Nov 18. The line in the sand is somewhere right around here…

–Yellen’s comments convinced analysts that a Dec hike is in the offing.  Jan’17 FedFunds went from 9938.5 bid to 9938.5 offer.  In other words, Dec is, and has been, priced for a hike.  However the dollar is on a tear, with DXY breaking out to fresh highs, and signs of stress are percolating in emerging markets.  The continued depreciation of the yuan (CNY 6.89) and decline in oil and other commodities due to dollar strength is disinflationary.  Recent moves are driven by a change in sentiment and off-sides positioning, but at this point are stretched, as interest rate futures continued to tumble late yesterday and this morning.  So where is the line in the sand?  The euro has fallen nine days in a row and is around 106, with 105 as a support level from the start of 2015.  The five year note has 178 to 185 as major resistance since the high first hit after the taper tantrum, and early today the lower end of that band was tested.  Tens have resistance at 235 to 239 (per Gundlach and Fibonacci) and again, this area was tested early today.  TYZ traded to 125-17, with maximum open interest in TYZ 125.5 and 125.0 puts (55k and 77k, expiry in one week).  There’s a lot of wood to chop to get through these levels; longer time frame participants will likely use these areas as support.  I would tend to ignore macro constructions at this stage; too many possible outcomes.  There was an interesting Bloomberg article citing Paul Romer of the World bank today with this clip: In between, he offers a wicked parody of a modern [typical economist] macro argument: “Assume A, assume B, … blah blah blah … and so we have proven that P is true.”  Well, we’re in the blah, blah, blah period right now, and I have no idea what P is going to be.

–What I do know is that there were a few large trades yesterday that bolster the steepening case.  A new buyer of 70k FVF 119/120 call spreads for 15 (settled 14 ref 118-12.25), and a program buyer of USF 152 puts (near 50 delta) in size of about 15k.  A couple of the near one-year euro$ calendar spreads pushed to new highs; the peak one year moved forward to March’17/March’18 at 42 bps.  However, the market is taking the Fed at its word in terms of a slow trajectory of hikes.  For example, Feb/April FF rose 1 bp but still only prices around 16% odds of a hike in March.

–Leading Indicators today expected +0.1.

Nov 17. Full Employment and Wage Growth….but Yellen’s not sure

–Top billing this morning goes to Yellen, who will appear before the Joint Economic Committee, with the text of the speech to be released 2 hours earlier at 8am EST.  Odds for a December rate hike are already cemented.  However, the possibility of another move in March is barely priced, with Feb/April Fed Fund spread at 2.5/3.0 late in the day (FFG7/FFJ7).  Settlement of 3.0 represents a mere 12% chance of hike in March.  While Yellen’s trepidation about forward economic and labor prospects always shines through, it’s worth taking a look at the last Wage Tracker chart from the Atlanta Fed showing acceleration to 3.9%.  The mandates of full employment and increasing inflation both appear to be in place.  https://frbatlanta.org/chcs/wage-growth-tracker/?panel=1

–Yesterday the ten year yield rose in the morning, falling just shy of Monday’s high 230.  The five year yield actually edged to a new high for the week of 173.4 (180 to 185 has been a 3 year cap), but by the end of the day tens fell back to 222 and fives to 167 as positions squared in front of this morning’s testimony. The dollar is close to breaking out to new highs as cracks are appearing in many parts of world.  For example, Prince Alwaleed mentioned the idea of the Saudis cutting the USD peg (in the future).  Mexico is expected to raise rates.  There are concerns about Malaysia instituting capital controls.  Bitcoin is again near the top of the range.  And of course the yuan has been depreciating.  A breakout to new highs in the dollar index (DXY) will likely be taken hard by US equity markets.
–Still underlying bids in long dated green straddles in dollars.  Somewhat interesting?? …back in mid-October, EDU9 (Green Sept) was trading around the 9862.5 strike and the atm straddle was right around the strike price (that is, it was trading 86), which seemed cheap for the longest dated green.  On the other hand, a price of 9862 is a yield of 1.38% and 86 is a big chunk of that.  Since the election, the yield has gone up to 2% (EDU9 closed 9804.5) and the atm straddle is now 103.5.  On the other hand, the change in yield has been 42% (from 1.375 to 1.955) and the atm straddle has only expanded by 20%.  Clearly the change in atm straddle prices shouldn’t match the change in yield, but the underlying bid for longer dated premium in the back end of the dollar curve is certainly understandable.
–Other news on the day includes CPI expected +0.4 and Core +0.2.  Housing Starts expected 1.156k.  Jobless Claims 257k and Philly Fed 7.8 from 9.7.

–Interesting link from ZH on the disaster of Illinois pensions. http://www.zerohedge.com/news/2016-11-16/illinois-pension-funding-sinks-376-unfunded-liability-surges-130bn

Nov 16. Interest rate vol crush

–Turnaround Tuesday in interest rate implied volatility as Dec Treasury straddles were hammered.  For example, on Monday USZ 154.5 straddle settled 3’04 and yesterday at 2’30, a drop of over 2 vols.  TYZ 126.5^ fell from 1’16 to 1’01 (7.1 to 6.1).  Blue and gold Dec midcurve straddles also fell 3 bps.  While rates were stable to just slightly higher (tens rose 1.5 bps to 223.7 and 30 yr fell 1.2 to 297), there is renewed pressure this morning with TYZ trading 126-03, close to Friday’s low of 125-305.  Positions are still heavily offsides, and that is likely the biggest factor driving the market.

–Once again new highs were made in some of the near eurodollar calendar spreads.  Peak one-yr is still Dec’17/Dec’18 at 42.5 bps (+0.5 on the day).  As spreads approach 50 bps it’s consistent with expectations for two hikes next year.  However, strength in USD may still temper actual Fed hikes, as a stronger ccy acts as a restraining factor.  New low this morning in yuan with USDCNY 6.8758 and the yen has also made new lows with $/yen 109.62.  (Beat the tariffs by depreciating the currency).

–News today includes PPI expected +0.3 with Core +0.2 and Industrial Production +0.1.

Nov 15. Nearing targets

–Early Monday morning the ten year yield hit 230 before coming back to end the 222.2 at futures settlement, up 5.4 bps on the day.  The area of 235 to 239 is a target level.  Volume was heavy, and euro$ calendar spreads again pushed to new highs, with the peak one-yr spread Dec’17/Dec’18 at 42 bps (+3).  The red/green/blue butterfly (as a pack spread) has now exploded 13 bps in a week, a monster move, as reds/greens rallied that much harder than greens/blues.  By the way, from greens back there was slight flattening: Greens -6.75, Blues -6.125 and Golds -4.625.  The five year note yield ended near 165, only 20 bps away from the top of a three year range that has been tested several times.

–While there were position adjustments throughout interest rate options, some large new positions are clearly pressing the trend.  For example, Green June midcurve (2EM) 9725p traded 100k with open interest up the same.  Settled 6.5 ref 9850.0 (so 125 bps out of the money).

–While inflation expectations have been rising, the fall in oil since October has been particularly viscious. However, it made a spike low yesterday but held the low from August, then rallied, closing higher on a spirited afternoon run.  Higher yet this morning over 44.50, up over 2.30 from the low yesterday.

–Chinese yuan continues to sink, with USDCNY now 6.8535.  Some of the industrial metals like copper have had huge run ups as the Chinese ccy has depreciated; not sure whether its because Chinese industry is again ready to surge, or whether it’s inventory hoarding…hold metals rather than yuan.  In any case copper is showing some signs of a top, and the stronger USD in general is a weight on commodities.

–Retail sales today expected +0.6 and VC Fischer speaks this afternoon on bond market liquidity.

Nov 13. He’s not selling any alibis (just bonds)

At one point you have to choose: Revolution or Frank Sinatra.  For me it was Frank Sinatra.  I want to show people a lot of things…with this.—see link at bottom, surprise quote

You said you’d never compromise
With the mystery tramp, but now you realize
He’s not selling any alibis
As you stare into the vacuum of his eyes
And say do you want to make a deal? –Bob Dylan, Like a Rolling Stone (…mystery ‘Trump’?)

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Trump’s election sent shockwaves through the markets and indeed through the world.  Protesters incite revolution; I’d rather listen to a track of My Way.  There has been a tremendous amount of analysis and soul searching, both within markets and through society as a whole.  As my friend at the local wine shop (The Bottle Shop in beautiful downtown Wilmette) told me yesterday, “We have been delivering a LOT of alcohol since the election.”  I, of course asked, “for commiseration or celebration?”

Analysts with a much broader perspective than me have laid out their ideas, some with an almost amazing sense of foresight (as they might like to think, whereas I might call it hubris).   I’ll leave it to the big thinkers.  My slant is that we’re at an inflection point, in the middle of the Fourth Turning, and the distribution of outcomes suddenly seems much wider.  The only thing I know for sure is that people are rebelling globally against the powers that be (or should we use ‘were’) paternalistically lecturing them about what’s in their best interests.  It’s still not really sinking in.  For example, Jean-Claude Juncker, President of the EC, this weekend said, “We will need to teach the president-elect what Europe is and how it works”.  Dude, did you miss the whole “America First” theme?   Do you think you’re going to set the Donald down and tell him how things work?  In terms of this being a “teachable moment”, the new model seems to be trickle up rather than trickle down, a perception, though perhaps fleeting, of a shift towards empowering labor and the average Joe.  It can easily turn messy.

Enough of that, as I’m out of my depth.  Probably better to stick to the markets, and even the broad strokes there are difficult to handicap.  I think we’ve turned.  For example, James Grant of Grant’s Interest Rate Observer has said for years that rates hit their lows and are going to start going up.  If there’s ever been a time to make that call, this is it.  I think July’s low in tens of 136 will mark the nadir going forward.  Perhaps I will be proven wrong, but at least I will be in fine company.   In any case, the shifting sands make it less likely that investors indiscriminately sell premium in order to try to squeeze out a few extra basis points of yield.  The fact that VIX came all the way back down to 14, even with the rally in stocks, is somewhat surprising to me.

From here, I will concentrate on US interest rates, without much of an overlap into macroeconomic themes.  Even more boring than usual.  And… no cartoons this week.  I know, some of you will stop right here, but before you do, note that Yellen is scheduled to speak in front of the Joint Economic Committee on Thursday at 10:00 am.  On Tuesday the 15^th Fischer speaks on Bond Mkt Liquidity and Lael Brainard speaks Friday on something having to do with working arrangements.

https://www.federalreserve.gov/whatsnext.htm

Net changes and signals 

According to my own calculations using Friday’s settlements in treasury futures (due to the holiday), the ten year note yield soared 38 bps this week from just under 178 to nearly 217.  The blue pack on the euro$ strip (4^th year forward), jumped over 54 bps in yield.  Implied volatility screamed higher.  One-year Eurodollar calendar spreads exploded and curvature returned to the euro$ strip.  The peak one-year spread is now Sept17 to Sept 18 at 39 bps (up 21 on the week).   Dec’17/Dec’18 also closed at the peak level of 39. Even with this rally in one-yr spreads, it’s interesting to note that the dot projections from the September FOMC (using a trimmed mean) for end of year levels in 2017 and 2018 are 1.30% and 2.11%, suggesting a red/green Dec spread of 81 as opposed to 39.  The red/green/blue pack butterfly leapt nearly 10 bps from -1.875 to +8.5 as spreads between reds and greens rallied much harder than the more deferred spreads.  More on that below.

On Friday, Fed VC Fischer again made comments indicating a rate hike was likely this year.  January’17 Fed Funds, (FFF7) closed at 9941.5 about 75 to 80% odds of a hike at the Dec 14 FOMC.  However, even though the domestic situation is now front and center, the Italian referendum is on December 4, and could conceivably push an already fragile euro over the edge and reignite Fed concerns over international stability.

In terms of this week’s economic impact, I read a blurb about bonds having seen $1 trillion evaporate in value.   That’s a pretty big number in the context of $18.6 trillion GDP.  Some of the capital losses are horrendous.  For example, just consider the 30 year bond future USZ6, which was 168 at the start of October and closed at 155, a loss of nearly 8%.  A 2.75 coupon doesn’t do much to take the edge off that sort of hit.  Let see, per million it’s about $3400 in positive carry and $130,000 capital loss.

Gundlach mentioned that increased mortgage rates could begin to bite into housing.  Perhaps, but on a mortgage of $400,000 (just below the conventional limit) an increase of 50 bps is just a bit over $100 per month.  (Assume 3.5% to 4.0%, 30 yr conventional, monthly pay from $1796 to $1910). Sure, it’s significant, but I would bet that health insurance premiums and deductibles are a larger concern for most people.

Eurodollar futures…  First, all curve trades made new highs.  By a lot.  On the week, white ED’s closed -7.25, reds (2^nd yr) -27.25, greens (3^rd) -46.0, blues (4^th) -54.375, and golds (5^th) -55.125.  So, the question going forward, is which part of the curve goes up or down hardest?   The market seems to be telling us longer contracts will continue to go down harder, not only because of net changes, but because of straddle prices.  For example blue midcurve atm straddles had been trading at a premium to green atm straddles of about 3 bps.  On Friday that spread is more like 5 to 6 bps.  Recall that in 2012-13 greens had higher absolute values.

In terms of one-year calendars, fronts (whites) to reds went out an average of 20 bps, reds to greens 18.75, but greens to blues only 8.375 and blues to golds 7.5, which might suggest that blue atm straddles are perhaps expensive to greens.

Note that at the start of the taper tantrum in 2013, the third red to the third blue (2 yr spread) started below 100 bps (~80) and shot up to over 200 by Q4 (Chart below).  Currently that spread is EDH8 to EDH0 and it’s just 64, below the level of all of 2012.  In 1994 and 2004 when the Fed began actual, concerted, tightening cycles, the third red to blue declined.  I think the primary considerations going forward are whether the Fed will hew to its mantra of very gradual increases, and also how the market views central banks and their policies in general.  My lean is that this episode will be similar to 2013; that central banks will be behind the curve, but my conviction level is malleable.

In terms of target levels on the Ten Year, I would note that on Friday we nearly hit the 50% retrace level of 219.4 from the 2014 high of 303 to this year’s low of 136.  The 0.618 retrace is 239.  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.

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*** NOTE: Treasury yields were imputed from futures settlements

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Quote at the top was from Jimi Hendrix  https://www.quora.com/To-what-degree-was-Jimi-Hendrix-interested-in-politics-social-change-etc

November 11. Pointing out the obvious

–Yields continue to rise like the phoenix from the ashes.  Since the employment report last Friday, blue Dec (EDZ19) has fallen 50 bps. At the time, the Blue Nov (3EX) 9850 straddle was 13, and December was 22.5.  As we might say with the benefit of hindsight, those levels were too cheap (you’re welcome). And it’s not over, as November midcurves expire today, an illiquid holiday. The ten year was up another 4.5 bps yesterday to 211.5.  All curve trades made new highs with the peak euro$ one-year calendar spread now at 36.0, Dec’17 to Dec’18.  From a fundamental basis, I think one-year spreads around 3/8% or 37.5 make sense in the near term, as the Fed is likely to maintain a gradualist approach.  Note that Yellen is now scheduled to appear before Congress next Thursday.

–2/10 treasury spread tacked on another 3 bps to a new high of 121.  Red/gold eurodollar pack spread is now almost 84 bps (up 4.625), having been as low as 50 bps a month ago.  I know I’m pointing out the obvious, but it’s not at all clear that hemorrhaging from offsides positioning is anywhere near over.

–Once again there was heavy volume in interest rate futures.  Open interest rose a whopping 480k in eurodollars as, suddenly, the need to hedge rates became apparent.  The June’17 contract alone added more than 100k contracts, however, at a price of 9794 or 1.06%, it still seems a bit ‘rich’ with libor now setting above 90 bps.

–In tens, there was a new (adding) buyer of TYZ6 125.5/124.0 put spread for 4-5/64’s, settled 5 ref 127-18.  Dec options expire in two weeks and the top strike is around 25 bps away, a yield level of around 2 3/8’s on cash tens.

–One last note concerns China yuan, which is at another new low with USD/CNY 6.807.  We will be in today though trading floors are closed.

–Veterans Day.  You may not like Trump, but one of his themes is to thank and honor those that have served in the armed forces.

Nov 10. Curve surge on staggering volume

–Staggering day on many levels.  Trump’s victory and the Republican wins in Congress are perceived to have cleared a path to fiscal infrastructure spending and related borrowing.  The US ten year yield surged by 20 bps to 207.  The curve steepened dramatically with 2/10 treasury spread up 17 bps to 118.  5/30 was up 11 to 140.3.  New highs in all curve measures.  In dollars, the red/gold pack spread rose 16.5 bps with golds down 26 ( ! ) on the day.  One-year calendar spreads, which had been churning around 3/16% forever, widened to new highs.  The peak one-year is now 30 bps, with several spreads having settled at that level, the nearest being March17/March18.  Stocks, which initially plunged after it appeared Trump might win, soared all the way back when he DID.  Copper has simply exploded to the upside, having gained 24% just this month, from around 207 at the end of October to 257 as of this writing.  I would also note that oil had an outside day and closed higher; selling pressure there has been arrested.

–Record volume in many products sparked a 6% rally in CME stock to a new high.  Ten year treasuries traded over 4 million contracts.  30 year auction today, which should find good demand as the yield surged 24.5 bps yesterday and some will likely use the auction to pare down on steepeners.  In tens, the 50% retracement from the high yield in 2014 of 303, to the low this year post-Brexit of 136, is 219.4.   As of yesterday’s futures settle that’s 12.4 bps away, approx one full point in the TYZ contract; just above the 127 strike.  Yesterday there was heavy trade in TYZ 128 strike as the previous buyer of 70k at 5-7/64’s apparently took profit; settled 34 with open interest -67k.  New outlier buyer of 125.5/124 ps which settled at 3/64’s, in size of 30k.

–Going forward there should be much less certainty about the Fed’s tightening trajectory.  Depending on fiscal initiatives on the one hand and the threat of an isolationist drop in global trade on the other, Yellen may face (for the next 15 months until her term expires) an economy that either runs very hot or grows cold.  For now, the market is voting for the former.

Nov 9. Saddle up

–It was a gracious victory speech from Trump, and as he said, the work is just beginning.  “…it’s been what they call an historic event, but to be really historic, we have to do a great job.”  As the Russian proverb says, “We’re slow to saddle, but fast to ride.”

–The Trump hedge yesterday was buying EDX 9912c for 1.0, with 40k new positions added to that strike.  High in EDZ6 only 9915 on the Trump victory and now well below strike; had to be nimble to monetize that bet.  Stocks sold off but as of this writing are back above Friday’s low, when it appeared as if the FBI might derail Hillary.

–The curve has steepened fairly dramatically with TYZ up 10/32’s and USZ down over a point.  Yesterday several curve measures made new highs with 2/10 closing above 100 and red/gold ED pack spread near 63.  The trend of curve steepening will likely continue.  Without a true rout of stocks, it’s very unlikely that the Fed will be deterred from hiking next month.  Announcements relating to plans for the first 100 days of the new administration may well jolt the market into the idea that the Fed’s tightening campaign may be much less shallow than promised.

–Though I understand a decline in the dollar, with gold up $60 at one point, I fail to see how EUR traded 113.  I think the Trump win is net negative for the euro.  And it’s certainly a negative for official pollsters, and other ‘experts’ that expected business as usual.  Time to saddle up.  It might be a rough and tumble ride, but hopefully the theme of unlocking potential takes hold.

–Once again, everything you need to know is on old Simpson’s episodes (though in this case the inherited budget crunch is being laid in Trump’s lap, courtesy of Obama)

https://www.youtube.com/watch?v=WecTaboaoi4

Nov 8. Judgment Day

–Yesterday stocks soared in an apparent endorsement of a Clinton presidency.  ESZ jumped 50 points back to the level of November 1. However, while treasuries sold off, they came nowhere near the low on November 1.  The market seems to be saying that a Clinton term would be more of the same, that is, the Fed will continue to function as primary backstop for the economy.  Great… stocks go up on expectations of continued monetary accommodation, leading to share buybacks and M&A, while treasuries find underlying support on thoughts of increased QE.  Happy days.

–In terms of price action yesterday, it was a fairly muted session.  The curve had a steepening bias, with 2/10 spread squeaking to a new high of 100.6 bps.  The ten year yield rose 4.6 bps to 182.4 in front of tomorrow’s auction (3’s today).

–Somewhat interesting that copper has seen a blazing 10% rally in the last 11 trading sessions, with other base and industrial metals also seeing strong gains.  For example, zinc, steel rebar (Shanghai), rubber all making new highs.  At the same time, China’s fx reserves are being drawn down and yuan is close to new lows. It appears as if China is leaning toward more stimulus in order to put off the debt day of reckoning, but China’s structural problems are likely to loom as a challenge for a new president and the markets.  In a more immediate challenge, ZH says NATO has put 300,000 troops on ‘High Alert’ in readiness for a confrontation with Russia concerning the Baltic states.

Nov 7. No matter who “wins”, budget problems loom

–Mad scramble to cover equity shorts as the FBI decided Clinton wasn’t any more careless and irresponsible than she was on the first pass. Likely means more of the same for markets in general, and underpins the idea of a steeper curve.   Interesting link on Bloomberg this morning which notes increased interest costs as a percent of both the gov’t budget and the economy at large.  http://www.bloomberg.com/news/articles/2016-11-06/obama-s-successor-inherits-a-bond-market-at-epic-turning-point

Obama’s Successor Inherits Bond Market at Epic Turning Point www.bloomberg.com Barack Obama will go down in history as having sold more Treasuries and at lower interest rates than any U.S. president. He’s also leaving a debt burden that threatens to hamstring his successor.

–Though only a footnote due to the overwhelming influence of the election, Consumer Credit is released today.  In August it was $25.9B, a sizzling SA rate of 8.5%.  The release today is for September and is expected $18.7B.

• 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.