March 9. When’s a hike not a hike?
–The big mover yesterday was oil, which plunged nearly $3/bbl yesterday to settle $50.28 (CLJ7). The range this year has been roughly 52.50 to 56.00. Between yesterday and this morning the price change has well exceeded that range, from over 53 on Tuesday to 49.33 last. I am not sure what the knock-on effects will be, but it’s worth keeping in mind in the context of low implied vol environments in treasuries and US stocks, that big moves sometimes happen in a hurry.
–At the other extreme is the front end of the US market. There has been endless hand-wringing about whether the Fed would hike in March, and, in the aftermath of the Fed’s guidance last week, Fed funds contracts indicate near certainty (93%). So I looked back just prior to the last Fed hike in December. EDZ16 was around 9901. Now EDH17 is 9887. Gasp! A change of 14 bps. When’s a hike not a hike? The date I chose was 7-December, about a week prior to the hike. At that time, the red/green pack spread was just over 39, yesterday it closed (at a new recent high) of 40.625. Red/gold was just over 90 three months ago, now just under 80. The ten year was 235, now 255. Pretty modest changes overall.
–What is perhaps a bit more interesting is some of the front spreads. Currently the first 3 month spread is EDH17/EDM17, march/june. It settled at a new high of 19. In December of last year Dec/March was only 5.25 and the Z/H/M fly was -7.75. Currently H/M/U is +5.5. Just looking at these spreads one might conclude that EDM7 looks a bit cheap.
–A huge ADP print yesterday likely removes any drama from the payroll number tomorrow. Solid demand at the ten year auction limited damage in terms of a big yield jump. Tens up 4.2 bps to 255.1. In euro$’s, all front end 1-yr calendar spreads made new highs, with EDM7/EDM8 settling at 57.5. The back end of the curve though, remains rather flat. So while the red/green pack sprd settled at a new recent high of 40.625, green/blue closed at just 23.375 (red/grn/blue fly at new recent high of 17.25). 30 year auction today.
March 8. Old School
–Relatively quiet day Tuesday, with yields edging higher. Tens up 1.6 bps to close 250.9. Red/green euro$ pack spread rose nearly 1 bp to end at a monthly high of 39.5 (the peak last December was 44.5). Today’s news includes ADP expected 183k, Productivity 1.4% and ten year note auction.
–Fundamental data is mixed. For example, the Atlanta Fed revised its GDP Now Q1 growth forecast to just 1.3 from 1.8. “The forecasts for first-quarter real personal consumption expenditures growth and real nonresidential equipment investment growth fell from 2.1 percent and 9.1 percent, respectively, to 1.8 percent and 7.3 percent, respectively, after Thursday’s motor vehicles sales release from the U.S. Bureau of Economic Analysis. Q1 GDP went from 1.8 on March 1 to 1.3 on March 7.”
However, global passenger air traffic reportedly grew 9.6% yoy, the fastest pace in years (according to BI it’s correlated with global growth). Then there’s Consumer Credit from yesterday afternoon, showing growth of just 2.8% with revolving at MINUS 4.6% (lower by $45.5b). Finally, I would note that last week’s Trump inspired rally in stocks has evaporated in the past two days.
–In any case, treasuries are trading a bit soft this morning heading into the ten year auction (30’s tomorrow), and in front of next week’s FOMC. One of the headline summaries of Gunlach’s new presentation yesterday: `OLD SCHOOL’ SEQUENTIAL RATE HIKES MAY BE COMING. Blue, you’re my boy!
March 7. Implied vol low, but percolating under the surface
–Chart below shows 30 year vol, which as can be seen, is at the very low end of the range for the past nine years except for 2014. The chart shows May vol, which, due to the French election, trades at a substantial discount to June, which I marked yesterday at 9.9 (vs 9.1 on the chart). In either case, bond vol looks cheap, and the futures chart portends lower prices. 30-yr bonds are auctioned Thursday, preceded by 3’s and tens today and Wednesday.
–Quite interesting article on FT Alphaville yesterday, https://ftalphaville.ft.com/2017/03/06/2185614/guest-post-cds-markets-signal-rising-fear-of-euro-breakup/
This note informs that prior to 2014, “Buying CDS wouldn’t have helped [against currency redenomination of sovereign debt] becasue the standard contract explicitly excluded debt redenomination from the list of credit events if the issuer were a member of the G7…” Two years later, new ISDA standards entered into force: contracts made since 2014 protect against euro area countries redenominating their debt into nat’l currencies.” The article goes on to note that ‘the difference between CDS-2014 and CDS-2003 has doubled from 20 to 40 bps” in Italy and in France has gone from 3 to 24 bps.
–As noted above in the US vol spread between May and June due to French election uncertainty, the CDS market also reflects fears of a eurozone break-up.
–Huge adjustments yesterday in red and green midcurve put spreads: Long put spreads in short and green April and May put spreads were sold on exit, in turn adding to existing long 25-wide put spreads in short and green Sept and Dec. Details on a later note.
–New high bitcoin. China ccy also edging weaker.
Widening of old vs new (after 2014) Italy CDS, from FT Alphaville story
March 6. Maybe less gradual than previously advertised?
–Yellen cemented a March hike Friday, and this morning we are seeing slight flattening as longer maturity contracts rally. Stocks are also seeing some profit taking pressure for which there might be several contributing factors: N Korea lobbed a few missiles, raising the prospect of direct military intervention; China modestly reduced its growth goal to 6.5%; DB is changing course and trying to raise capital through share sales, a reminder that the european banking sector in general retains fragility; rather than soften the idea of upcoming rate hikes, Yellen indicated that adjustment to the neutral rate might occur fairly quickly. Given subdued VIX, it’s probably worth considering buying VIX spreads…long near contracts and short deferred.
–On Friday, near euro$ one-year calendar spreads pushed to new highs, with June’17/June’18 up 0.5 to 57, having closed at 46 the previous Friday. 5/30 closed at the bottom of this year’s range at 106. In general, yields were little changed Friday as previous Fed speakers had already done the heavy lifting in terms of preparing the market for a rate hike.
–News today includes Factory Orders expected +1.1 from +1.3 last. Treasury auctions of 3, 10, 30 year paper commence tomorrow.
March 5. Finally, a meeting where something gets done!
A client once said, it would be nice in your missives if you spent less time talking about the environment we’re in and spent more time telling us what was going to happen. He was sort of joking. But like every joke, he sort of wasn’t. So… in this note I describe the current environment.
First, I would like to highly recommend a new book by Michael Lewis, The Undoing Project,* which highlights the psychological research of Danny Kahneman and Amos Tversky on decision making. I am not through the entire book, but its main thrust is that people, including highly trained professionals, wrongly estimate odds (by a lot) in arriving at decisions, through a variety of biases. There are many amusing, though quite serious nonetheless, examples, even doctors that are using the same diagnostic tools for evaluation and coming up with varying conclusions, occasionally even contradicting themselves, even though the key factors that determine a given disease were already identified and agreed upon. I will be returning to this book many times, but for now I will simply quote a passage. “He [Tversky] had listened to an American economist talk about how so-and-so was stupid and and so-and-so was a fool, then said “All your economic models are premised on people being smart and rational, and yet all the people you know are idiots.”
The reason I mention the book is because the topic is obviously of interest to the Fed. The other Fed speech on Friday was co-chair Stanley Fischer’s, on Fed decision making, rules vs committees.** It’s obvious that Fischer leans toward human intervention through committees; that is, after all, his life’s work. And like other professionals in the Undoing Project, he holds the concept that the array of information is so vast and complex that a simple model will fall short of thoughtful analysis. But in his last couple of speeches he is very clearly giving the matter serious thought.
Let me give an example of professional analysis. Towards the end of last year, there were numerous articles identifying the new Fed board as dovish leaning relative to the last, and what the implications of that change might mean. For example, having seen inflation already ticking up, one might be inclined to sell butterflies on the Eurodollar futures curve. This, for example, was my thought: that the Fed would be slow to respond to actual increases in inflation and therefore the back end of the curve would steepen relative to the front. In fact I had recommended doing just that, selling EDM7/EDM8 spread and buying the two year spread behind it, EDM8/EDM0 at a level of -13. Settled -8 on Friday and traded higher during the week; I would have been stopped out. Even though we THOUGHT the Fed would hew to the dovish line this year, members clearly began to signal a hike in March, through Kaplan and Brainard, and punctuated by Yellen on Friday. Brainard laid out the case quite clearly on Wednesday and even said, “Recent months have seen an increase in the upside risks to domestic demand.” Yellen essentially said that a hike in March is a done deal: “Indeed, at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” She also spent a reasonable amount of time talking about the estimated decline in the neutral rate, suggesting that total rate hikes won’t be of great magnitude. She did however, repeat that “…a cumulative 3/4 percentage point increase in the target range for the federal funds rate would likely be appropriate over the course of this year”, and added “…partly because my colleagues and I expect the neutral real federal funds rate to rise somewhat over the longer run, we projected additional gradual rate hikes in 2018 and 2019.” Implicit in this analysis are several ideas. First, that the Fed will be successful in holding inflation at its 2% goal and second, that China or another part of the world won’t implode. (I mention China here rather than the Eurozone due to a recent NY Fed paper outlining looming issues in China).
In some ways, I think the Fed moved up the hike timetable simply due to the departure of Daniel Tarullo from the Fed’s Board after this meeting. There are already two unfilled vacancies, and Tarullo will be the third of seven. I recently read a note that said with only four members left on the board, even informal deliberations will be subject to FOIA requests, i.e. ALL conversations will be more or less public. Or maybe the Fed simply decided they could sneak a hike through now, while Donald is too preoccupied with Arnold to notice.
How are we left in the markets? First, January 2018 Fed Funds settled at 9868.5 on Thursday and 9870.5 on Friday. If we take the current Fed effective of 66 and shave off half bp for month-end weakness, that’s 65.5 (a price of 9934.5) vs 129.5 implied by the Jan contract, a difference of 64 bps. Complete certainty of three Fed hikes this year would, of course, have FFF8 at a rate of 140.5, a price of 9859.5. So the market hears Yellen, but because of being burned a couple of times already, won’t entirely trust the Fed forecast. This is also apparent in one-year Eurodollar spreads. For example, EDM17/EDM18 settled 57, up 11 on the week but still only projecting a bit over two hikes per year, and EDM18/M19 settled at 40.5, a marginal new high, up 6.5 on the week, but well under ½ pct.
Unemployment is released Friday, but now has little market moving value unless it’s a huge outlier. Not surprisingly, implied vol seeped out of the market by the end of the week. In the 2004 to 2006 hiking cycle the market was programmed to expect a hike at every meeting. Once into the pattern, vol was tame. In hindsight, while the curve flattened and other signs of dislocations were apparent in the last hiking cycle, it still took another year and a half for the damage to occur in the form of a crisis. It’s the boiling frog syndrome: at first you don’t notice the heat being increased…
Speaking of professional advice regarding decision making, here’s a link to a salient article. It sagely informs us that investment results will improve if we can sidestep crashes. Thanks.
“Alas, for investors looking for guidance on whether to sell now, the paper holds few clues. The reason is simple: nothing going on in the market today would’ve qualified for investigation under the authors’ base case for bubbles.” [In other words, sell now].
Besides the employment report, we also have auctions of three, tens and thirty year bonds this week. The FOMC meeting is March 15. On a personal note, whenever I think of committees and business meetings, I can’t help but think of the Barrons cartoon below, from many years ago.
Brainard: Fed Funds First!
-Yields soared as the market continues to adjust to the idea that the Fed is pushing up its rate hike schedule. Brainard’s speech last night was another important voice giving a blessing to the transition to gradual rate increases; more on the speech below.
–From Tuesday’s close of open outcry, the ten year yield jumped 10.6 bps to 246.2. The eurodollar curve, which had initially flattened Tuesday afternoon, steepened fairly aggressively yesterday, with reds -7.625, while greens, blue and golds were -11.125, -12.25 and -12.5. 2/10 treasury spread popped 3.5 bps to 117.8. There was one large put spread buyer in red and green midcurves, all 25 wide put spreads in size of 40k in June, Sept and Dec; details below.
–Fed fund contracts in March and April now indicate about 75% chance for a March hike. Given the current Fed effective of 66 bps and expected move to 91 bps, the June 2017 FF contract at 9908 (or 92 bps) indicates certainty of a near term hike with a teeny bit more priced in at the June meeting. June FOMC is on the 14th of a 30 day month.
–What is somewhat astonishing is lack of a vol bid. There is not even a whiff of panic. Most atm straddles were unchanged, or in by 0.5 bp. Perhaps that’s understandable in USM where the atm straddle went from 6’02 to 5’50 as the 5/30 spread notched a new low to 108. But I would say for example, that 2EJ 9775 straddle at 23 bps is simply the wrong price. In the past few days the contract has moved 22 bps (Friday high to yesterday close). I would also note that there was quite a bit of ‘French election trade’ exits, i.e. buying back of May treasury premium which expires before the election and selling out June, which expires 26-May. Caught out by gamma.
–The first line of Brainard’s speech says it all: “The economy appears to be at a transition. We are closing in on full employment, inflation is moving gradually toward our target, foreign growth is on more solid footing, and risks to the outlook are as close to balanced as they have been in some time.” She had previously been very cautious, but is embracing a transition, even though she continues to point out foreign risks, especially with respect to China. Another telling line: “Recent months have seen an increase in the upside risks to domestic demand.” In terms of monetary policy, she discussed increasing Fed Funds versus trimming the balance sheet; she favors a policy of Fed Funds First…”subordination” of changes in the balance sheet to more typical changes in FF, in part to re-stock ammo in case of a downturn.
–Large midcurve put buying: 40 k each, all 25 wide put spreads. In 0E (red mids) June 9812/9787 8.75s, Sept 9800/9775 9.0s, Dec 9750/9725 8.0s. Paid 27-27.5 settled 25.75. In 2E (green mids) June 9750/9725 5.0s, Sept 9737/9712 5.75s, Dec 9725/9700 6.5s. Paid 19.0 settled 17.25.
March 1. New month and new odds of a Fed hike March 15.
–It’s now all about a rate hike at the March FOMC which is just two weeks away, as Williams (SF) said that meeting was under “serious consideration” and Dudley followed up by saying the case was more compelling for a move in the near term. March FF traded to 9925 indicating 72% odds of a hike, with April at 9919 at more like 66%. This evening Brainard speaks with Q&A to follow, she has generally leaned more dovishly. Front June eurodollars were also crushed, making new lows at 9867.5, having taken out the post-election low which was made in December (9869). Other contracts have not made new lows yet, and the question becomes, ‘if the Fed hikes in March, then will the market finally begin to price the back end of the curve as if 3 or 4 hikes are possible in any given year?’ EDZ7 contract has been bouncing around 9840 to 9850 recently, consistent with the idea of two hikes by year end. Late yesterday that contract traded 9838.5, down to 36.5 this morning, a fairly decisive break of the range. However, the Fed also seemed to be taking pains to set the market up for a hike in September 2015, which they ultimately passed on. Brainard tonight and Yellen on Friday can cement expectations… or not.
–EDZ7 9850 straddle traded 27.0 earlier in the week, with one massive trader repeatedly saying that front vol was wrong in this environment, That straddle settled 28 yesterday, with the underlying contract already having fallen 14 bps from Monday’s high. If odds of Fed moves are re-calibrated then front month vol will do the same. In the same vein, near treasury vol firmed vs June, as immediate US monetary policy considerations outweigh French elections…
–2/10 treasury spread made a new low at 114.4 by the close of open outcry and declined another 2 bps in late trade. In the early part of the session there was a large buyer of EDM7 9887/9875/9862p butterfly 5.25, which was trading 4 late in the day vs 9868/68.5.
–News today includes Personal income and Spending, both expected +0.3. Core PCE prices were +1.7% last (the Fed’s preferred inflation gauge, and the last one that seems to be moving). ISM also released, with Beige Book in the afternoon.
–Stocks are up this morning, basking in the afterglow of Trump’s speech, USD also stronger. However, I would also note that bitcoin, the alternative currency, is also at new highs, flirting with 1200.
Feb 27. Market is squeezing out even ‘gradual’ hikes
–Yields little change this morning after a strong rally in interest rate futures on Friday. The ten year fell 7 bps to 231.5. The eurodollar curve flattened with all near spreads posted new recent lows. For example, EDM17/EDM18 dropped 4 bps to just 46. EDM17/EDU17 fell 1.5 to 11.5. Red/gold (2nd to 5th year) euro$ pack spread fell 3.75 bps to just over 74 bps. The German Schatz (2yr) has had a blistering rally, with Friday’s yield at -95 bps. While there was surprising selling pressure in Fed Funds on Friday (with March and April settling at just over 30% odds for a hike at the March FOMC), the market is generally squeezing out expectations for aggressive action from the Fed. Thoughts of three hikes this year are evaporating. International headwinds will likely keep the Fed sidelined until June; Yellen speaks on Friday and undoubtedly will mention non-domestic challenges.
–There’s an interesting story on ZH this morning about Target 2 imbalances between southern and northern countries, namely Italy and Germany. http://www.zerohedge.com/news/2017-02-26/european-debt-bomb-fuse-lit-target2-imbalances-hit-crisis-levels
I would also note that Germany’s deputy finance minister ruled out haircuts on Greek loans. When is an asset, (an IOU) not really an asset? Sort of like the $1 trillion (over 5% of GDP) that the US carries on the books in student loan debt.
Feb 26. Fat tails
“The ECB has a monetary policy that is not geared to Germany, rather it is tailored (to countries) from Portugal to Slovenia or Slovakia. If we still had the (German) D-Mark it would surely have a different value than the euro does at the moment. But this is an independent monetary policy over which I have no influence as German chancellor.”
I missed this quote, which occurred last Saturday, 18-Feb. Merkel was responding to criticism from the Trump administration that Germany is benefitting from an under-valued euro. Innocuous enough, but in the context of last week’s price action it takes on considerably more importance.
The German schatz (2 year) plunged nearly 14 bps in yield this week to minus 94.7, and the bund fell 11.6 to 18.6. The upcoming French elections have refocused the market on the possibility of a euro break up. Given the “it’ll never happen” attitude pre-Brexit and pre-Trump, it’s causing traders to be a little more circumspect regarding fat tails. The question becomes, “what is the ultimate denomination of German debt?” and not “what is the correct yield level?”
It was July 26, 2012 when Draghi uttered his famous promise, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The five year anniversary is in 150 days. He probably wasn’t thinking about Le Pen. On the chart below, which is the spread between Germany and Italy 10 year yield, the left hand side with the spike above 500 bps was the situation Draghi confronted. He stopped it cold and by the start of 2013, the spread had halved to 250 bps. Currently, stress is rising again, with the particular spread below, currently just over 200 bps, as high as it’s been since early ’14. While I highlighted Italy/Germany, it is the same directional picture with France/Germany and other sovereign spreads as well.
The lowest 2 year rate I have seen is Switzerland at -111. I recall a friend of mine asking me, (with stupendous timing, about a month before the SNB broke the euro peg), if I could find him a price on the CME floor for euroswiss options. I told him, repeatedly, that no one would make a price, but he insisted I check around every few days. He then called a friend at a bank who said, “we are only making prices for our largest and best clients; it’s a binary event.” Well, we are living in a binary event world. Fake, real. White, black. The models run along continuous paths, but we all know that trades don’t always work out that way. I had another friend mention (and I didn’t personally check this) that market makers in bobl options were making bid/ask 10 wide on Friday, normally 2. What can the model tell us about the ‘correct’ yield level for short end German debt? Not much.
Anyway, I am no expert in German debt instruments, but I do know that treasuries experienced a sympathetic flight to quality (and/or short covering) rally on Friday. Both fives and tens fell over 10 bps on the week, to 1.803 and 2.315. As noted last week, US swap spreads continue to widen. Typically, I would associate this with risk-off. However, US stocks remain extremely well bid, though small caps (supposedly more encouraged by Trump’s deregulation policies) have recently had the air seep out relative to large caps. As Doug Noland of CBB said, ‘Defensive stocks outperformed this week, while “Trump reflation” wagers underperformed. ‘ Big cap defensive stocks appear to be recipients of USD ftq buying. Key this week will be the market’s reaction to Trump’s speech before Congress on Tuesday night.
Below is a chart of Ten Year treasury vol in white, and the ten year swap spread in blue. Since November there has been a fairly large divergence, with treasury vol generally easing since the election spike, and the swap spread surging. As mentioned previously, there has been significant buying of June FV and TY calls vs May, a play on the outcome of the French election. In my opinion, June treasury vol should push much closer to 6 (or higher) rather than Friday’s mark of 5.3.
*************************************************************************************
Moving away from Europe and the US for a second, I would footnote news from China that Guo Shuqing, “…considered by many as a passionate reformist”, was named as new Chairman of the China Banking Regulatory Commission. From Reuters*: Banking assets over the last five years have more than doubled, helping to push the volume of non-performing loans at Chinese commercial banks to 1.51 trillion yuan by the end of last year, the highest since 2005. …Guo [Shuqing] will work closely with China’s powerful central bank, which is tightening oversight of the surging asset management industry that has drawn the eye of investors seeking high yields and quick profits.
While the US has seen investor confidence in growth surge due to potential deregulation and tax relief, the opposite trend appears to be happening in China. A regulatory crackdown on runaway debt dynamics in China will stifle growth in the short term. Given that China has contributed about 40% of global growth compared to around 10% for the US **, it’s worth keeping in mind.
While the America First theme permeates most of the financial press, I would note that the Fed has often warned of international headwinds as an excuse to forestall rate increases. While US growth, solid employment data, frothy asset prices, and increasing inflation levels provide ample ammunition for the Fed to decide to raise rates March 15, turbulence in non-US markets will likely exert a restraining influence. (March and April Fed Fund contracts now reflect around 30% chance of a hike at the next FOMC meeting). Let’s not forget lingering problems with Greece, with Germany’s deputy finance minister Jens Spahn saying this weekend that there will be no haircuts on previous loans.
Perhaps Yellen will touch on these subjects in her speech on Friday. Just a reminder, the employment report will be released the following Friday, March 10. Effectively, Yellen’s speech will be the last one prior to the blackout period.
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| 2/17/2017 | 2/24/2017 | chg | |
| UST 2Y | 122.2 | 114.3 | -7.9 |
| UST 5Y | 190.8 | 180.3 | -10.5 |
| UST 10Y | 242.4 | 231.5 | -10.9 |
| UST 30Y | 302.9 | 295.3 | -7.6 |
| GERM 2Y | -81.0 | -94.7 | -13.7 |
| GERM 10Y | 30.2 | 18.6 | -11.6 |
| JPN 30Y | 92.0 | 84.6 | -7.4 |
| EURO$ M7/M8 | 51.5 | 46.0 | -5.5 |
| EURO$ M8/M9 | 37.0 | 34.0 | -3.0 |
| EUR | 106.15 | 105.62 | -0.53 |
| CRUDE (1st cont) | 53.78 | 53.99 | 0.21 |
| SPX | 2351.16 | 2367.34 | 16.18 |
| VIX | 11.49 | 11.47 | -0.02 |
___________________________________________________________________
http://uk.reuters.com/article/us-germany-security-merkel-euro-idUKKBN15X07C
* http://www.reuters.com/article/us-china-banks-regulator-appointment-idUSKBN1640CT
** https://www.weforum.org/agenda/2016/09/why-china-is-central-to-global-growth
Feb 19. Inflation and swap spreads…going higher
NAPM mfg and service prices/ ATL Fed Wage Tracker / 5y5y Inflation Frd / 10y Tip b-e / CPI yoy / Core CPI yoy / Core PCE
The above chart is comprised of several inflation measures. The one that the Fed chooses as its preferred measure, is, of course Core PCE prices, the blue sideways laggard at the bottom of the graph. Every line is generally tracking upward. A couple of these are at new highs, including the NAPM Price indices and yoy headline inflation (red line, released this past week). Headline CPI yoy was 2.5% and Core 2.3% (Core equal to the high print of last year). From a late January posting from the Atlanta Fed macroblog: “As measured by the Atlanta Fed’s Wage Growth Tracker, the typical wage increase of a U.S. worker averaged 3.5 percent in 2016. This is up from 3.1 percent in 2015 and almost twice the low of 1.8 percent recorded in 2010.” Market reaction to both Yellen and CPI this week was astonishingly lame.
In spite of Yellen warning against ‘waiting too long’ to raise rates, weekly changes were quite modest. The five year yield was up 2.3 to 190.8 and tens up 1.7 to 242.4. Since the beginning of 2017, Friday to Friday changes in EDM18 (red June dollars) have been in an incredibly tight range between 9826.0 and 9821.5 (Friday’s settle).
Last week I suggested trying to sell May FF at 9925 which was the settlement, but never got the chance. This Friday the settle was 9921.5. I had calculated the chance of a March hike last week at about 20%, and this week odds have pushed a bit higher to just above 25% (using March and April FF prices). I find it difficult to discern why the Fed would wait to hike, but near euro$ calendar spreads remain languishing around 50 bps, indicating two hikes a year.
Once again it seems as though international headwinds have the potential to buffet the Fed’s decision making, with France to Germany 10 year yield spread around 74 bps, highest since 2013, though well below the high of 146 in 2012. However, a key indicator that markets may be running out of charitable sentiment towards central banks may be the Japanese 30 year rate, which closed at a new high of 92 bps, up 6.7 on the week. The BoJ has been successful pegging tens below 10 bps, but the genie is wafting out of the lamp’s spout at the long end.
An interesting note was embedded in a presentation by Grant Williams (link at bottom, thanks DW). The debt of the Federal Government has more than doubled since 2007, from $6.1T to $15.9T. *Fed’s Z.1. However, the interest rate expense on the debt has remained nearly constant from $430B in 2007 to $433 in 2016, due to the drop in rates. Some think that rates can’t go up because of the stress it will cause on the government budget. I think the opposite.
Another market feature that bears mention is the dramatic widening of swap spreads to the highest levels since 2015.
(Bloomberg) — A proposal to eliminate interest-expense
deductions as part of a Congressional tax overhaul plan is
already causing dislocations in the interest-rate swaps market.
The spread between 30-year U.S. swap rates and government bond
yields has reached the highest level since 2015 and could widen
further, according to a Deutsche Bank AG pricing model
forecasting a 5 basis point jump should the measure be passed.
The model forecasts a slump in corporate issuance of as much as
28 percent, translating into a smaller base for fixed-rate
receivers, which would pressure long-end spreads
Well I guess the DB model is right, on direction anyway, because before the election the 30 year swap spread was at its low around -55 and is now -38. From the two year to thirty year, swap spreads are all in bullish configurations (widening). Post-election late November lows to now, 2y 19 to 35.8 currently, 5y -3 to 10.75, 10y -18 to -4.5 and 30y -58 to -38. For both the ten year and 30y the late Nov levels were record lows, and both spreads are now higher than all data in 2016. Ten year is pictured below.
10 yr swap spread
There are a variety of reasons for this movement, though my main goal is simply to ride the wave. A treasury paper from last summer (linked below) explained negative swap spreads with the following observations: GSE’s had been large fixed payers when they were retaining mortgages, and with the Fed taking GSEs out of the picture, and putting MBS on the balance sheet without hedging, the pay-fixed demand abated. (That factor would seem to be on the verge of reversal as the Fed considers trimming the balance sheet). Another driver is the Libor to GC spread. In 2015 General Collateral funding costs exceeded Libor due in part to regulatory reasons. As libor moves up and regulatory burdens are expected to ease, this factor reverses. Foreign central bank selling of treasuries also increases supply of collateral. Finally, there may be issues related to the upcoming debt ceiling. I am no expert in the intricacies of this pricing, so any comments are appreciated. However, I would definitely favor long midcurve Eurodollar puts over treasury puts given the strong upward trend in swap spreads.
This week features auctions of two, five and seven year notes. FOMC minutes are released Wed.
March treasury options expire Friday.
Yellen speaks on March 3, the Employment report is March 10, one week later. March FOMC is Wednesday, 15-March; March midcurve ED options expire the PREVIOUS Friday, 10-March, on NFP.
_________________________________________________________________
| 2/10/2017 | 2/17/2017 | chg | |
| UST 2Y | 119.4 | 119.4 | 0.0 |
| UST 5Y | 188.5 | 190.8 | 2.3 |
| UST 10Y | 240.7 | 242.4 | 1.7 |
| UST 30Y | 301.0 | 302.9 | 1.9 |
| GERM 2Y | -78.9 | -81.0 | -2.1 |
| GERM 10Y | 32.0 | 30.2 | -1.8 |
| JPN 30Y | 85.3 | 92.0 | 6.7 |
| EURO$ M7/M8 | 50.5 | 51.5 | 1.0 |
| EURO$ M8/M9 | 37.5 | 37.0 | -0.5 |
| EUR | 106.42 | 106.15 | -0.27 |
| CRUDE (1st cont) | 54.33 | 53.78 | -0.55 |
| SPX | 2316.10 | 2351.16 | 35.06 |
| VIX | 10.85 | 11.49 | 0.64 |
__________________________________________________________________
https://www.frbatlanta.org/chcs/wage-growth-tracker.aspx?panel=1
https://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm
https://www.federalreserve.gov/releases/z1/current/html/d3.htm
