Feb 1. Market based measures of inflation? Chgo Metra rail passes increase in price today, 4 to 12.3% more

–FOMC announcement today.  No press conference, no change expected.  In the last announcement, the Fed said “…labor market has continued to strengthen and that economic activity has been expanding at a moderate pace.”  With respect to inflation, “Market-based measures of inflation compensation have moved up considerably but still are low; most survey-based measures of longer-term inflation expectations are little changed, on balance.”  I would only mention that market based measures have continued to increase since the mid-Dec FOMC, and the Fed should make note of it this time around.  For example, Ten year treasury / tip spread was around 175 bps pre-election, had moved into the low 190s going into the Dec FOMC and is now more like 205.  2/10 was 100 pre-election and is now 125.

–Yields eased yesterday and the dollar fell as portfolio rebalancing took effect.  The ten year yield fell 3.5 bps to 245, and back month euro$ yields fell a similar amount (blue pack +4.0).  At the end of the day there were a couple of significant bearish trades.  Buyer of 25k 0EH 9825p/9850c combo covered 9838.5, call was sold at 0.5.  And in treasuries, the TYH 122p was bought for 5.  Open interest declined 30k in the TY put and 20k in the March midcurve, so trades appear to be exits.

–Other news today includes ADP, expected 168k and Mfg ISM expected 55.0 from 54.7.  Chicago PMI yesterday was much weaker than expected at 50.3.

–Warren Buffet reportedly bought $12 billion in stocks after the election.  It wasn’t too long ago that Bernanke pointed to solid equities as evidence that the Fed was doing a great job.  Subsequently, the complaint from Central Banks was that they couldn’t do it all, fiscal policy had to do its part.  Here we are, with Trump promising to significantly juice the fiscal side (blatantly obvious to guys like Icahn and Buffet) but the Fed isn’t quite sure about the trajectory.

–Silver appears to have broke out of a bottoming formation yesterday, copper continues to flirt with the 274-75 resistance.

Jan 31. Trump’s new executive actions will positively impact JOLTS!

–Little change in interest rate futures despite a modest end of the month pullback in stocks.  One trade of note was a new seller of 30k FFJ7 (April Fed Funds) at a price of 9929 down to 28.5.  It’s pretty slow when we’re forced to highlight FF trades…but here it goes.  April 1, 2 are both weekend days that will use the Fed effective from the last day of March. April 28 is the last weekday of the month, so the Fed Eff for the 28th, 29th and 30th will also be lower.  For our purposes, assume 10 bps lower for end-of-month days.   Current Fed eff is 66.  So if no change then (66*25 + 56*5)/30 is 64.3 or a price of 99.357.  On a hike in March, assume new Fed Eff of 91 and month end 81 which yields 89.3 average or 99.107.  So at a price of 9928.5 the odds of hike are 29%.  Which is too low.  Because they’re gonna hike.  Just remember, NO press conference at tomorrow’s FOMC, so the Humphrey Hawkins testimony on Feb 14 and 15 might be quite important.

–BoJ modestly increased growth estimate for the coming year to 1.5% from 1.3%.  (But still finds it appropriate to hold the ten year JGB near zero).

–News in the US today includes ECI expected +0.6 and Chicago PMI expected slightly firmer at 55.3.

–Trump is ALREADY fulfilling his promise creating new job openings in the US…first in the State Dept and now Justice!

Jan 30. Rebalancing flows

–Stocks are under some selling pressure this morning, as some point to the immigration suspension as a source of concern, along with the possible border tax.  Another factor might be a note on ZH claiming that tax reform might not occur until spring of 2018.  Net changes are actually quite modest, and given the fact that nasdaq has rallied about 9% since early December, not surprising…perhaps VIX will get a small boost from its close of just 10.58 on Friday.  Obviously, the overarching technical issue is portfolio rebalancing going into month end.

–News today includes Personal Income and Spending, expected +0.4 and +0.5.  Core PCE prices yoy were +1.6 last, so still below the Fed’s goal of 2%.

–The ED curve edged a bit flatter Friday as Feb treasury options expired. Red/gold pack spread eased 2.75 bps to just above 86 bps; the ten year yield fell 2.5 to 248.1.  Nearly all of the 3 month eurodollar spreads out two years are around 1/8%, though EDM18/EDU18 settled at just 11 bps and EDM18/EDZ18 settled at 23.0.  Worth buying the latter for roll-up.  There’s a slight concession for the turn of the year in the Dec’17 contract, which is also evident in the EDZ18 contract.  I.e. the Sept/Dec/March butterflies are +2.5 in the former and +3.5 in the latter.

–FOMC is Wednesday.

Jan 29. The important thing was, that I had an onion on my belt….

“We can’t bust heads like we used to, but we have our ways.  One trick is to tell them stories that don’t go anywhere.”   Grampa Abe Simpson – Union Buster

Look, there’s just not much to say about the week that just passed, notwithstanding a flurry of executive orders.  The market story didn’t really go anywhere, reflected by the drop in VIX, now languishing just above the decade’s lows (10.58).  Net changes were small, with a slight bias toward higher rates and higher stocks.  Oh, I could regurgitate what a lot of famous investors/traders have already said:  Gundlach. “…short German bunds.  They are yielding 0.27 and Germany’s inflation rate is 1.7%. Historically, it is very rare to have a Bund yield below the inflation rate. The current gap is a record. The Bund yield is unsustainably low. “ That’s from Barron’s a couple of weeks ago; this week the bund edged to a new recent high of 48.4.  Or, Kyle Bass on Bloomberg last Wednesday, “Inflation, set to increase in the U.S., will also spike in Germany, which will prompt a tapering of the European Central Bank’s bond-buying program and possibly an increase in interest rates.”  Morgan Stanley said in a report this week that the Fed will stop mortgage re-investment in April of 2018.

So…. sell bonds, steepen the front end of the curve.  I’ve been on that topic for a while, and there are still interesting plays being made to reflect those themes (some noted in the ‘Trade Thoughts’ section below).  In the bigger picture, opportunities still abound, given that one-year Eurodollar calendar spreads are just slightly above ½% on the front end of the curve, and taper down to about ¼% from the last greens to the last blues. For example, EDU’17/EDU’18 settled at exactly 50 bps, and EDU’19/EDU’20 settled at exactly 25 on Friday.  The point is that the market is still leaning toward the idea that the Fed is on course for two or maybe three (gasp) hikes a year at the outside, and those estimates are likely too low.

We can argue that moves have already started, and that the adjustment immediately after the election substantially decreased any ‘edge’ from entering positions at the current location given uncertainties that still plague the global landscape.  I suppose that line of thinking plays right into the Fed’s handbook…  ‘On the one hand there are fiscal stimulus risks, on the other hand there are global concerns…’  Oh, right, there’s a meeting of the FOMC this week.  It’s on Wednesday, but perhaps would have been more appropriately scheduled a day later: Groundhog Day.  The Fed has been pushed ever so slightly to acknowledge that there might be some upside risks.  As Grampa might say, “WAKE UP AND SMELL THE COFFEE”.  As mentioned last week, bond yields are going up globally, stocks are at new highs, copper is near new highs, inflation measures are increasing. The lows in oil were set in Jan and Feb of last year, so yoy comps will start to filter in NOW.  As a clear example of ringing the bell, the National Federation of Independent Business Optimism Index simply exploded last time.  Here are a couple of quotes from that report. “Small business is ready for a breakout, and that can only mean very good things for the U.S. economy.”  The other two big movers in the survey, “Sales Expectations” and “Good Time to Expand,” jumped by 20 percentage points and 12 percentage points, respectively. “In this month’s report, we are also finding evidence that higher optimism is leading to increased business activity, such as capital investment.” (The next NFIB is Feb 7).  It’s stunningly obvious that Trump is not afraid to make changes to reach his goals, and clearly his appointments are PRO-GROWTH, and PRO-INVESTMENT in the context of full, (if under) employment.   Add in the prospect of protectionist trade measures and a Treasury Secretary that thinks the dollar is too strong… the inflationary tea leaves are brewing.  As David Bowie might say, ‘it’s like putting out fire….with gasoline.’

Not only was vol hit in equities, it declined across the interest rate curve this week as well, with March US bond vol at only 10.0.  Somewhat surprising in front of a week chock full of data including Personal Income and Spending on Monday, ISM reports mid-week, and the jobs data on Friday, in addition to the FOMC.  Though this FOMC will not be followed by a press conference, the statement will likely have a hawkish bias.  And, making up for the lack of a press conference, Yellen is scheduled for her semiannual testimony in front of the Senate on February 14.  The St Valentine’s Day massacre, where she could easily set the market up for more rapid ‘normalization’ to counter the Trump effect.

Finally, as it’s the year of the Rooster, a quote from a famous figure born under that sign:

Some people feel the rain.  Others just get wet. –Bob Marley

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Jan 24. Surprising short cover rally

–Heavy volume associated with the rally in eurodollar futures yesterday.  Total 4.6 million traded, but open interest was down 220k with only EDM8 posting an open interest rise over the first 12 quarterlies.  EDM7 open interest fell 77k and EDZ7 62k (EDZ had heaviest volume on the strip at 570k).  Similar story in tens, heavy volume of 1.6m but open interest down slightly, falling 6k as cash tens plunged 7 bps in yield to 2.40%.  Lifting of hedges?  In any case, the curve edged flatter, with 2/10 in 2 bps to 125.6.  Some of the near ED calendar spreads traded remarkably low levels, for example Sept7/Dec7 went 14 offer and settled there.  June7/June8 fell 2.5 bps to close at just 49.  If there was substantial pricing of Fed tightening on the curve, short cover buys would be understandable, but EDZ7 closed 9850.5, only 50 bps lower than the final settlement of EDZ16.  Can we really be sure of only two hikes over the year?  It doesn’t really cost much to take the ‘over’, as several option plays suggest…

–On the option side, bearish trades continue, as buying put spreads, selling calls remains popular.  Yesterday the midcurve March (0EH on EDH8 underlying) 9850 calls were sold vs buying 9825/9812 p spreads and 9837/9825 p spreads; the contract settled at 9839 with options expiring March 10, just prior to the March 15 FOMC.  Similar trades occurred in Green Sept and Green Dec midcurves.

–The dollar index slid, trading 100.19, well through the old highs set in 2015.  JPY was trading late at 112.75, though this morning it has bounced back to 113.40.  A strong dollar has been one of the factors suppressing inflation…

–Two year auction today, followed by 5’s and 7’s Wednesday and Thursday.  Feb treasury options expire Friday.

Jan 22. (bond yields) breaking with the past

Short note this week, mostly in the form of a question, “could yields now be in a bear market?”

Above is a chart of 4 bond yields, US in blue, UK in white, Japan in red and Germany in green.  I used the Japanese 30 year yield as the ten year JGB is being targeted by the BoJ, holding around 5-6 bps.  Since Q3 2016, all these yields bottomed and have been moving higher.  The German bund closed on a new high of 42 this week.  The 30y JGB is also right at the high, 80 bps.  In the US, Bill Gross has talked about 2.60 as the level above which we will be in a confirmed bear market in bonds.  Gundlach has mentioned 3%.  The latter level was last reached at the end of 2013, the year of the ‘taper tantrum’.  On the chart above, it clearly appears as if 3% is a big hurdle to overcome.  In the UK I would say a close above 2.1% would be the level.  In Japan, 1.5% and in Germany 1%.  Of course, Q2 of 2015 also looked like a break out of yields, especially as bunds exploded.  However, there are differences this time, including accelerating measures of inflation expectations and.. . the Donald.

Of course, there are still many bond bulls out there, including Lacy Hunt who received a reasonable amount coverage with latest call, unsurprisingly, that yields are going lower.  His track record on lower bond yields has been unwavering, his reasoning completely on target.

https://www.bloomberg.com/news/articles/2017-01-18/bond-guru-who-called-last-bear-market-40-years-ago-says-go-long

The question is, could we be in the midst of a turn now?  Hunt points to the low and declining velocity of money as evidence that rates can continue to decline.

However, part of this decline is related to the numerator, M2, which had been at a fairly stable growth rate of around 6% from 2015 to the beginning of 2016, but accelerated as the year went on and closed 2016 around 8%.  https://ycharts.com/indicators/m2_money_supply_growth

What if velocity also begins to turn from here?  Could inflationary expectations start to get away from the Fed?  It’s not completely uncommon.  From the end of Dec 1986 to end of Sept 1987, yoy CPI went from 1.1 to 4.4.  March 1999 to June 2000 it went from 1.7 to 3.7.  June 2010 to Sept 2011 from 1.1 to 3.9.  And currently, from Sept 2015 to Dec 2016, from 0.0 to 2.1….so far.

This week Yellen said the economy was strong enough to withstand rate hikes, and there were also a few comments (Harker) about shrinking the Fed’s balance sheet.  However, the peak one-year calendar spread on the Eurodollar curve is only 56 bps (EDH7/EDH8) and most are below 50 bps, suggesting only two rate hikes per year.  Last week I mentioned the flatness in the curve and noted that the red/gold Eurodollar pack spread (2^nd to 5^th year) closed at a recent low of 71, citing this level as the halfway point from the Sept 27 low of 41 to the Dec 12 high of 101.5.  This week we bounced and closed 81.625.

News is fairly light this week, with auctions of 2’s, 5’s and 7’s.   Feb treasury options expire Friday.  The first 100 days of the new administration arrives at the end of April; there is an FOMC meeting on May 3.

Jan 19. Yellen’s Core Message- higher rates

–The main event yesterday was, of course, Yellen’s speech on monetary policy.  While she didn’t mention upside risks due to fiscal policy, or instability caused by frothy financial assets like Commercial RE, the message was one that accepted the idea of steadily higher rates.  Eurodollar calendar spreads rebounded slightly off the lows which had been made this week, though the curve still seems too flat.  For example, the one year spread June/June (EDM7/EDM8) settled at just 51, an indication of just 2 hikes per year.  A headline on the FT this morning says “Fed officials prepare ground to cut bank’s $4.5tn balance sheet“.  Recall that during the taper tantrum of 2013, further back one-year spreads (for example middle reds to middle greens) shot up to 90 bps.  Currently the red/green pack spread is just 34 bps.

–A lot of the damage yesterday was done after the futures settlement, as Yellen’s speech began right at that time (3pm EST).  For example, at the futures close I marked the five year yield at 188.7, and by 4:45 EST it was 4.5 bps higher at 193.2.  Tens went from 239.1 to 242.8, a rise of 3.7.  The dollar also firmed, with $/yen posting an especially dramatic reversal – outside day and closed near the high of 114.77.

–ECB today with Draghi expected to maintain dovish posture and contain expectations.  News in the US includes Housing Starts at 1.2m, Jobless Claims at 255k, and Philly Fed expected 16 from 21.5.

–There was a late (post Yellen) block trade yesterday, +50k EDM7 9887/9900c spd for 2.5.  This spread had settled 2.75, and appears to be a fade for the possibility of a Fed hike in March.

Another HAPPY customer

Jan 18. Curve falls to flattest of this year

–Yields fell yesterday and settled near the day’s low with tens down 5.6 bps to 232.4.  The curve flattened with nearly all eurodollar calendar spreads posting new recent lows.  2/10 treasury eased 2.4 to end slightly higher than 117.  The peak one-year spread is EDH17/H18, March/March, which fell 4 bps to just 52.5.  All other year spreads are below 50 bps, indicating market perceptions of just two Fed hikes per year.  The red/green pack spread (2nd to 3rd year) is now only 32.75, and green/blue (3rd to 4th) is just 21.  The dollar weakened with DXY trading 100.30 late in the day, re-testing or actually slightly through the old highs from 2015, as Donald talked it down.  Gold jumped $20. Treasury implied vol firmed up; if rates start to retrace this last leg lower vols will probably slip back down.

–Today’s news includes CPI, expected +0.3 with Core +0.2, but yoy core is expected 2.1, the highest since mid-2014.  Energy comps are likely to start biting over the next few months, as January and February of last year marked the lows in oil. Once again I would mention that the Bloomberg Commodity Index rose about 13% last year, and grains have been perking up over the past few sessions, with March Beans closing at their highest settle since last July.  Other news includes Industrial Production +0.6 and the Beige Book summary for the Feb 1 FOMC.  Yellen talks about the economic outlook at 3 EST.

January 16. Skyscrapers to heaven

Looking back in history, the Chrysler and Empire State buildings were completed one year into the Great Depression. Lawrence has extended his analysis from the 1800s to the 2010 anointment of the current title holder, the Burj Khalifa in Dubai, and found that the correlation still holds.”

–The story above cites a few skyscrapers or ‘mega-tall” buildings in China.  But for those that believe in the skyscraper index, here’s another article that will absolutely cement fears of a hard landing:

“In the so-called “race to the top,” China is so far above the competition that it can hardly make out any of its competitors. In 2016, a total of 128 buildings of 200 meters in height or more were completed around the world, 84 of those were in China, according to a year-end report from the US-based Council on Tall Buildings and Urban Habitat (CTBUH). That’s more than double the next ten countries combined.

The United States came in second with seven skyscrapers completed, four less than the number built in the city of Shenzhen alone. South Korea was in third with six skyscrapers, the same as the number built in both Guangzhou and Chongqing. Chengdu and Dalian finished the year with five a piece.”

https://www.washingtonpost.com/news/wonk/wp/2016/01/12/the-worlds-tallest-buildings-may-come-with-a-curse/?utm_term=.df1bd1f2957e

The world’s tallest buildings may come with a curse – The … www.washingtonpost.com The Shanghai Tower in China was officially crowned the second-tallest building in the world last week. The same day, as if on cue, the country’s stock …

http://shanghaiist.com/2017/01/13/2016_skyscrapers.php?utm_source=fark&utm_medium=website&utm_content=link&ICID=ref_fark

128 skyscrapers were completed around the world in 2016, 84 of them in China shanghaiist.com To literally no one’s surprise, China dominated the skies in 2016,

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.

  The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.