July 20. Stocks at new highs; nothing else to worry about

–Stocks making new highs this morning.  Must be because we can now drop ‘presumptive’ and say that Trump is the official nominee.  So, I guess that’s good, as VIX fell below 12  yesterday, lower than any level since prior to last August when the Chinese devalued.  It’s not as though we can expect another shock devaluation out of China, just a slow grind lower in the yuan.  However, that’s not to say there couldn’t be some sort of surprise.  This morning US Chief of Naval Operations John Richardson said “The U.S. Navy will continue to conduct routine and lawful operations around the world, including in the South China Sea, in order to protect the rights, freedoms and lawful uses of sea and airspace guaranteed to all. This will not change.” Seems to be on a collision course with this, from China: ‘Freedom of navigation patrols carried out by foreign navies in the South China Sea could end “in disaster”, a senior Chinese admiral said over the weekend. ‘ (Business Insider)

–Pressure continues on front end of the market, after a Hilsenrath article yesterday suggested the Fed could hike in September.  Additionally, an EU court yesterday ruled that Slovenia acted legally in enforcing “burden sharing” on junior debtholders.  In other words, no bailout for Italian banks by taxpayers;  apparently a lot of subordinated debt is held by retail investors, who are now on the hook for a bail-in. No easy way out for the european banking system even though the ECB is buying everything.  At the margin, this likely leads to dollar funding concerns; EDU6 traded a post-brexit low of 9923.0.

–Pressure continues on GBP (though up this morning) and on the Turkish Lira, and EUR also looks to test post-Brexit lows as the chance of a Fed hike increases, while the ECB looks for more forceful ways to depreciate the currency.

–Corn and wheat sold off yesterday and remain at extremely depressed levels.  Beans sold off as well.

–In one of the dumbest things I’ve seen in a while, comes a report from the Council of Economic Advisors that student debt is great, because it leads to a better educated workforce.

“Federal student loan programs help expand access to high-quality education, which has long-lasting benefits to individuals as well as the overall macroeconomy through higher labor productivity and faster GDP growth,” said the report from the CEA.
http://www.businessinsider.com/white-house-student-debt-is-good-for-economy-2016-7

WHITE HOUSE: Student debt is good for the economy www.businessinsider.com The Council of Economic Advisers said in a report on Tuesday that the growing mountain of student debt is, in fact, good overall for the US economy.

So I guess, the blazing economic growth we’ve been experiencing, and the fact that the workforce is growing mostly for those over 55, is due to the massive expansion of student debt.  Huh?

July 19. It’s a Cadillac

–I almost missed a window of opportunity regarding the situation in Turkey.  On a slow day some time ago, (like yesterday), a euro$ options pit broker who shall go unnamed, is standing around in the crowded pit doing the crossword puzzle.  Clue:  COUP D’_ _ _ _   Subject’s answer: VILL.  See?  The floor is better than the screen.

–With all the fanfare about stocks recovering and pressing new highs, having shaken off Brexit in a few days and the Turkish coup in a few minutes, it’s interesting to note that Calpers annual results ending June 30 showed a gain of just 0.6%.

“It was the second straight year Calpers failed to hit its internal investment target of 7.5%. Workers or local governments often must contribute more when pension funds fail to generate expected returns.”  Perhaps Calpers was heavily invested in Hamptons real estate. (Reuters) “Total sales volume in East Hampton fell 53 percent from a year ago to $44.7 million as the median sale price fell 54 percent to $2.38 million.”  In more middle of the road anecdotal data, Volvo scaled back its sales projections for heavy trucks in the US as demand slows more than forecast.

–Rates were little changed yesterday, having eased by 0-2 bps across the curve; bond was unchanged.   Large trades were a new buyer of EDZ6 9912/9925/9937 c fly 1x3x2 which settled 1.25.  Also a buyer of EDZ6 9925c vs sale of same strike in 0EZ for a credit of 0.5 (sold 0EZ over).  EDZ6/EDZ7 futures spread settled 18.0 (9917.5 and 9899.5).   The former trade targets a settle of 9925, the latter does best with a settle above 9925 with the calendar spread maintaining relatively wide levels.  Housing Starts today.

July 18. I don’t know, I think it’s C-O-O

–In the new world of the 20 minute news cycle, Turkey had a coup on Friday, now forgotten as it failed.  In an amusing sidenote cited by the Daily Shot, google searches for “coup” jumped on Friday, but so did searches for “coo”.  That’s right kids….sound it out.  In the US there was another deadly attack on  police officers in Baton Rouge. In Cleveland naked women protested the beginning of the Republican convention, which I personally prefer as a means of demonstration, (within reason) though there are risks that it could be taken up a notch.

–For the first time in a while I heard that some midcurve puts were abandoned Friday.  EDU8 settled 9886.5, meaning 2EN 9887.5 puts were auto exercised, but an immediate rally on the start of the Turkish coup attempt sent futures higher to 9889 and caused abandonment.  I am not sure of quantity, but interesting in terms of expiration risks.

July 17. Men Walk on Moon

On Friday, we had clipped a headline from Bloomberg and forwarded it; it was something about Atlanta Fed’s Lockhart (“Don’t count on quick return to ‘normal’”).  In response, we instantly received a return post from a client, a link from the NY Times, with the 1969 image of the front page headline, “Men Walk on Moon”.  Due to my being a bit slow on the uptake, I didn’t get the connection.  It was, of course, a well-deserved dig at forwarding an innocuous, stale piece of news.

In my readings this weekend I came across Blackrock’s mid year Global Investment Outlook.  It highlighted three main themes:  “1) We are living in a low return world; 2) Monetary policy has been a key driver of asset prices – but its effectiveness looks to be waning;  3) We see more volatility ahead as Brexit-related anxiety weighs on Europe’s economy and the business cycle matures.”   My immediate thought was “JFK’s Been Shot”.   To be fair, the actual report is quite interesting (link at bottom).  For example, the Reflation Debate section succinctly outlines pro and con arguments. There’s also this warning; “Those seeking to buy into market weakness should beware of notionally cheap assets facing structural challenges… We like value, but it has to have a pulse.”  (Cited European bank shares).

This week, inflation data did indicate signs of a pulse.  Core yoy CPI printed +2.3%.  As the Blackrock piece mentions, reflation can occur simply due to the arithmetic of base effects (of stabilized energy), increasing wages and service sector factors.  Retail sales also came in stronger than expected.  If there’s one thing that almost insures the return of higher inflation data it’s this:  [Mnpls Fed’s] Kashkari says “Risk of out of control inflation overshoot is nil.”  The mush.

Of course, there are global issues that tilt the other way, for example, China continues to export deflation through a weakening yuan.  Note this passage from the Q2 Hoisington Investment letter:

According to the Netherlands Bureau of Economic Policy Analysis’s (NBEPA) World Trade Monitor, the year-over-year change of the three-month average in the value of goods that crossed international borders has been hovering around 0% for the last six months. This is a dramatic slowdown from the 4.5% average growth rate registered since the end of the 2009 recession. Moreover, the last six months constitutes the weakest period since the recession. United States exports and imports confirm this deteriorating trend. In the latest twelve months, real U.S. exports and imports both contracted 1.6%. Such declines could only reflect a predominance of fragile global conditions and confirmation that the world lacks an engine of growth.

In terms of the free flow of goods and services, terrorist attacks like last week’s in Nice, and even the failed coup attempt in Turkey, likely tend to further restrict those flows (not to mention tourism).  The utter lack of warning regarding the events in NATO member Turkey (even if internally orchestrated) gives rise to concerns that intelligence resources are spread thin.  While the Republican convention this week will have massive safety precautions, as was likely the case in Paris for the UEFA Euro Football Championship, the delayed low-tech attack on a soft target like Nice can be devastating.   As the Blackrock piece implies, the world is subject to many exogenous events that can cause volatility.  I would further note that, according to a report I saw from last year, more than half the world’s annual merchant fleet tonnage passes through the South Seas.  China has given notice that it will simply ignore the Hague’s toothless decision ruling in favor of the Philippines regarding a territorial claims dispute.  According to Wikipedia, the US and Philippines have a Mutual Defense Treaty.  And while this dispute may not escalate in a military sense, economic pressure may ensue, which could accelerate yuan depreciation.

The market, having digested all the bullish underlying factors in support of treasuries as a safe haven, ran out of buyers last week, and ten year yields saw a significant back-up.  The US ten year yield rose over 22 bps to end at 159. The German bund rose just under 20 bps and edged to a slightly positive yield.  The 30 year bond contract had an outside week range and closed at the low (30y yield up 19.7 on the week to 230).  The euro ended slightly lower, GBP stabilized.  I would note that the adjustment in the pound has probably done a great deal to cushion the blow delivered by the Brexit vote; for example, the price of commercial real estate fell, but the currency translation coupled with the outright price decline provides value investors with a more compelling case.  However, Italy, for example, gets no such comfort from a weaker currency.  Just bone grinding on bone, hoping it will get better.

On the short end of the curve, it’s worth noting that Dec’16/Dec’17 one-year Eurodollar calendar spread closed at 19 bps, an indication of a turn.  Recall there had been a size buyer at 18.5 a couple of weeks ago, but that price was repelled as the spread drifted back down to 11.5/12.0.  Now with a close above 18.5, there’s a good chance to test 25-26 (which really only signifies one hike over a year…)  EDU6 and EDZ6 completely reversed; both are now at pre-Brexit levels, in part due to concerns about USD funding pressures.  Tightening odds have increased somewhat as well, for example, in Fed Funds, Aug/Oct (isolates odds of a September rate hike), settled at 3 bps, but Nov’16/Jan’16 (which targets the December FOMC) moved out 2 bps on Friday to 7.  Maybe a once a year hike in December will constitute a new ‘tightening cycle’.  Though nobody really considers the non-quarterly FOMC meetings, Jan’17/Feb’17 at 0.5 bp is quite a cheap expression for a hike at the first meeting of the new year, which is Feb 1.

This week features an ECB meeting, and a host of US earnings reports including BofA, GS and MS.

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https://www.blackrock.com/investing/literature/whitepaper/bii-global-investment-outlook-midyear-2016-us.pdf

http://3.bp.blogspot.com/-__YpqCAYEME/T7KiA_goVPI/AAAAAAAAAis/nWVwxnoWSUk/s1600/man+walks+on+moon+newspaper.jpg

July 15. Attack in France

–Another horrific attack in France.  The potential for these assaults on western values and innocent lives is only growing.  Today in the US for example, Day of Rage protests (though not targeted at western values) are scheduled across the country, with this headline in the Washington Post, “Military told to avoid 37 US cities for fear anti-police protests may turn violent.” Here is a link of locations http://www.thegatewaypundit.com/2016/07/warning-day-rage-blacklivesmatter-protests-set-friday-37-us-cities/
–Markets are relatively calm, though Chinese data showed Q2 growth +6.7.  However, WSJ characterized the numbers this way: “Massive stimulus keeps China GDP steady in Q2.”  And Reuters notes that fixed asset investment growth [though at an envious rate compared to the US] slowed in the first half to 9%, the weakest since 2000.  It appears as though gov’t stimulus is supplanting private investment, a concern going forward.
–The yen has continued its plunge and is now at the pre-Brexit level of 105.97 on expected stimulus.  In the US, rates are also erasing the move related to brexit as stocks continue to levitate.  Interesting trade yesterday is a buyer of 35k Blue March 9800/9925 combo for 0.5, buying the put.  Given the flatness of the curve, the trade makes sense, with  EDH0 settling 9868.5.   Spread between reds and blues only 33 bps (the low of the year is 28 bps).  Settles were 3EH 9800p 7.0, 17d and 9925c 6.75, 19d, expiry 239 days March 10, 2017.  There was also a new buyer of 2EM 9800p for 8.0.  Interesting to see longer dated plays for a steeper curve. Ten year yield rose 6.4 to 153.
–July midcurve options expire today.
–News in the US includes Retail Sales expected +0.1, +0.3 ex-auto and gas.  CPI +0.3 with Core +0.2.  Industrial Production +0.2.

July 14. BoE decision awaited…

–US stock index futures are soaring to new highs as the Bank of England’s (ease) decision is awaited.  Yesterday’s bond rally is being partially reversed as a result.  The $2 plunge in oil yesterday to two month lows (high inventories) is also seeing a modest reversal, with CLQ up 50 cents this morning.
–Heavy trade yesterday in EDZ6 put options.  For example, EDZ6 9912p bought in size of 50k to sell 200k 9900/9887ps for 0.25 bp.  While it appeared to be a roll up, open interest in all puts declined, by 86k, 184k and 250k.  While not at new lows, the first ten eurodollar one year calendar spreads are all between 15 and 16 bps (though Harker inexplicably suggested a chance of  2 rate hikes this year).
–Beige book yesterday was noncommittal, noting modest improvement in the economy.
–Today’s news includes Jobless Claims, expected 265k, PPI +0.3 with +0.1 Core.
–Dallas Fed President Kaplan said yesterday that the Fed is very sensitive to the strength of the dollar.  Although I am probably taking the comment out of context, it suggests a bias towards looser policy as a stronger USD undermines competitiveness of US exports (while the world is engaged in devaluation wars, with the yuan near a new low of 6.69).  An article on Bloomberg notes that Bernanke, when visiting Japan, suggested that the gov’t float perpetual bonds which the BoJ could completely monetize.  http://www.bloomberg.com/news/articles/2016-07-14/bernanke-floated-japan-perpetual-bonds-idea-to-abe-adviser-honda
Apparently other measures like fiscal stimulus were also discussed.  This in a country where the birth rate is not enough to overcome the death rate.  Sometimes known as a “structural” problem, which monetary policy may not address….

Renzi channels Clapton. “Before you accuse me, take a look at yourself”

Let’s start by taking a look at some ten year yield levels, and changes ytd (in red):

This is just representative.  I only included the Netherlands because on Friday, that yield actually joined Hades underworld before closing at zero.  These declines are stunning.  Just for fun, let’s look at sifma’s end of 2015 rate forecast.   When the survey was completed on 12/4/2015 the 10 yr was 2.28%, and median survey forecasts were 2.55% for June 2016 [only off by 100bps] and 2.70% for December 2016.  On the plus side, “The overwhelming majority of respondents expected the Treasury yield curve to flatten by mid-2016 (94%)”

Well, the curve certainly has flattened to crushing new lows.  2/10 treasury spread ended at 75 bps, having started the year at 122.  Red/gold pack spread plunged 5.625 bps on Friday alone to close at 47.25, having started the year at 89.  The latter is just 47 bps away from this century’s low of 0 in 2000 and 37 away from the intervening low of 10 in 2006, essentially following the same path set in 2004 to 2006 when the fed was hiking 25 bps at EVERY meeting.  [Chart of red/gold below]

Of course, not all forecasts were off the mark.  For example from an interview in early 2015, Jeffrey Gundlach “…thinks the 10-year that finished 2014 at 2.17% could potentially take out its modern-era low of 1.38% yield hit in 2012. This would particularly be the case if crude-oil prices keep falling to, say, $40 a barrel from their 2014 year-end level of about $55. This further drop …would only accentuate deflationary forces he sees at work globally that continue to drop long-bond yields.”  He added this, which is still highly appropriate for today:  “And the strengthening dollar, which we think will continue, only makes U.S. bonds all the more attractive, for not only do foreign investors benefit from higher relative rates, but they also win on currency translation profits.”  Speaking of fx translations, note that Serena Williams’ Wimbledon “…prize is worth $2.59 million when converted to U.S. dollars, about $380,000 less than it was worth a few days before the tournament, on the eve of the U.K.’s vote to leave the European Union. “  Doh!

I would add a couple of other bullish factors for bonds.  First, a story on Bloomberg notes “the outstanding amount of treasury notes and bonds split into principal- and interest-only securities jumped to $223.1b in June, the highest level in more than 17 years” due to demand for duration.  By way of comparison, this week’s auctions of 3s, 10s and 30s is $56b.  Second, an article from the Telegraph says the ‘World faces a deflation shock as China devalues at an accelerating pace.’  From Hans Redeker, currency chief at MS, “They seem to be overriding their own model and letting the remnimbi fall to improve competitiveness.  They are in the same sort of deflationary syndrome as Japan in the 1990’s but on a much bigger scale.  The global economy is in no position to absorb this.”  Just to emphasize this point, China’s trade minister Gao Hucheng said at the G20 meeting on Saturday that the global economic recovery remained “complicated and grim”.  “Global trade is dithering, international investment has yet to recover to levels before the financial crisis, the global economy has yet to find the propulsion for strong and sustainable growth.” Gao’s not really one to mince words…  Another G20 downer from BBG, G20 Trade Ministers See Global Investment Falling Up to 15%.

The above points don’t even factor in safe haven demand given the possibility of an unexpected bomb in the European banking system, or any of the myriad of other reasons for a flight into treasuries.   Not to put too fine a point on it, but Italy’s Renzi  threw some shade at DB saying Italy’s bad loan problem is tiny compared to the size of potential derivatives issues.  “If this non-performing loan problem is worth one, the question of derivatives at other banks, at big banks, is worth one hundred. This is the ratio: one to one hundred,” Renzi said.

So let’s say you’re from another planet, and you’ve just taken a job as an underfunded pension manager looking for returns of 7% a year.  What do you do?  Well, you buy US bonds because they have a relatively juicy global yield.  You buy high-yield (HYG and JNK hi-yld etfs made new highs for the year).  You buy US stocks despite the earnings recession.  You sell premium to squeeze out a few additional basis points.  And you do all of this with a dollop of leverage.  Then you go to a casino, order a stiff drink and play craps… realizing in the back of your mind that the Nikkei has not exceeded its bounce from 1996 in the past 20 years.

A few comments about Friday’s astonishing trade.  First, while the headline NFP number showed a nice rebound in jobs, the household survey didn’t, at just 67k.  Second, all Eurodollar one year spreads are making new lows.  While they were mostly around 25 bps throughout April and May, they are now less than half that, with Sept16/Sept17 at just 11 bps and Dec16/17 at 11.5.  On the FF curve, you can buy a hike for the Feb 1 FOMC meeting for nothing… FFF7/FFG7 is -0.5/0.0.  Of course, that’s because the guy selling it to you is buying an EASE for the same price!

BOE meeting this week.  Carney to the rescue?  Also earnings season starts in the US this week.

Tarullo speaks Tuesday, Exploring Shadow Banking; Can the Nation Avoid the Next Crisis?

Policing in other countries:   http://news.sky.com/story/cops-karaoke-classic-is-a-glasgow-pub-hit-10302383?utm_source=fark&utm_medium=website&utm_content=link

Trade thoughts

On Friday I looked at just buying TYU 136c which were 16 at the time (133-08), and settled at 20/64 (21d, 47dte).  From the settlement of 133-25.5, the 136 strike is around 25 bps away, or approx. 1.11% yield on the current ten year.   I don’t see much reason why US tens can’t get to the same yield level as, let’s say, Spain.  Also vol was spanked Friday with atm around 5.3 to 5.4, at the lower end of the range.  Note that Sept treasury options expire on August 26, the same day as Yellen is slated to speak at Jackson Hole. The conference is entitled “Designing Resilient Monetary Policy Frameworks for the Future (because we’ve given up on the present)”  Just kidding, I made that last part up, but really, it doesn’t seem so far from the truth.

July 8. Civil unrest

–Today it’s about the employment report.  But the shooting of Dallas police officers with 5 dead is a much larger event for the country and perhaps for the markets as well.  Even prior to this event, Martin Armstrong posted this: “The Federal government is arming every agency from the IRS to the State Department for domestic purposes. This is clearly a response to what they know is coming. There is no question that they are preparing for an uprising.” (thanks Marco)  Flight to safety may take on another meaning (though the market definition may still push ten year yields much much lower).  https://www.armstrongeconomics.com/international-news/north_america/americas-current-economy/us-government-preparing-for-massive-civil-unrest/

–NFP today expected 175 to 185k.  Avg hourly earnings +2.7%.  5/30 made a new low close just below 118 bps.  There was a lot of put buying (as is typical in front of big reports), 0EN 9912p 2.0 paid for about 40k covered 9921-22.  Makes sense to see protective put buying.  The range in TYU for the last employment report in June was 129-27 to 131-02, and the day ended with the ten year yield at 170.  Yesterday TYU6 settled 133-22 with the cash yield more than 30 bps lower at 138.7.  However, France just auctioned 10’s at 16 bps.
–Just a couple of other tidbits.  German export orders were -1.8% (need a weaker euro…).  Also a Gallup poll on daily spending by Americans fell from $95/day in April to $93 in May to just $88 in June.  There appears to be deterioration in trend.  http://www.gallup.com/poll/127544/consumer-spending-weekly.aspx

July 7. Horizon looks clear

–Byron Wien of Blackstone was on CNBC yesterday saying that he didn’t see recession on the horizon because the curve isn’t inverted.  It may not be inverted, but it flattens every day.  New low again in 2/10 to just 80 bps and 5/30 fell over a bp to a new low of 119.   About a month ago all of the one-year euro$ calendars were around 25 bps, now they are huddled around 15.  The front spread, Sept16/Sept17, traded as low as 7 yesterday before rallying back to 11.5 settle.
–Data related to jobs is released this morning, with ADP expected 150k and Jobless Claims 270k.  As is typical in front of the unemployment report, there was high gamma put buying in eurodollars…usually it’s red midcurve puts, but yesterday there was a block buyer of 100k 2EN 9900p for 3.5 with EDU8 trading 9909.5.  These options expire one week from Friday; EDU8 settled 9906.5, puts settled 3.5 (the hi-gamma part wasn’t especially apparent in the settlement price).  There was also heavy buying of EDU6 9912.5p for 0.5.  The continuing erosion of european financial shares has raised concerns about funding.  Additionally, the gating of real estate funds in the UK is a gentle reminder that liquidity can sometimes be an issue.  Fortunately, it’s IMPOSSIBLE for any of those issues to spill over into US markets.  On the other hand, minutes from the last FOMC were also released yesterday, and contained this nugget from the staff summary:  “The risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff’s assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks.”  Adverse shock?  What’s that?

July 6. Now youse can’t leave

• 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.