhaps THAT asset ‘bubble’ bursts as a result of China’s financial policies.
It’s a bit hard to see on this chart, but 5’s and 10’s are essentially the same yield, 3.65 and 3.63. In 2013 China’s 10 hit 4.75. The difference between the two yields is in the lower panel.
The Trump/Comey situation is going to drag along, and drag down the odds of instituting important parts of the economic agenda. I think new rules on student loan debts are also going to be a negative for the economy at the margin. (One company being chosen for collections, with increased fees).
The Fed leans towards removal of accommodation, and odds for a June hike closed at around 75%. We’re not all that far from the end of Yellen’s Chairmanship, and the Fed may not be as generous in terms of cushioning asset declines as in times past. The underlying treasury bid is underpinned by both political and economic risk.
May 19. Don’t ignore flattening curve
–Earlier this year Brazil’s Bovespa index reached a five year high. Yesterday it was down 8.8% on political turmoil involving bribery reaching the highest levels of gov’t. Just a small reminder of risk. In the US interest rate market, changes were much more nuanced. However, it worth noting that back eurodollar spreads edged to new lows, as the red pack (2nd year out) was the weakest part of the curve -3.5. Red/gold pack spread fell 1.25 and is now below 65 bps. Red to green pack spread (2nd to 3rd year) lost 0.5 bp to close 26.5. 2/10 treasury spread sits just above 97 bps.
–A flatter yield curve isn’t particularly encouraging for the function of financial machinery. We still live in a ‘borrow short/ lend long” world. While US stocks were able to bounce a bit, some of the financial indexes look sick. For example, KRE (regional bank index) and XLF (large financial services) are both pretty much near lows for this calendar year. (This in spite of Mnuchin yesterday saying the admin does NOT support a separation of banks from investment banks). July FF are bouncing around between 9890/94, closing yesterday at 9892, 73% chance of hike in June.
–Trump is off to the middle east this weekend. Today’s news includes comments by Bullard at 9:15 and Williams at 1:40.
May 18. Political theater
–SPX fell 1.8%, Nasdaq dropped 2.6% and Russell 2.8% as the Trump agenda morphed from economic stimulus to a long parade of investigations and testimony. There’s not much question that a big part of the equity market rally was predicated on tax cuts and growth, so it should be no surprise to see an unwinding of expectations. As mentioned yesterday, some markets have already fully erased post-election gains (dollar index, 2/10 treasury, inflation measures). SPX had been just below 2200 in the months before the election, and closed yesterday at 2357. Many had expected a ‘crash’ if Trump was elected, which is to say a sell off from nearly 200 points lower than our current level. That could still occur…
–The price of insurance suddenly went up. For example, on Tuesday, USM atm straddle closed at 1’26 ref 151-09. Yesterday the USM atm straddle (which shifted to the 154 line) settled at 1’50 as the future price rose 2-06. While implied vol rose, it’s not particularly high, it’s just bouncing off a very low base.
–The peak one-year eurodollar calendar is EDZ17/EDZ18, now only 33 bps. May FF to January’18 FF (FFK7/FFF8) closed at 29, just above 1/4%, indicating one more hike in 2017. FFN7 closed up 3.5 at 9894.5, so the odds for a June hike have been shaved back to 62%. It’s times like this where the Fed should probably show a bit of backbone and actually tighten even as asset prices give back some gains. However, the 2/10 treasury spread made a new low of just 97.2 bps (-5.7 on the day) and financial stocks were hammered; another hike would likely cause further flattening. Trump will probably pull Yellen aside and ask her to back off any tightening plans…
–Comey testimony next Wednesday, which will likely overshadow the release of the FOMC minutes from May later in the day.
–Today’s news includes leading Indicators, expected +0.3 and Philly Fed, expected 19.6 from 22.
