If everyone is thinking alike, then somebody isn’t thinking

If everyone is thinking alike, then somebody isn’t thinking

–General George Patton

There are a few things that come to mind when looking at this week’s markets.  Strangely enough, General George Patton is one of them.  For those who don’t know, Patton was a famous, controversial, and profane leader of the Third Army in World War II.  Though I am not given to using military analogies, I often think of a tactic that I believe is attributed to Patton, which is this:  At the front lines your fighting force will be involved in the most brutal fighting and incur heavy casualties, causing both sides to deploy more resources.  However, if you’ve committed to taking losses, once you break through the front, your forces can swiftly and easily take vast amounts of territory because the resources of the enemy have been expended.*  That is what happened to the US stock market this week.  (And other markets as well).  Throughout all of 2015 and into the start of 2016, “the Front” was 2100 to 2140 on the SPX.  In the summer post-Brexit, the Front moved a bit north, to 2160/2190.  This week the market vaulted 3% higher after the Italian referendum, on heavy volume.  The warnings from Soros, Druckenmiller, Gross, Gundlach and even Icahn (who seems pretty fluid in his views) were steamrolled by the Trump tanks, meeting little resistance after the big battle.  I am not suggesting that the above investing stars were caught out by the moves, (they are where they are because they adapt to changing conditions), but I am suggesting that the resources of short sellers were expended at the front, and resistance behind enemy lines is sparse.  As a friend of mine says, “You can be bearish.  Just don’t be short.”

The other thing that this market makes me think about is 1987. A chart from 1985 to 89 is below, showing SPX in blue and the ten year yield in white.

Note that when SPX broke through the front in 1986 at around 255, it quickly gained about 20% in Q1 of 1987 to a bit over 300 and then added further gains to around 340 going into October, when the market crashed.  (So the rally from 250 to 340 was a gain of 35% in a year.  In our current case, 2160 x 1.35 is 2916, or… NEW PROJECTION!!!  DOW 25000!!!). It’s interesting to note than in the beginning of 1987, the dollar index was right about where it is now, just below 102.  However, in 1986 going into 1987 the dollar was on a fast train south, as opposed to rallying in the current case.  History rhymes.  There are a few additional interesting similarities.  First, there was concern about trade: “The announcement of a larger-than-expected trade deficit came on October 14, 1987. In response, Treasury Secretary James Baker got tough with U.S. trading partners, specifically Germany. Baker’s message… was “if you don’t lower rates, we’re going to lower the dollar and you’re going to have export problems.”  A threat regarding trade from a high-level official.  Probably couldn’t happen with this new buttoned-down and low key Trump administration….right?  How’s this from the President-elect:  ‘China is not a market economy … they haven’t played by the rules, and they know it’s time that they’re going to start.” Second, in October 1987, Iran hit a couple of American owned supertankers with silkworm missiles.  Third, and this is where our story dovetails with the interest rate markets, yields were marching higher.  From the beginning of 1987 to October, the ten year yield went from around 7% to 10%.  Whoa, now those were some rates!  However, our current ten year yield has risen by a similar magnitude, from 1.60% to 2.40%, i.e. 1.5x the starting rate.  Does it make a difference?  Not yet, but given the huge debt levels in the current situation, it’s worth bearing in mind.

CHINA

A couple of charts on China below.  The first is the US 2/10 treasury spread vs the Chinese ten year yield.  Correlated.  However, the rise in China’s ten year yield doesn’t seem to be stopping weakness in the renminbi, as shown on the next chart.

This chart includes Chinese reserves (white), the inverse of CNY (red) and, again, the Chinese ten year yield (green).  Reserves continue to slide as China tries to stem the decline in the currency related to capital outflows.  Capital is fleeing because of structural problems, which will likely be exacerbated by trade issues with the US.  Which, in turn causes selling of reserves comprised of US treasuries.  Which causes additional pressure on US rates, which stifles US economic growth.  Which Trump can blame on China…   I’m sort of joking about this self-reinforcing loop scenario.  Sort of.

ECB

Really this week was about the ECB, which extended QE, though at a slower pace after March 2017, and expanded eligible securities which can be bought in shorter maturities.  The result was steeper curves everywhere, and new highs in long end rates.  For example, the German 2/10 spread rose over 10 bps to 111.8.  US 2/10 rose to a new high just over 133.  Even Japan’s ten year went to a new recent high of 5.6 bps, and the 10/30 spread in Japan went to 65 bps (highest since March).  The banks loved it.  Italian bank shares rose over 12% this week.  US banks were up over 5%.  Goldman has launched 33% in a month!  “What’s good for General Motors (oops, I mean Goldman Sachs) is good for America.” **  Of course, the dollar index closed at the high of the week  as the euro threatens to test 105.

This week it’s the US Fed’s turn.  A hike is priced, with January Fed Funds trading 9936.0.  The only drama is related to forward looking statements.  Last time the statement said, “The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace…” It added, “Near term risks to the economic outlook appear roughly balanced.”  And, “…the actual path of the FF rate will depend on the economic outlook as informed by incoming data.” GRADUAL and DATA DEPENDENT.  Maintain course.  Any chance that financial stability concerns are voiced with respect to inflated asset prices?  I doubt it.  Another Patton quote: “No good decision was ever made in a swivel chair.”

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I will be out of town this week and therefore not recommending trades.  However, note that in euro$’s, Friday is midcurve option expiration.  Back month Eurodollars (greens back) settled at new lows for the move.  Given relatively low straddle levels, there are cheap ways of playing for a contrarian bounce.

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https://www.goodreads.com/author/quotes/370054.George_S_Patton_Jr_

*I couldn’t find an exact reference to the tactic, but I did find this quote: “Our basic plan of operation is to advance and to keep on advancing regardless of whether we have to go over, under, or through the enemy. “

http://www.history.com/news/10-things-you-may-not-know-about-george-patton

https://en.wikipedia.org/wiki/Black_Monday_(1987)

https://www.federalreserve.gov/pubs/feds/2007/200713/200713pap.pdf

http://www.crossingwallstreet.com/archives/2009/06/whats-good-for-general-motors-is-good-for-america.html  **

Dec 9. Curves steeper in wake of ECB / Fed’s Z1 debt levels

Dec 4. The Price of Risk (or Raising the ‘G-A-S’ factor)

Trichet [in 1994] declared that monetary union would permit the elimination of risk premiums. In the middle of the following decade he appeared to have been right: Greek government bonds, for instance, yielded virtually the same as German gov’t bonds of the same maturity, and for a brief period in 2007, Spanish gov’t bonds yielded slightly less than their German equivalents.  Why?  Because the traditional determinant of cross country bond yield differentials among developed countries, expectations of currency appreciation or depreciation, no longer applied within the monetary union. Ergo bond yields should be equalized.  The great- and very, very obvious- mistake in this reasoning was that monetary union simply converted currency risk (the risk that a certain govt’s bonds might be devalued in terms of another currency) into credit risk (the risk that a government might simply be unable to pay its creditors).  Astonishingly, the credit rating agencies took Trichet at his word: they actually upgraded , on entry into the monetary union, countries with lower ratings than Germany’s.  Why? …It seems there were two factors. One was an implicit assumption that if such countries got into trouble, Germany would somehow bail them out.  The second … was that the mechanisms of the Maastricht Treaty… would make everyone financially sound.

–Bernard Connolly, The Rotten Heart of Europe

Draghi’s famous “Whatever it takes…” line in July 2012, followed the Trichet doctrine: If there is certainty in the institutional support of the the euro, then yields across countries will be suppressed.  (Below is the 18 second clip of Draghi).

https://www.youtube.com/watch?v=tB2CM2ngpQg

If malinvestment and ensuing bad debts had their gestation with the indoctrination of the euro, they’ve been further encouraged and allowed to fester with QE programs and China’s shadow lending.

Later today we will know the results of the Italian referendum.  Though I think Renzi will lose, I don’t know how the market will price all of the various scenarios.  What I think I do know however, is this:  the suppression of yields and spreads, due to transfers of risk to the public sector and to central banks appears to be at ‘the beginning of the end’ phase.  The implication is that the price of risk must shift higher.

This reminds me of a Kyle Bass interview from years ago, when he mentioned a particular lending institution (I forget which) where he said the executives of the firm were personally, financially, at risk for some portion of loans made.  As Bass put it, “It really raises the ‘give- a- sh-t’ factor” regarding who you lend to.”  I think the G-A-S factor is rising across the investment landscape.

The month of November (since Trump’s election of course) has encompassed a sea change in terms of projections of economic growth.  Yields have soared, with ten year treasuries hitting 2.49% before closing the week at 2.39%.  The five year note reached 1.93%; 1.80 to 1.85 had capped fives since the taper tantrum surge in 2013, with that level being tested twice in 2014 and twice in 2015.  The 2/10 treasury spread ended the week near the year’s high at 128.3, up over 50 bps from the year’s low of 75.  Even 10 yr JGBs closed near a high of 3 bps, having been -30 in July.  In euro$’s there is continued buying of calendar spreads, especially from reds to blues (the 2^nd to the 4^th year).  One year euro$ calendar spreads have likewise firmed, with the peak spread, March’17/March’18 nearly reaching ½% (high was 48), a level not seen in one-yr calendars since the very beginning of the year.   An article on ZH suggesting a ‘Hindenburg Omen’ [link below] notes 236 New Highs and 74 New Lows on the NYSE.  In my mind, those relatively high numbers on both extremes are simply an indication of euphoria or despair over perceived winners and losers from a new administration.

The big mover on the week was oil, which rose 12% and is near the high of the year.  This move of course, is due to a production cutting agreement by oil producers, but in keeping with the theme of unshackled growth and construction, note that copper has risen 25% in the month of November.  I’ve previously shown that inflation expectations are closely related to the price of oil, which is underscored by the chart below.  Note once again that the price of oil one year ago was dropping like a rock; if the price stays here (around $51) into the new year, the yoy change will have more than doubled.

There’s a bit more to the oil story that increases its importance this week.  The rally in oil this year has been instrumental in the decline of credit spreads in the US.  In the beginning of the year, the credit quality of the oil sector crashed with the price of the commodity, and all corporate spreads rose on the spillover.  For example BBB Corporates to treasuries peaked in the beginning of this year around 230, near the high of mid-2012.  But that spread now sits at just 159, near the low for this year.  However, HYG and JNK etfs are not making new highs, and the SPX index encountered some profit taking this week, in spite of the surge in oil.  Both Gross and Gundlach have suggested that the Trump rally has run out of steam.

The key points to keep in mind going forward are these.  Deleveraging since the 2007-09 crisis has not occurred anywhere, except in the US household sector in mortgages (the outstanding amount has declined from a high of $10.6T to $9.6T currently).  Every other category in the US flow of funds data has increased, with the total (HH + Business + Gov’t) going from $33.2T in 2007 to $46.3T currently, with the majority increase due to the Gov’t category.  It is going to be difficult (though certainly not impossible) for growth to truly accelerate given the overhang of debt loads.

There are several ways out.  Grow, or restructure, or slash the value of the underlying currency.  The latter two mean accepting lower values on outstanding debt.  As rates increase – the result of the morphine of central bank support slowing to trickle – these factors are exaggerated.   This means that assets with previously positive correlations may begin to break down.  For example, higher oil might be perceived as inflationary and negative for both bonds and stocks.  It might mean that credit spreads are at their nadir and may begin to firm from here.  It might mean that demand for US funding by emerging economies becomes more problematic.  Regardless of the results of the Italian referendum, I expect the US curve to continue its steepening trend, and I further think that all dips in implied vol should be bought.

Dec 2. NFP and Italy Referendum

Dec 1. Large euro$ trades

–Bearish factors sent yields close to new highs yesterday, with tens up 6 bps to 236.5.  An OPEC deal caused oil to explode higher by nearly 10% from Tuesdays’s close, a rally of over $4, and this morning CLF is nearing $50.  ADP was much stronger than expected at 216k.  The new Treasury Sec’y suggested the US issue 100 year bonds (‘you want duration?’).  Another minor factor might be the idea of $100 billion student loan forgiveness that Obama floated.

–Two large trades of note yesterday.  First, in size of 55k, a buyer of curve.  SOLD 0EG 9837/9812 put spread vs BOT 3EG 9762/9737 put spread for 2.5 debit.  Underlying contracts are EDH8 at 9851.5 and EDH0 at 9779, so 14 out of the money on top strike on the first ps, and 16.5 out on the latter.  The 9837 strike has been a popular target in reds; on Tuesday there was outright selling of 0EF 9837p in good size…the general idea is, given the Fed’s insistence on the idea of gradual hikes, the downside is limited in reds.  On the other hand, as I’ve mentioned before, post-taper tantrum reds/golds hit 300 bps, and that spread is now 91.  Reds/blues (which is what this option spread is) is only 69 bps as a pack spread.  On a continued sell off, the idea is that the 0EG put spread will finish worthless or perhaps slightly in the money, with the blue put spread filling out.

–The second large trade was a block seller of 80k EDU7/EDZ7/EDH8/EDU8 double butterfly at 6.5.  This settled at 7.0 as U7/Z7/H8 settled +4.5 and Z7/H8/M8 settled -2.5.  The structure of the trade works out at -1/+3/-3/+1, so the core of the trade is long EDZ7 and short EDH8; that spread settled 9.0.  On the attached chart, you can see that historically, this is a high price for the 4th/5th/6th/7th double, which is another way of saying that EDZ7 is ‘cheap’ on the curve.  The gap moves on the chart indicate rolls of contracts…December contracts historically trade with a bit of “turn of the year’ premium.  Why might EDZ7 trade a bit cheap currently?  For a variety of reasons, including 1) it’s the first red which means there are short dated options with large positions, 2) Dec 29 in 2017 is Friday so there’s a 4 day turn, 3) there are some strategies related to the Fed’s ‘dot plot’ that focus primarily on December contracts.  Related to the turn, recall that ever since Y2K when the Fed promised end of year liquidity, there hasn’t been much of a turn effect at all.  I am almost wondering whether a Trump-inspired laissez faire Fed might not be quite as mindful of companies’ need for liquidity….just a passing thought.

–In any event, both trades received publicity yesterday and both of course are high probability trades.  But in terms of profit potential, the option trade could conceivably make 22.5 bps (max) while the double fly could perhaps see a move to -1 or -2.

Nov 30. Oil and China

–Oil up 2.67 to 47.90 as of this writing on prospects for an OPEC production cut.  US interest rates fell slightly yesterday, but have rebounded this morning.  TYH currently 125-245, right around early levels yesterday.   Data today includes ADP, Personal Income and Spending +0.4 and +0.5, with Core PCE yoy holding steady at 1.7%.  Chicago PMI expected 52.  Beige Book in the afternoon.

–An article on ZH mentions a liquidity squeeze in China and notes that yen cross-ccy basis swaps have crashed to record lows, indicating strong demand for USD funding.  However, EDZ6 is only down 0.5 at 9901.25.  http://www.zerohedge.com/news/2016-11-29/china-liquidity-crisis-deepens-spreads-across-asia   An article on Reuters also notes China stresses (Shanghai Comp -1%)…”Coking coal and steel rebar futures prices were on track for their biggest one-day drop on record while Chinese stocks were the worst performing stock market in the region with a drop of 1 percent.”

–Popular early trade yesterday was buying EDH7 9887/9875ps for 1.5, traded about 30k.  An increase in USD funding demand would help this trade, as would an increase in March FOMC odds, however, the Feb/April Fed Fund spread came down 1 to close at just 3.5 bps, only about 15% odds of a hike in March.  Late in the day there was another round of front end vol selling, with EDH7 9900 straddle sold at 10.0 (settled there) and EDU7 9875 straddle sold at 26.0 (settled 26.5).

Nov 23. Trump: the volatility denouement

–Tuesday was as large of a vol crush as I have seen recently.  Many euro$ straddles lost 2-3 bps. (Perhaps Kanye was just long vol?)  As an example consider 0EH 9850 straddle (red midcurve March) that settled 28.5 on Friday, then 27.5 Monday, and 26.0 yesterday.  2EH 9812 straddle (green march midcurve), settled 41 on Friday and 38.5 yesterday.  EDU7 9875 straddle was 30 on Monday and settled 26.5 yesterday, with 300 days until expiration (so linearly less than 1/10th of a bp per day decay).   TYF 125^ was 1’58 Friday and 1’41 yesterday (ref 124-28 and 125-015). Net changes in futures were small, with rates easing a few bps.  Ten year treasury fell 1.6 to 231.7.  Seven year auction today.

–The Fed releases the minutes from the FOMC meeting earlier this month, as a hike at the next meeting is all but assured with January Fed Funds trading 9937/37.5.  The Fed effective has been 41 bps; Jan FF indicate 63 bps.

–5/30 treasury spread has been selling off as the belly of the curve has led the way to higher rates.  From a high of 140 just after the election to 123 now, this spread is now around the halfway point of its rally since the start of September (from 103 to 140) and should find strong support here.

–An interesting post on ZH says “US Municipal Bond yields have now risen for 10 straight days, spiking from 1.72% to 2.34% today – the highest since July 2015.”  Obviously markets continue to be roiled by Trump’s victory, and perhaps the tax benefits of munis aren’t quite as compelling in the current environment.

–Finally, while you have the tin foil out for wrapping Thanksgiving leftovers, consider making yourself a hat….

http://paleofuture.gizmodo.com/1970s-researchers-predicted-debit-cards-would-be-great-1699216972?utm_content=buffer36656&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer

This is a fascinating article about debit cards and surveillance.

Nov 22. Flows suggest steepening has ended for now

–While net changes in interest rate futures were small, there were quite a few position adjustments of note.  First, open interest continues to rise in almost all interest rate contracts.  For example, there was a large seller of EDH7 yesterday which closed -1.0 at 9896.5, with an increase in OI of 62k.  Total ED OI +170k. Ten year futures added 106k open positions and fives 73k as the roll also gets underway.

–There was continued buying of the EDH7 9887/9875 put spread for 1.25.  In red midcurves, option premium was crushed, with many straddles losing 1 or more bps.  For example, 0EF 9850 straddle was sold at 20 during the day and settled 19, -1.5 on the day, with EDH8 down 0.5.  Heavy new sales as well in 0EF 9837 puts at 4.0, and the 9837p was a targeted sale in other red contracts as well.

–In treasuries, the shift leaned bullishly.  For example, TYZ 125.0 puts (26 delta) expiring Friday were sold on an exit, with OI dropping 34k, and rolled into TYF 121.5 puts which have an 11 delta.  Large purchase of TYZ6 126.5 calls for 5 and 6.  Settled 6 ref 125-175.  OI was up 53k.

— In summary, flows indicate continued pressure on the very front end of the curve, but a flattening bias and possible squeeze higher in longer maturities.  In terms of the 126.5 calls, they had a delta of 15 at settlement, with Fed minutes released tomorrow, auctions of 5’s and 7’s today and tomorrow, holiday Thursday and short day Friday.

–Crude oil surged yesterday, with CLF7 settling up 1.88 yesterday at 48.33, and it’s higher yet this morning, nearing 49.  Stocks continue their Trumpian rally, blustering to new highs.

Nov 20. Past Performance is no Guarantee of Future Results

When I sent last week’s note, I thought it was a little ‘loose’, that perhaps I could have boiled down some thoughts and left others out, but on a re-read, I did mention a couple of things that worked out.  Most notably, “Given the incredible shift in sentiment and the fact that positioning still needs to be adjusted, I think 235 to 240 is a reasonable level to attain prior to the next employment report”.  I was referring to the US Ten Year yield, and that target was attained faster than I had thought, hitting 235 by the end of Friday.   On this holiday weekend, I promised myself to shorten up the note, but there are many themes to address and I found myself wanting to include some old trading floor stories…

LeRoy Neiman CME print, loosely based on the currency quadrant.

This has been a very tough week for some, likely to be seared into mental trading history.  Nothing burns into your brain like personal involvement in a bad trade, except, once in a while, a great trade.  During the week I walked off the train with a friend who stands in the Eurodollar option pit.  He was marveling at how some market making groups continue to accumulate the EDZ6 9900 straddle, even as we slide toward the strike…”well, yeah, this is better because I bought it 0.25 cheaper.”  “Right, but now it’s offered 0.5 below that.”  “So buy more…”  In fact, earlier in the week we had reported that 6.25’s were trading, and a client immediately chatted back, “How’s it left?”  I, of course, drew on my years of professional insight and said, “Still trading 6.25 but bid there, can I bid some for you?”  “No.  I am a seller.”  Of course.  Another impressive read on my part.  It settled the end of the week at 5.0 vs 9902.5.

This reminds me of another story, which accounts for the pic of the currency quadrant above, which, amazingly enough was pretty vibrant at one time…pre-political correctness days.  (There were a few good looking women in the d-marks there in the middle, can you see them?  I can.)  Anyway, a long time ago, there was a trader that used to call the floor to trade pound options (back in the upper left corner).  At the time, all the banks had desks on the floor.  This trader, known as The Sheik, started to sell a strangle, slamming the bid almost every day.  I was on the other side of the floor in Eurodollars but everyone knew of the Sheik.  He would call for a market and desks would frantically shout down for a quote, with NY desks buying the floor and pasting OTC bids.  Of course, the pit market makers were also buyers.  The pound gradually started to slide towards the put strike, but the Sheik continued to hammer the same strangle.  Finally, it’s expiration day.  The calls are worth nothing, the puts are maybe 20 pips out of the money, the Sheik calls for a market.  Finally, he is going to buy these puts back!  So the pit shades the bid slightly expensive.  And of course, as the final indignity, the Sheik slams the bid, with the market ultimately edging a little closer to strike that day, but still worthless.  I always take delight in that story when a friend who was in pound options at the time, tells it.  You know, it’s delightful in the Conan “What is best in life?” way:  “To crush your enemies, see them driven before you, and hear the lamentations of their women.  That is good.”  Of course, this isn’t even my favorite British pound story.  That one involves Bino and Spootie, and I laugh to myself every time I think of it.  Remind me and I will tell you when I see you, over a beer.  https://www.youtube.com/watch?v=6PQ6335puOc

Moving from ancient history to the present….

Both yields and stocks closed on their highs.  VIX went lower, treasury vol surged (chart below).  Dollar Index at multi-year highs.  Eurodollar one-year calendars all at new highs with the peak, March’17/March’18, at 45.5 bps, nearly ½%!  UST 2/10 spread new high of 128, up 27 bps since the election.  Ten year to bund yield soars to 206.  BTP to Bund at the highest spread in two years at 182. Adjustments have been swift and severe.  There are literally hundreds of things to talk about but I will briefly focus on a couple.

First, consider the end of 2013.  Both the US ten year yield and the red/gold euro$ pack spread peaked  ABOVE 300 bps. (Chart attached to email).  2/10 peaked at 264 at that time.  This year, the ten year yield has rallied 100 bps off the low in July, post-Brexit, to 235, while 2/10 is up 53 from the low (to 128) and red/gold up the same magnitude, from 40.5 to 93.5.  My question is, how can tens be only 65 bps from 3% while reds/golds are 206 bps away from the high three years ago?  Just consider this: at the end of 2013, the gold pack was around 96.20 or 3.80% vs Friday’s close of 97.52625, or 2.47%.  NOTE TO SELF:  Don’t recommend buying any blues or golds unless you have a VERY compelling reason (or unless buying PUTS).  Obviously there has been financial repression, and changes in the regulatory landscape, etc, which have tended to make the euro$ curve flatter than in the past.  My intuition is that an adjustment back to previous history would have rather negative implications for credit. (think HYG and JNK).

Though I am not drawing any hard and fast conclusions about which trades should be entered, I am trying to determine which sorts of trades should be avoided, which is perhaps more important.  So, here are a few more points which may help colorize this picture.  First, we all know that Trump and Bannon plan to rejuvenate the manufacturing base with a trillion dollars (??) in spending. From BBG:  “The president-elect’s pledges include tax cuts and spending $500 billion or more over a decade on infrastructure, a combination that’s seen as spurring quicker growth and price gains in the world’s biggest economy.”  I am not sure of the amount, but I will say that at the height of the mortgage refinance boom in 2005-06, homeowners were extracting something like $600 billion at an annual rate from “home equity”.  Now THAT was stimulus.  Spending a trillion over several years might not have as much juice as one might think.  That’s right, a trillion ain’t what it used to be (the bond market lost a trillion in value since the election), though I know, of course, there are many intangibles with new leadership.

I went back and reviewed a few figures from the Fed’s Z.1 flow of funds report to try to get a sense of stimulus.   As mentioned above, the end of 2013 was when rates last peaked after the taper tantrum, with tens over 3%.  From Q4 2013 to Q2 2016, Federal Gov’t debt outstanding went from $13.705T to $15.571T, an increase of 13.6%.  Total business debt (Corporate being the majority), went from $11.293T to $13.223T, an increase of 17%.  GDP went from $17.000T to $18.651T, an increase of just 9.7% over the same time frame (from St Louis Fed).  My conclusions are as follow: 1) an increase in debt, in and of itself, hasn’t had a multiplier effect.  2) Corporate debt is at a nominal record $8.376T and we know a lot of that has gone to share buybacks.  If leverage continues to outpace growth, possible credit problems lie ahead.  3) this isn’t a conclusion, but rather another salient point… in Q2 2015 the BAML BBB option adjusted spread was 180 bps.  With the washout in oil and tighter Fed, the spread surged to just over 300 bps in the beginning of this year, in other words, financial conditions tightened.  Now, it’s back to 180.

I am hopeful that the change in ‘animal spirits’ will spark growth.  However, rates have probably gone up too fast for the time being and may churn around these levels for a week or two.  Demand for the auctions this week (2’s, 5’s, 7’s) may provide clues as to whether this concession will draw strong bids.  January Fed Funds are almost fully priced for a hike in December, and one-year Eurodollar calendars are close to projecting 2 hikes per year as they near 50 bps.  Having said that, colleague TD reminds me that there aren’t that many trading days left in the year, conditions may become more illiquid, some adjustments may still need to be made.  I don’t expect yields to continue their surge, but will be sensitive to the possibility.  Also note that Dec Treasury options expire on Friday’s shortened session.

Finally I am attaching a chart of VIX versus TY vol.  VIX is in white, treasury vol in orange.  The spread, (lower panel) is about as narrow as it gets.  Also, in many cases it appears as if treasury vol leads.  Current circumstances given the election are much different than before, but it almost feels as if selling TY put spreads vs buying ES put wings might have merit.

I realize that some of the above thoughts can almost be thought of as contradictory, in keeping with the spirit of the President-elect.  That’s why I started with the disclaimer right up on top.

Good luck this week and happy thanksgiving

Nov 21. All of a sudden it’s important to hedge

–ESZ starting the holiday week near new highs and crude oil is up 74 cents with CLF7 over $47/bbl in a formation which looks similar to the bounce off August lows.  Two year auction today; the w/i was 1.07 late Friday, a safe and relatively juicy yield, especially in light of the upcoming Italy referendum.  Also today, the Chicago Fed National Activity Index; a negative value indicates slower than average growth.  The 3 month moving average has been negative for 20 straight months, and today will make it 21.

–The Chinese yuan continues to edge lower with CNYUSD 6.8961.  A headline in the FT notes that Malaysia is asking foreign banks to stop trading the ringgit.  Emerging market stresses continue to grow.

–Yields ended at their highs on Friday, with tens trading 235 late and 30’s over 3%.  All near eurodollar calendar spreads made new highs, with the peak one-year spread now March’17/March’18 at 45.5 bps.  Prior to the election all one-year calendars were around 16 to 18 bps.  Red/gold pack spread closed at a new high 93.625, up 5 bps on the day.  While calendars on the front end of the curve have surged, the back end remains relatively flat.  For example, the blue/gold pack spread (4th to 5th years) closed just below 23.5 bps.  Barrons this weekend brought up the idea of the US issuing 100 year bonds.

–5’s and 7’s are auctioned Tuesday and Wednesday.  Dec treasury options expire on Friday’s shortened session.  Note that the largest open interest in a near strike is the 125 put with 74k.  125.5 puts have been whittled down to only 44k (TYZ6 125-18s).  Open interest in all treasury futures rose on Friday as hedging is suddenly in vogue; open interest in tens was up 101k contracts on Friday.

• 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.