May 8. Not all stock markets are correlated
Not all stock markets are correlated….
Below is Kospi vs Shanghai Comp. By the way, China stocks at new low for the year.
May 7. Overbought…financial stability
Employment data was released Friday. The chart below is the unemployment rate, which is just 4.4% as of April. The last time we touched this level was in May 2007, a decade ago. The Fed Fund rate at that time was 5.5% (the end of the last hike cycle). We also had a period from 1999 to early 2001 when the rate was below 4.4%, having bottomed at 3.8% in April 2000. At that time, (in June 2000), Fed Funds had topped at 6.5%. Besides those two periods, one has to go back to March of 1970 to find a rate as low as 4.4%. So in the past 47 years, or 564 months, we’ve only had 28 months at a rate below 4.4%, around 5% of the time.
The Fed has attained the employment mandate.
There has been a lot more discussion recently of rules based decision making regarding Federal Reserve policy, and the rules say rates should be quite a bit higher. With Friday’s data release, it’s no surprise that market expectations for a hike at the June FOMC ratcheted up to a new high, with July FF at 9892.0 pricing about 75% odds of a hike, and June Eurodollars at 9869.5, pricing slightly lower odds. On the other hand, the Eurodollar curve is loath to price in a series of hikes, in part because the economic data has been coming in on the soft side and the reflation narrative has sputtered. For example, EDM18, one year forward, is 9830.5, only 39 bps higher in yield than EDM17. I have seen two notes recently from large Eurodollar option market makers that essentially said the same thing: Euro$ puts are unfathomably cheap and open interest is huge. “I have NEVER seen put skew as cheap as it is now.” Another friend referred to it this way: “Every day [the mkt makers] are getting choked by a giant pillow.” I am sort of paraphrasing and inferring the following, but there has obviously been recent variability in libor/ois (though all one way, down), and some of these options have a long time to go. For example, EDU7 9837p trade 0.5 with 4 months to go and have 926k of open interest. EDZ7 puts: 9825p 2.0 settle with 826k, 9812p 0.75s with 388k and 9800p 0.25s (0.25/0.5) with 565k. Just as a point of comparison, open interest in futures is EDM7 1.45m, U7 1.40m and Z7 1.65m.
However, the low vol theme could cover almost all markets. It’s obvious in Eurodollars, treasuries, fx and stocks. Three weeks to go and the TYM 125.25 straddle settled at exactly 1’00. Barrons noted that VIX had slipped below 10 during the week and named the London investment firm Ruffer as the consistent buyer of 50 cent VIX call options. An article on ZeroHedge noted that 1yr implied vol on USDCNY had dropped from about 8% in the beginning of the year to just 4.7%, and cited BBG as saying the last time it happened, China devalued in August 2015. It’s this latter point which I would like to explore a bit further in terms of a possible catalyst, but first I will digress to the (related) subject of commodities.
It’s well known that industrial commodities, led by oil, have been under severe pressure, with Crude dropping over $3/bbl this week. Iron ore has plunged by about a third from its high two months ago. Though copper had a technical bounce Friday, it’s well off the ‘reflation narrative’ high set in February. Silver has had 15 straight down days and is down 12.5% from the high in mid-April.
On the topic of crude, I’ve seen the latest sell off referred to as a ‘capitulation’ trade, but I am not so sure. The chart below shows open interest at a record even with the price drop, (as friend JJ has pointed out). To me, it’s unlikely that this configuration leads to a gentle recovery in prices.
My own theory is that some of the commodity price action is spurred by China. I further suspect that some of the treasury market selling is coming from China, though a Bloomberg story this weekend notes that “China’s foreign-exchange reserves rose for a third month in April, beating estimates, as tighter capital controls kept money from flowing out of the country and the yuan was stable.” I very much doubt reserves will increase in May. President Xi recently gave a speech on financial stability in China, and it seems pretty clear that the rise in rates in China is having a direct effect on commodities.
While regulatory enforcement sprees are not new to China, investors fear there may be no let up in a new wave of tightening soon after President Xi Jinping last week made a rare speech on financial stability. http://www.reuters.com/article/us-global-markets-idUSKBN181022
Kyle Bass has noted the surge in the duration mismatch in WMPs. There have been many articles outlining the huge growth in debt in China, but most think that the PBoC and Chinese Gov’t have the resources to handle it. It’s remarkably reminiscent of the US subprime crisis, where officials almost all said that subprime just wasn’t large enough to create a systemic problem. The problem is that China has become a much larger part of the global economy. IF Chinese authorities aren’t able to gracefully tamp down on excesses, then the low vol financial world is going to blow up. Of course, the warnings from experts have been sounded, but they’ve been early (as they always are) so they’ve now faded into the background cacophony as the can is kicked along.
In an effort to get a sense of magnitude, I am adding a chart below. It shows the extraordinary growth in debt levels over the past few years as a percent of GDP. While total non-financial debt as a % of GDP in the US is about the same level at 255%, business debt in the US is only about 73% of GDP (which is still a record), while corporate debt to GDP in China has exploded from 130% to 156% in just the past five years. This is an accident waiting to happen.
It’s often said that the Fed can’t raise rates too aggressively because of bloated debt levels. But rates are increasing in China. 3m Shibor has moved up from around 2.85 in Q4 2016 to 4.36 now. Of course, growth rates are also higher, but China faces many of the same demographic headwinds as other advanced economies do, and has become a much larger share of the global economy. Since the end of 2008 China’s GDP has increased 2.4x from $4.6T to 11.1T. In the US it rose 22% from $14.7T to $18T. In 2008, China was 7.3% of Global GDP, now it’s 14.9%. In 2008 the US was 23.2% of Global GDP, versus 24.2% now.
US stocks are posting all-time highs in an environment of low volatility, while the Fed is set to gingerly continue removing accommodation, and cracks are appearing in the commodity sector. While fears of European contagion have been swept to the side with the French election, it’s important to note that risks from Asia are larger than ever, and could easily upend US complacency.
Fed speakers all week long as the treasury auctions 3’s, 10’s and 30’s beginning on Tuesday. The week ends with CPI and Retail Sales on Friday.
April 30. Arithmetic is the problem…or is it deeper than that?
The Undoing Project is the latest work by Michael Lewis. Although many themes run through the book, a large part of it concerns decision making by experts (including, for example, sports scouts, economists and doctors). In many cases, it appears as if simple models of complex problems can provide better decisions than relying on the (unconsciously biased) deductions of experts. This goes to the heart of the Fed’s deliberations, to the Taylor Rule and to the choice of Randy Quarles to serve as Vice Chairman for bank supervision. From an interview in 2015, Quarles said, “An important element of Republican thinking about monetary policy currently is that it ought to be more rules based.”
Doctors tended to see only what they were trained to see. That was another big reason bad things might happen to a patient inside a hospital. A patient received treatment for something that was obviously wrong with him, from a specialist oblivious to the possibility that some less obvious thing might also be wrong with him. The less obvious thing, on occasion, could kill a person. From The Undoing Project.
We’ve been in economic ‘recovery’ for nearly a decade. Is there something else going on?
I was struck late this week by a couple of experts’ comments about gov’t finances. “We are on the path of exploding deficits,” Fink, chief executive officer of BlackRock, said at the Morningstar Investment Conference in Chicago. “We will have a severe issue if the reform increases deficits.” * And, from former Chairman Greenspan, who simply said about Trump and his budget: “His arithmetic is the problem.” The Bloomberg article goes on to cite Greenspan saying that the Trump plan is likely to lead to bigger deficits and higher interest rates.
This is what we learn from experts: Higher deficits lead to greater bond issuance. More supply means that prices adjust lower, i.e. higher rates. Conversely, this is what we actually see: large deficits are typically related to slower growth and thus lower interest rates. Certainly, with this administration we have more moving parts than before, and it’s rather difficult to piece together a cohesive picture. There are many divergences, including a disparity between soft and hard data, with Q1 coming in at a weak 0.7%. It begs the question as to whether Trump’s tax cuts can really unleash business capital investment, a key element for improved productivity and growth. The markets seem split. Stocks are apparently pricing odds of reduced taxes, while bonds embrace a mediocre growth outlook. The two markets aren’t necessarily at odds; if stocks are pricing an increase in earnings due to lower taxes which are still discounted into the future by relatively low rates, then everything might be priced “right”. The problem may end up being as much political as economic, in that those who are worried about the deficit may provide significant resistance to deep tax cuts. It’s pretty obvious that there are ‘experts’ on both sides.
In fact, even for me, the warning statement that “stocks are priced for perfection” is like a stale piece of bread. Anyone that is paying attention can see that there is deterioration in some economic measures, including auto loans, student loans, retail bankruptcies, and increased corporate debt that has diluted balance sheets. Blackrock more or less shouted it from the rooftop: LARRY FINK SAYS U.S. IS TRULY SLOWING DOWN. So, stocks are NOT pricing perfection. They are pricing to model.
What I hypothesize in terms of a potential market problem relates back to the main theme of the Undoing Project. That key idea concerns the results of expert decision making versus that of models. Due to huge advances in computing prowess, the bulk of trading decisions are now made through algorithms. There has also been an explosion in ETFs of all sorts, which, in my simplistic way of thinking, exponentially compounds trading positions relative to true values of underlying assets. QE and the quest for returns in a zero-bound world have accentuated this trend. So, when the computer is picking off disparities between a myriad of etfs and futures contracts, and specific stocks, and includes spot prices and vol, the ‘true intrinsic value’ of the underlying asset ceases to have meaning. “If I can buy X here and sell Y and Z there, I’m locked in. It doesn’t matter what price A (the actual underlying) is.” It’s like the block stacking game. And that can lead to problems. Great insight, huh? Well, not really, but it’s probably an improvement on the economic textbook description that more supply leads to lower prices. It’s sort of like the essence of James Tobin’s Nobel prize winning theories on diversification of portfolios, which he explained to a reporter as “Don’t put all your eggs in one basket.”
In the grand scheme of things, the only metric that matters is debt servicing costs as compared to income. And even that doesn’t matter in all cases, for example, student loan debt. The US gov’t is the main holder of $1.4T outstanding. What’s Uncle Sam going to do? Re-possess nametags and hairnets? Of course there is the power to garnish wages. However, Fannie Mae made this announcement last week: New policies will help borrowers with student debt qualify for new homes, in part by rolling student loans into mortgages. It’s called Student Loan Cash-Out Refinance on the press release (linked below). I didn’t delve into details, but it sounds suspiciously like rolling NPL’s from one government entity to another.
Hoisington’s latest quarterly review notes that Total nonfinancial debt “surged to a record 254.8% of GDP in 2016, 5.6% greater than in 2009.” They further say, “Business debt surged to a record 72.6% of GDP in ’16…eclipsing the prior peak of 70.2% reached in 2009.” Maybe the US can skate past these issues, and of course there is no telling when the ice might crack. However, China seems to be embracing capitalistic tenets. From the FT “China’s premier on Thursday described finance as the “core of a modern economy” adding that “accurate judgment of potential financial risks serves as a precondition for maintaining financial security.” Earlier in the week the PBOC’s Deputy Governor said NPLs are under control, but vowed to control asset bubbles and prevent systemic risks. This, as China’s Q1 credit creation surged to over $1 trillion while 3 month Shibor rose from 2.9% in Q4 to 4.3% currently. China has become a much bigger block in the global economic stack. Contagion risks have increased.
Trade thoughts
Last week’s action was primarily an unwind of bets made on the possibility of a HUGE ‘undoing project’ related to survival of the euro, as the threat of Le Pen receded. Implied vol was crushed everywhere. The US bond market, however, didn’t have much of a week-to-week change. The ten year yield was up less than 5 bps on the week to 228, while the thirty year bond was up 6 to 295. With the new two-year, the 2/10 treasury spread flattened slightly to end at 101.4. The same message was sent by the euro$ red/gold pack spread, which closed just under 66 from 67.25 last week. July Fed Funds traded as low at 9891.5 during the week, and closed at 9893.0, indicating around 70% odds of a hike at the June FOMC.
This week’s data includes ISMs, the FOMC announcement on Wednesday and Employment Friday. Friday post data will feature a slew of Fed speakers, including Fischer, Williams, and Yellen. Bullard, Rosengren and Evans will also be appearing on a panel discussion. French election is Sunday.
A friend (thanks AOK) notes that SPX had the first inside monthly bar since 1970. Possible sign of exhaustion.
_________________________________________________________________
| 4/21/2017 | 4/28/2017 | chg | |
| UST 2Y | 119.7 | 126.6 | 6.9 |
| UST 5Y | 175.5 | 181.4 | 5.9 |
| UST 10Y | 223.3 | 228.0 | 4.7 |
| UST 30Y | 289.1 | 295.1 | 6.0 |
| GERM 2Y | -79.2 | -73.3 | 5.9 |
| GERM 10Y | 25.3 | 31.7 | 6.4 |
| JPN 30Y | 75.5 | 77.6 | 2.1 |
| EURO$ Z7/Z8 | 37.0 | 37.0 | 0.0 |
| EURO$ Z8/Z9 | 26.0 | 25.5 | -0.5 |
| EUR | 107.27 | 108.97 | 1.70 |
| CRUDE (1st cont) | 49.63 | 49.33 | -0.30 |
| SPX | 2348.69 | 2384.20 | 35.51 |
| VIX | 14.63 | 10.82 | -3.81 |
_______________________________________________________
http://www.fanniemae.com/portal/media/financial-news/2017/student-loan-debt-6546.html
April 28. Ignore Q1?
–Quiet session Thursday with a bias toward lower yields. Seven year auction saw solid demand, coming at 208.4 vs 210.6 just prior to auction time. Ten year yield eased 1.7 to 229.5.
–GDP released this morning, expected 1.1, though the Atlanta Fed revised its forecast to just 0.2%. The Fed seems prepared to ignore weakness in Q1 growth with a sunny outlook for the rest of the year. The question is whether they are missing a more fundamental slowdown, given marginal deterioration in credit (autos, credit cards) and declining growth in C&I lending. And even if that were a concern, top Fed officials voicing it may only be self-fulfilling. At the ECB press conference, Draghi appeared much less willing to embrace the emergence of growth.
–In the final analysis, we probably have to just take our cues from the market. For example, everything Trump says is a negotiating tactic, to be taken with a grain of salt. ‘If there’s a shutdown, it’s Democrats’ fault.’ ‘We’ll rescind NAFTA, but now maybe just alter the edges.’ And…’We’re close to a major conflict with N Korea.’ On this last one, I might dismiss Trump, but I’ll take my cues from the generals (more akin to the market), who say we’re at top military readiness.
–The market is telling us there’s a pretty solid expectation of another Fed hike in June, and smaller odds of another by year end, and then it gets murkier, with the red/green pack spread only hanging just above 1/4%. In my view, oil and copper are signalling economic concerns. Although oil bounced nicely off yesterday’s test of March lows, I would suspect that 51 will provide major resistance if we can even get that high. And with Trump complaining that the Saudis don’t contribute enough to military defense, another supply shock (in the form of Saudi over-supply) could easily occur. The dollar index is also at a low point for the calendar year; not as willing as the Fed to ‘look through’ Q1 weakness.
–Vol continues to be pressured in rates, with market makers choking on long premium. Last Thursday, the atm midcurve straddles (0EK, 2EK, 3EK) were 14.5, 20.0, and 21.5. Yesterday, 10.0, 13.0 and 14.5. Sharp declines! But the outlier of course, was last week’s elevated levels. In late March when there were 2 weeks before expiry for April midcurves, the levels were 10.0, 13.5 and 15.0, nearly exactly where we are now….
–One last note, FT reports that Shibor hit its highest level since April 2015, at a rate of 2.819%, with 3 month 4.3% vs 2.8 six months ago. Clamp-down on shadow banking. From the FT: “China’s premier on Thursday described finance as the “core of a modern economy” [uh-oh] …adding that “accurate judgment of potential financial risks serves as a precondition for maintaining financial security.”
April 27. Big tax cuts, big growth, big deficits….and lower yields?
–Two serious financial experts unveiled the Trump administration’s tax reform plan and said it will lead to a surge in growth and employment, and yields fell? Many private analysts say that higher deficits will likely ensue, and yields fell?
–One of the lessons I keep in mind, I believe from Richard Dennis, is this: when the market gets bearish news and doesn’t go down, it’s bullish. One could easily argue that all the tax hype had already been built in, but it’s still somewhat surprising that the ten year yield eased 1.5 bps to 231.2, given the core goals of Trump, Cohn and Mnuchin of jobs and growth. Is it all just month end buying? Perhaps so, open interest surged in both fives and tens, +62k and +55k respectively. There was also call buying in TYM 126 and 127 strikes, adding to already substantial open interest. However, implied vol remains under the cloud of the French election unwind, with TYM closing at a new recent low 4.5%. USM straddle is hovering around 3 points, ridiculously low with 30 days until expiry. As I recently said about oil, huge levels of open interest are tinder for large moves. (By the way, oil is lower this morning and threatening to test the March lows).
–If one needs a depressing synopsis of the low growth scenario, just read Hoisington’s new missive. Here’s a snippet:
“The situation in the business sector deserves particular scrutiny. Business debt surged to a record 72.6% of GDP in 2016, for the first time eclipsing the prior peak of 70.2% reached in 2009. With the business sector so levered, not much room for miscalculation exists.”
But it’s not just business. Several articles yesterday note deterioration in credit card debt:
And there’s an article on ZH citing Core Logic, noting that mortgage performance is deteriorating as well.
–Against this backdrop we have the Central banks. The BoJ used the word “expansion” for the first time since 2008, but lowered inflation projections. We have Draghi up shortly, expected to leave things unchanged, with the onset of a graceful (?) withdrawal of accommodation perhaps in June. And then the Fed meeting next week.
April 26. Tails LOOK fat because atm is so skinny
–It’s hard to find something of interest to comment on regarding yesterday’s action. Yields declined and stocks soared as the unwind from last week’s French election continues and Trump’s tax proposals come into clearer focus. Of course, in the Trump world, the announcements seem to mark the high points and implementation is much thornier. The classic ‘buy the rumor’ environment. The ten year yield rose 5 bps to 232.7. July Fed Funds settled at a new low of 9892.5, representing over 70% odds for a hike in June as we also await next week’s FOMC. Draghi tomorrow with possible hints of accommodation withdrawal. Five year auction today.
–Implied vol continues to soften across markets. TYM atm straddle was 1’52 Friday and traded as low as 1’19 yesterday (TYM 125^ settled 1’22). A friend noted this article (thanks AOK) http://mrzepczynski.blogspot.com/2017/04/fat-tails-everywhere-even-if-volatility.html?m=1
with the headline Fat Tails Everywhere Even if Volatility is Low. Not sure if we put trades yesterday in the category of fat tails, but there was a buyer of 20k TYM 132c for 1/64 yesterday, and 25k USM 136p for 1 as well. June VIX 22 calls were bought for 40 cents yesterday. VIX calls in June seem remarkably cheap, though of course VIX itself continues to sag, nearing single digit territory (closed 10.59). We’ve reached a permanently low plateau in vol?
April 25. A certain ‘quality’ is missing
Which are the continuity of quality.
Phædrus read on through line after line, verse after verse of this, watched them match, fit, slip into place. Exactly. This was what he meant. This was what he’d been saying all along, only poorly, mechanistically. There was nothing vague or inexact about this book. It was as precise and definite as it could be. It was what he had been saying, only in a different language with different roots and origins. He was from another valley seeing what was in this valley, not now as a story told by strangers but as a part of the valley he was from. He was seeing it all
He had broken the code.
–From the powerful book, Zen and the Art of Motorcycle Maintenance by Robert Pirsig (died yesterday at 88).
“Make me one with everything.”
–Below is a chart of bond vol. Now near major support, (though the washout may mot be over yet). In a longer term context, the idea of MBS leaving the Fed’s passive hands and moving back into the world of hedgers should boost vol, but that’s down the road.
–Stocks soared but the eurodollar curve actually flattened a bit by the end of the day, with reds -4.5 and golds -3.375. FFN7 settled 9894 (-4.0 ), back to a 2 in 3 chance of a hike in June. If the Fed hikes in June with no timetable on the Balance Sheet, look for 5/30 to trade 80 (now 113).
–Trump announced a 20% tariff on lumber from Canada. Sure, tax cuts in the US are a benefit, but a decline in the global economy due to trade wars is a negative. And it’s no sure thing that deficit hawks in Congress will pass tax cuts, especially as the Debt Wall is reached. For now… full steam ahead.
April 24. A sigh of relief
–Huge sigh of relief with Macron expected to easily beat Le Pen in the second round of French elections. Green eurodollars traded -12.5, the euro soared over 109, ESM gapped higher and as of this writing prints +26 on the day. Implied vol is being hammered as insurance is being exited at fire sale prices. TYM 126^ settled 1’52 on Friday and the atm 125.5^ this morning is now below 1’30. The front end of the eurodollar curve steepened modestly. The peak one-year spread is EDZ7/EDZ8 which closed 37 on Friday, traded as high as 41 overnight, and is now back below 40.
–This week features treasury auctions of 2, 5, and 7 year notes. Obviously, the market is back to building in greater odds for Fed hikes, though it will take stronger US data to really push the needle. July Fed Funds are back down to 9894.5, pushing June’s odds back to around 60%. One outside market of note: China Shanghai Comp fell 1.4% today. Markets are a function of global liquidity, and China is apparently acting to quell some of the more speculative impulses.
April 23. This is Serious Business
On April 13, there was one week to go for May treasury options. The May 126 straddle settled 41/64’s with futures 126-025. On Friday, the one week straddle expiring this Friday, April 28, settled 1 08/64’s vs 126-02, or 75% higher! Still one week to go with the same underlying futures price. In comparison the price of the TYM7 (June ten year) 126 straddle was 1’52 on Friday. That is, the four extra weeks between April 29 and May 26, which is June expiration, is only worth 0’44 (1’52 – 1’08).
Another example of odd pricing was in one-week US bond options, pointed out by colleague RW. USM7 settled 154-05. This Friday expiry 155/157 call 1×2 settled 1/64, 57 vs 28. On the downside, the 153/151 put 1×2 settled 26/64, 40 vs 7. So the 151/157 risk reversal settled at a whopping 21/64s.
Of course, this is the weekend of the French election, so there is nothing we can do now about the above pricing. However, it does indicate a significant re-pricing of risk. There was chatter Friday of risk managers requiring position cuts, and/or stopping new trades. This is somewhat understandable given a known upcoming event. Typically, higher risk comes hand in hand with reduced liquidity.
In a way, ideas of risk and liquidity tie into comments made by Stanley Fischer on a CNBC interview Friday, where, when asked about repeal of certain features of Dodd Frank, was steadfast in his defense of core of DF provisions with respect to strengthening the financial system and making sure banks don’t engage in overly risky behavior. “This is serious business. …We seem to have forgotten that we had a financial crisis which was caused by behavior in the banking and other parts of the financial system… This [crisis] was huge.”
In other words, the Fed in its role as financial regulator will likely lean against loosening of Dodd Frank by tightening alternative requirements. In the same vein, other aspects of the Trump agenda have also met resistance, and clearly large swaths of the Trump reflation trade have rescinded their enthusiasm. (Curve, DXY, some industrial commodities). Again, I would make note of the fact that financial conditions have actually eased over the past two Fed hikes. The dollar index is lower than it was at the time of both the Dec and March Fed hikes, the thirty year bond yield was 3.15% at the time of the December hike and 3.21% just in front of the March hike, and is now 2.89%. The 2/10 treasury curve is flatter: 131 in December, 122 in March and now 105.5. Equity prices are higher than in December, but about the same as they were in March. So, if the Fed does want to lean against easier conditions, it’s not just necessary to turn the spigot down a little; at this point another hike in June without a clear timetable on Balance Sheet Reduction (BSR) is likely to further flatten the US curve.
On the shorter end, perhaps no clearer expression of a hike being taken out of the market in the second half is displayed than by the April/January Fed Fund spread. This spread printed a high of 52.5 in December, and closed yesterday at 29, a decline of very close to ¼%. The July Fed Fund contract has been bouncing around 50% in terms of odds for a June hike. And the peak one-year euro$ calendar spread has shifted back from EDM17/EDM18 to EDZ17/EDZ18, with that peak now at just 37 bps. This may signify that the market perceives near term FF increases as less likely and longer term effects from BSR as more likely.
One other aside about Fischer’s interview comments. He noted that the first quarter has been weak for the past several years and said there was something the Fed didn’t quite understand about that weakness. Clearly, last year was in part due to severe problems in the energy patch. But this year oil was strong and there was a burst of optimism associated with Trump. I would say that softer data this year is more worrisome in terms of forward growth, whether it’s being restrained by student debt, or increased auto debt or high levels of corporate borrowing. Surprisingly, this is one thing Fischer noted: ‘Very large decline in the price of cell phone usage. It was very large, actually had an impact on the overall inflation rate.”
In terms of stress, Fitch late Friday announced a downgrade of Italy’s debt to BBB from BBB+ due to fiscal slippage and persistent weak growth. While the Germany/Italy ten year yield spread declined this week to about 200 bps, from a recent high of 213 last week, the narrowing is likely short lived even if the Le Pen threat recedes.
In the US, according to the Daily Shot, the debt service ratio of US corporates as a percent of income has been steadily rising from about 3.5% in 2014 to nearly 5.5% now. No surprise given the amount of stock buybacks financed with debt, but this factor is starting to see a bit more air time. The situation is much more acute in China, where many stories have recently run about excessive credit creation. However, according to a Bloomberg story citing a top fund manager He Qian, the risks are not being appropriately priced. “It’s interesting that investors were paying more attention to credit risks this time last year, when there were not as many credit events,” said He, whose $895 million fund has beaten 99 percent of its competitors since 2014, data compiled by Bloomberg show. “Such risks seem to have faded from investors’ memories.”
In short, besides the clear and present danger associated with the French election, there are many other risks which are unknown in terms of timing but lurking in the not too distant background. North Korea, increased credit problems in China, US gov’t shutdown. Are these factors being priced into implied vols? It can happen fairly quickly. In the meantime, it takes some patience (and bleeding) as evidenced by the buyer of 50 cent calls on VIX. “Basically they come in every day and they buy 50,000 VIX calls worth 50 cents. So in other words, they don’t care too much what the strike is; they just pick the option that’s worth 50 cents.” [link below] This activity is pretty obvious from May VIX call open interest. In May 20, 21, and 22 calls the OI is 418k, 324k and 220k. VIX futures have open interest of 442k in aggregate, of course the contract is ten times larger. There are now many contracts and etf’s with embedded equity market vol; how these pair off against one another is only likely to be seen in a large event. On Brexit the VIX etf shot just above 26 and on the November election, close to 23.
April 20. Big blues for Big Blue (IBM)
–“My name is George. I’m unemployed and live with my parents.” “I’m Victoria, Hi.”
https://www.youtube.com/watch?v=Z6c17WxIcCw
–That’s from the Seinfeld episode where George Costanza does the opposite. Funny. Except that 31% of 18-34 year olds now live with their parents (Census 2016). In 1975, 57% of this age group lived with a spouse, now that’s down to 27%. http://www.cnsnews.com/news/article/terence-p-jeffrey/census-more-americans-18-34-now-live-parents-spouse
–I’m not sure that statistics in the above story make much difference. The ‘living with parents’ percentage went from 26% in 1975 to 31% now, so it’s likely more of a statement about marriage than anything else. Although, the unemployment rate in 1975 was around 8.4%, so one would think that economic circumstances aren’t as constraining in terms of leaving home. Things change. IBM was a pretty hot cutting edge company in 1975. https://www.youtube.com/watch?v=52ktEpjIhnk Now it’s had 20 quarters of declining revenue and fell 5% yesterday.
–Oil also had a hard sell off yesterday, declining over 3% on a closing basis. However, despite renewed deflationary forces yields edged higher, with 10’s up 2.5 bps to 220. The peak one-year eurodollar spread had been the front EDM7/EDM8 spread, but has now pushed back further on the curve to EDZ7/EDZ8, the former settled at a new low of 32 and the latter at 34.0. Pretty subtle change, but indicative of a more drawn out process of ‘normalization’.
–French round one election this weekend. If there’s concern about Le Pen it’s not registering in interest rate premium. With 23 days to go green May 9812.5 straddle settled 19; the underlying contract has rallied 28 bps since March 31. Do the opposite. Buy stocks, sell vol. (But is that even “the opposite” anymore?).
–News today include comments by Powell, Jobless Claims, Philly Fed (expected 25.5 from 32.8 last) and Leading Indicators, +0.2.
