June 16. The weight of zero
–The FOMC continues to adjust the dots toward the market. I skimmed a couple of stories that suggest ineffectiveness of policy and capitulation, i.e. a loss of confidence in Central Banks. Yellen herself downplayed the significance of the dots and forecasts (I predict that the dots will be eliminated by the middle of 2017). In response, yields fell to new recent lows, with the ten year as low as 155. December Fed Funds closed at 9953.5, only 10 bps below June; the market is less than 50/50 on just one hike this year.
–The US equity market had a weak close after the Fed press conference, but inaction by the BoJ added to turmoil and spurred several breakouts. For example, $/yen trade 104. The Nikkei was again hammered. Gold has surged to a new high this morning around 1310. Bitcoin has…oh, never mind. US equities are under pressure going into the June option expiration. The BoJ also referred to the elusive 2% inflation target. It’s to the point now that if we were to hit that goal, we wouldn’t want it.
–Eurodollar calendars are obscenely low. For example, EDM17/EDU17 closed at 4.5. It’s a year away. There’s not a single euro$ one-year calendar above 20 bps until the blues to golds. There was a buyer yesterday of hundreds of thousands of 9950 calls, all new positions. Buying in EDU6 9950/9962c 1×2, same in EDZ6, and same as 1×1 in EDV6 (Oct). Open interest up 120k and 130k in Sept, 111k and 196k in Dec, and about 60k in both strikes in Oct.
–News today includes CPI, expected +0.3 with Core -0.2. Jobless Claims 170k, Philly Fed +0.8.
June 15. Let’s fake it
–FOMC today, though Brexit issues have overshadowed all else in the markets. Obviously, there will be some snap-back if the UK chooses to remain (and there appears to be some stabilization this morning). But as of yesterday’s settle, new lows in: red/gold euro$ pack spread at just 58; 2/10 just above 89; near one-yr euro$ calendar spreads with Dec’16/Dec’17 at just 18 bps. Implied vol everywhere has become elevated, though yesterday morning’s surge was met with selling in treasuries. For example, TYQ 132 straddle opened trading 2’04, but came back to 1’59/1’61 by the end of the day. Heavy liquidation yesterday of TYN 132c, open interest fell by 23.5k.
–Though Brexit is the dominant theme, it’s worth mention that the big US equity market sell off in August was spurred by China’s devaluation, and the yuan is making new lows, having traded 6.60 today, as the MSCI declined to add China to the benchmark EM basket. Coincidentally AliBaba CEO Jack Ma says that fake products are often better than the real thing. “It’s not the fake products that destroy them, it’s the new business models.” On a side note, the new Central Bank business models are likewise destroying the markets…
–The pounding of European banking shares probably is also partially Brexit related as negative yields destroy the transmission mechanism, but there was also weakness yesterday in US credit card companies, as a firm called Synchrony Financial (mostly private label cards) warned of increased delinquencies and charge offs. It might seem like a trivial piece of information, but American Express and Discover (AXP, DFS) were both down 4% on the news. Interesting in that yesterday’s Retail Sales were solid at 0.5%, and Consumer Credit surged a couple of months ago.
–The point is, that even if the worst fears of Brexit are avoided, trouble is lurking in Asia and, perhaps more importantly in the US household sector (which Yellen specifically pointed to as a forward risk).
–Outside of FOMC, PPI today expected +0.3 and +0.2 Core. NY Empire survey (which has been negative 8 out of last ten times) expected -3.5. Industrial production expected -0.1.
June 14. This indecision’s buggin’ me
–Many markets are getting stretched to new recent extremes. Bund yield fell below zero. New recent high in the yen as $/yen trades 105.74 going into the BoJ meeting. New low in curve with 2/10 sub 90 and red/gold euro$ pack spread below 60. New lows in all the euro$ one-year calendar spreads with reds/greens at just 18 bps. Treasuries making new highs this morning with tens down another few bps to 158. December Fed Funds closed up 1.5 bps at 99.52, suggesting less than 50/50 odds for one hike prior to year end. European bank shares are getting hammered to new lows. VIX powered to a new high. When the stock crash occurs, the Congressional oversight committee will say, “Why were there no warnings? No one could have seen this coming.”
–The key driver is the upcoming Brexit vote, but of course, the debate is only magnifying growing strength of euro-skeptic parties. Even if the vote is ‘remain’ the broader issues don’t disappear. Like the song says, “if I go there will be trouble. if I stay it will be double.” Or, ‘Si me quedo, es doble’ for those who need added emphasis. No good answers, just the Clash.
–Huge buyer yesterday in red midcurve 0EZ 9875/9850 put spread for 5.5 ref EDZ7 around 9900. Open interest up approx 170k in each. OK, that part of the trade works out fine if ‘stay’ wins. What’s the other leg? Buy a few VIX calls I would guess, though a little late this morning.
–Retail sales today expected +0.3 Core and +0.3 ex-autos and gas. Oh, and there’s a Fed meeting coming up too.
https://www.youtube.com/watch?v=jas0vAzFP20
June 13. Risk off
–Risk off. Nikkei -3.5%, Shanghai Comp -3.2%, Hong Kong -2.5%. By comparison, ESU only down 8 points; a move of 3% would be over 60 points. GBP hammered by increasing Brexit risks. $/yen sub 106 this morning and US ten year yield is nearing 1.6%. Bitcoin has exploded higher and now trades near 690. Gold up $11 and also threatening to make a new high for the year. On Friday, all near one year eurodollar calendar spreads made new lows, and are edging further down this morning. Almost all one year calendars are between 18.5 and 21.5.
–VIX also surged on Friday and this morning is at the highest level in three months. Friday is the quarterly option expiration in equities. So far, losses in the US are minor, and might be contained going into expiration. However, there is a heightened risk of a high gamma spiral. In terms of treasuries, I marked TYU vol 5.3 on Friday, recall that during the market turmoil in February it traded over 6.
–The massacre in Orlando exposes another risk. While the US has mostly sidestepped terror events, security is likely to tighten up at public events. On another more mundane note, though probably more important in terms of consumer sentiment, the price of gasoline has jumped noticeably, at least in the Chicago area. Regular gas was nearing $2/gallon and is now more like $3.00-3.30. The Fed thought that low energy was a net benefit for the US economy, this reversal will probably have a negative impact at the margin.
Not going to end well?
The University of Michigan Consumer Inflation Expectations survey plunged this week to its lowest level on record. Interesting, in that Brainard (as an example) implied last week that falling inflation expectations can have a negative feedback loop. “We cannot rule out that stubbornly low inflation may be having an effect on inflation expectations.” Bullard has made similar comments.
I don’t read much into the U of M surveys, but there is one thing in the confidence data that I do think is quite interesting. I created a spread chart of Consumer Current Conditions vs Expectations (below). The spread value is in the lower panel, last at 28.5. I am just taking the data at face value; I did not do an in-depth study of components. This chart below only goes back for 5 years, but I examined the data from the start, in the 1950’s. Notice that CURRENT conditions are right at the high. But EXPECTED conditions aren’t. In fact, earlier this year, (due to the stock swoon, no doubt) the spread between the two hit a high of 29.1. This is the highest level since August 2006, when oil was in the midst of an historic surge and the spread hit 35.8. Interestingly at that time, the current conditions index was right around where it is now.
Using a three month MA of the spread, it’s at the highest level (27.5) since June 2007, right around when Bear Stearns’ mortgage funds failed. There aren’t many readings of the three month MA above 26; my theory is that when future expectations are well below current conditions and the spread is high, it’s a pretty good indicator that things are going to go south. Conversely, when the values are low, like in mid-2009 when both CURRENT and EXPECTED were in the high 60’s, things are likely to get better (can’t get any worse).
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The phrase, “This isn’t going to end well” is overused. Most things don’t really just end in a big bang disaster, they deteriorate over time, sometimes faster and sometimes more slowly. In 2008 of course, it seemed rapid because the twin wealth-loss effects of both real estate and equity values were extremely clear. But the developed world is now undergoing the slow erosion of accumulated wealth through the decline of interest rate income. Bond yields everywhere are simply too low to support forward living standards and the demand to borrow for new productive endeavors is not apparent. For example, Morgan Stanley asked how companies were beating earnings estimates, and the majority pointed to expense cuts, rather than top line growth (spurred by new investments/projects).
It’s a slow drip, but can be debilitating over time. We’re likely somewhere in the middle rather than near the “end”. The crash in 2008 was an overt sign that things had gone wrong, and confidence in the system was at the nadir. But now, with rates near zero, there are fewer ways to generate returns, and those come with asymmetric risks. One of the Fed’s goals in raising rates last year was probably to instill confidence that things were much improved and on an upward trajectory. The long end isn’t buying it. 2/10 treasury spread remains pinned to the low at 90 bps, and the ten year yield closed at its lowest level since February, which in turn was the lowest since late 2012.
Over and over again I have seen charts with steady trends that are then shattered by a violent move that wipes out a large portion of former gains. I’ve always thought that the key is to try to sidestep those moves. In terms of asymmetrical risks, central banks, through policies which force spread compression, remove the cushion that absorbs shocks. The cartilage is gone, it’s now all bone on bone. Many commentators have mentioned this risk in bonds….at these super low yields, if rates move up by a tiny amount then all the former income is wiped out and there’s the added kicker of a capital loss. That’s why it resonates when former Dallas Fed President Richard Fisher says his rich friends are all hoarding cash.
As another example of asymmetry, look at the VIX index. Portfolio managers are inclined to sell a bit of premium to squeeze out a few more bps of return, giving the VIX a downward bias. But consider the last few weeks. From May 10 to May 19 SPX pulled back from 2085 to almost 2025, 60 points. This week, SPX pulled back from 2120 to 2090. Over the first time frame, VIX went from a low of around 13.3 to 17.7. Over the second time frame, a much shorter period with a much smaller absolute and percentage move, VIX went from sub-13 to 17.3. A greater sense of risk is palpable.
The increased odds of Brexit are undoubtedly one of the reasons for this. But China still represents another danger, as noted in this story from Reuters:
David Lipton, first deputy managing director of the IMF, warned in a speech to a group of economists in the southern city of Shenzhen that companies’ indebtedness is a “key fault line in the Chinese economy”.
“Company debt problems today can become systemic debt problems tomorrow. Systemic debt problems can lead to much lower economic growth, or a banking crisis. Or both,” Lipton said, according to a copy of his prepared remarks provided to Reuters.
Lipton said corporate debt in China stands at about 145 percent of gross domestic product, a high ratio. He singled out state-owned enterprises, which he said accounted for about 55 percent of corporate debt but only 22 percent of economic output, according to IMF estimates.
Note: US Corporate Debt to GDP is only around 50% (Corporate Debt is $8.28T according to this week’s Flow of Funds release).
There likely won’t be much drama associated with this week’s FOMC meeting. Again the market is sending pretty clear signals that odds of tightening have diminished appreciably. For example, all one-year Eurodollar calendar spreads made new lows. The first ten one-yr spreads are between 19 and 22 bps. Really flat and without curvature. Other news this week includes Retail Sales Tuesday, expected +0.3/+0.4 and inflation data on Wednesday and Thursday. (FOMC announcement and press conference on Wednesday afternoon).
June 10. Bond bears wave the white flag
–A skim of the news sites today shows that “government bond yields making new lows” is one of the day’s leading stories. Except for the Chicago Trib, which mentions “1 dead, 12 injured in Chicago shootings.” One might think that the bond story would be more important in Chicago, where Moody’s just downgraded Illinois again to just a couple of notches above junk. An example of misplaced priorities I suppose. But in case you find the Chicago story is more interesting, here’s a nice link of Chicago shooting stats, http://heyjackass.com/ that notes ytd “shot and wounded” in Chicago is 1383.
–US ten year yield eased a couple of bps yesterday to 167.8. New recent low in 2/10 treasury spread to just above 91 bps. Also a new low in the red/green euro$ pack spread to just 20 bps. The market simply will not forecast forward tightening by the Fed. There was substantial put liquidation yesterday, for example midcurve red December 9875p saw open interest decline 36k on heavy sales, settled 11.0 ref 9895.0 in EDZ7. A solid jump in wholesale inventories of +0.6 caused some to increase Q2 GDP estimates, though inventory to sales ratio is still elevated at 1.35. The FOMC next week is dead, though some are still holding a whisper of hope that a tightening could occur in July. It won’t.
–Yields are lower again this morning, oil’s down, and even stocks are under a touch of pressure. Interestingly, copper is near the low of the year, with HGN6 currently around 2.02 vs 195.80 as the year’s low, set in January. A trade that got some notice was the US1N (week 1 July bond) 172/172.5 c spread, bought for 5/64’s. Doesn’t look particularly bad this morning with USU 168-06 (+21)…the lower strike is only about 15 bps away, the cash bond yield closed yesterday at 248, and thirty year swaps are now below 2%. Oh, and Russia says it will respond to a US warship entering the Black Sea. So there’s that. Happy Friday.
June 9. Central banks losing their magic
–The edifice of central banking is crumbling. It’s a theme that’s been covered before, but the myriad of recent signals is breathing new life into the threat. Yesterday, the precious metals had a nice bounce, and bitcoin closed near the recent high of its breathtaking rally, around 581. OK, those are pretty minor clues. But the transmission of CB policy runs through the banks, and the revolt is gaining traction. For example, BTMU is dropping its primary dealer status: “Bank of Tokyo-Mitsubishi UFJ is preparing to relinquish its role as a primary dealer of Japanese government bonds as negative interest rates turn the instruments into larger risks, a fallout from massive monetary easing measures by the Bank of Japan.” And this from Reuters yesterday, “Commerzbank, one of Germany’s biggest lenders, is examining the possibility of hoarding billions of euros in vaults rather than paying a penalty charge for parking it with the ECB, according to sources familiar with the matter.” And this from Japan’s opposition party: “The Democratic Party wants to call for the withdrawal of negative interest rates. Negative interest rates shift the burden onto savers.” And this from Deutsche Bank, “Already it is clear that lower and lower interest rates and ever larger purchases are confronting the law of decreasing returns. What is more, the ECB has lost credibility within markets and more worryingly among the public.”
–The implications are a massive flight to safety, which may just be in the starting stage (with bunds holding just above zero…) And of course, splashy headlines this morning proclaim that Soros is back, with trades reflecting economic turmoil.
—-Quiet session in US rates yesterday, with a solid ten year auction. 30 yr bond auction today. Continuation of recent trades: TYU 134c bought covered another 8k with open interest now up to 35k. In dollars, there is a continued bid for EDM7, EDU7, EDZ7 100 c strip, 4.0 paid covered 9906.0 in EDM7. Open interest is 104k, 46k and 47k respectively. Could these be the turmoil trades of which you speak?
–By the way, stocks of US banks have generally been rising, with most charts mimicking the crude oil rebound. Oil has come a long way towards normalizing, as shown on the attached chart. The spread between the near contracts and one year forward showed a discount of nearly $10 at the start of the year and is now only $1.50 with all prices higher. Credit spreads have also come in. US banks have probably gotten just about all they can from these tailwinds.
June 8. Yellen and the data
–Yellen cited four uncertainties in her speech on Monday. Data relating to two of them was released yesterday. One was productivity: “A third key uncertainty for the U.S. economy is the outlook for productivity growth–that is, increases in the amount of output produced per hour worked.” Yesterday’s data: -0.6% and unit labor costs +4.5% (without I might add, much in the way of wage growth). Another concern was domestic demand: “The U.S. economy has performed better than many others around the globe, and that performance has relied chiefly on the resilience of domestic sources of demand, consumer spending in particular.” Yesterday’s Consumer Credit data showed a significant deceleration from March’s blockbuster growth. Revolving from 13.3 to 2.1 and Non-revolving from 8.2 to 5.4%. Semi-annual testimony is June 21. I would expect just a tone of increased caution.
–Yields continue to press lower. US tens ended -1.2 bp at 171.1 in front of today’s auction. German bund fell below 5 bps. Implied vol on US rate futures is sinking. I marked Sept bond (US) vol at a new recent low of only 9.7. With unit labor costs +4.5%, one might think that profit margins would be under pressure, and that stocks would see some degree of negative fall out. Nope. Similarly, a continued rally in oil and major commodity indices might be thought to spark a small inflation premium, perhaps in the form of a steeper curve. Nope. By the way, one of the other uncertainties for Yellen is how quickly inflation might move back to 2%. She’s allowing for a year or two… Let’s assume for a second that two years from now inflation is 2%. Where should the June 2018 eurodollar contract be? I don’t know, but I can tell you where it is now: 98.82 or 1.18%, barely 1/2% higher in yield than the expiring June 2016 contract.
June 7. Rate hikes pushed back
–A lot to talk about for a quiet Monday. Before the employment report, July/Aug FF spread was 10/10.5. On Monday it traded down to 5.0/5.5 and settled 5.0. So not only were the odds of a June hike swept away, but July’s odds were halved. However, August to October, which isolates the September FOMC, rallied from 5 to 6.5. So now the odds of September are going up.
–Also worth mention is strength in commodity indexes in general, and the grain complex in particular. July Corn was up another 9 cents yesterday, and is the highest since late July last year. A gradual Fed and softer dollar supports commodities.
June 6. Yellen confronts a softer job market
–Friday’s dismal NFP of only 38k sent yields tumbling. Tens fell 10.7 bps to 170.2. The red/green eurodollar pack spread fell to a new low of just 20.75 bps (from just over 40 at the start of the year). Fed speakers that have said two to three rate hikes would be appropriate this year are going to have to change their tune to “one to two” rate hikes. However, Rosengren spoke today and said he still expects “sufficient economic growth to justify a gradual removal of accommodation” and he noted that, at 4.7 percent, unemployment has dropped to his estimate of “full employment,” a key goal since the financial crisis. (RTRS). Today, Yellen speaks, and is likely to be non-committal in terms of timing. Once again, the euro$ curve never bought into the “two to three” rate hike narrative, and as the Brexit vote nears and polls show an even split, June is clearly off the table. But if there IS a split from the EU, then it’s likely that September will be the next plausible time for a hike…from one hike at every meeting in 2004-2006 to one hike per year, with plenty of hand-wringing about adverse consequences.
–While some will consider this payroll report to be an outlier, David Rosengren notes a weakening pattern: Feb +233k, March +186, April +123 and May +38. Lael Brainard, in a speech Friday also noted deterioration in the labor market, and expressed concern about inflation goals as well, suggesting the Fed should remain idle. She talked about inflation expectations, and I would note that the spread between ten year notes and the inflation-indexed ten year fell to a new recent low of 155 on Friday, right about where it started the year (though it was in the 120’s in Feb). While the decline in the dollar should help commodity prices, the other side of the coin is that it makes things much more difficult for the eurozone and Japan.
–June euro$ midcurve options expire Friday, and EDM6 expires Monday. I would note that last week as EDM6 was hanging around the 9925 strike, the straddle was 5.25-5.5 bps. On Friday EDM settled 9933.5, and concern shifted to the 9937 strike. At least 50k EDM 9937c were bought for 0.25 Friday, but there are still 700k open, with 1.1 million open interest in the underlying EDM6 future.
