May 13. Retailer results haven’t been good…apart from AMZN
–Retail Sales today. I haven’t determined any correlation, but recall that the latest Consumer Credit report for March was a blockbuster, with revolving credit +14.2% and total at +10%. In the months of both March and April, crude oil was pushing higher. Auto sales released earlier in the month were a strong 17.4 million annual rate. However, retailers (outside of AMZN) have been smacked. Expectations are +0.8 for headline, +0.5 ex-auto, +0.3 ex-auto and gas. One anecdotal note, we had a credit account hacked in the past two weeks, with bogus purchases of several thousand dollars. Apparently, the new chipped cards are in some ways more vulnerable to hackers, though I don’t know if that had anything to do with it. Charges have been reversed, but I wonder if initial charges (in aggregate) still show up in the credit data. PPI expected +0.3 and +0.1 Core.
–Speaking of credit, loan growth slowed in China from a blistering Q1 pace. (Reuters) “Data at the end of the Chinese trading day showed banks extended just 555.6 billion yuan ($85.22 billion) in net new yuan loans in April, well below analysts’ expectations and less than half the 1,370 billion yuan reported in March.”
–Heavy buying in the past few days of TYM 130.5 puts. Expire in one week, yesterday settled 19 vs 130-19. Open interest in the puts jumped 27k yesterday to 70k, the largest put strike outside of 128p with 93k. However, these purchase were absorbed, as was the 30 yr bond auction, and TY futures are higher this morning as equities falter. 2/10 treasury spread edged to a new recent low just below 100 bps.
From the Washington Post: “The Federal Reserve is a vital institution for our economy and the well-being of our middle class, and the American people should have no doubt that the Fed is serving the public interest,” [Clinton] spokesman Jesse Ferguson said. “That’s why Secretary Clinton believes that the Fed needs to be more representative of America as a whole and that commonsense reforms — like getting bankers off the boards of regional Federal Reserve banks — are long overdue.” In a roundabout way, that’s a tacit endorsement of Trump. Get bankers out of Fed banks, and get politicians out of politics.
May 12. New lows in the curve
–In spite of new highs in oil, and the fact that Italy and Spain have issued 50 year bonds, the US yield curve is flattening. The ten year yield fell 2.3 bps to 173.5. 2/10 treasury spread notched a new low just above 101. Red/gold euro$ pack spread closed at 68.5, its lowest level since 2008. Many 3 month euro$ calendar spreads only trade 5 bps, for example EDZ6/H7, EDH7/M7 and EDM7/U7. AMZN is making new highs but the rest of retailing world is struggling. A client yesterday coined it the “uberzon effect”. Hyper-efficient distribution forces down prices (and likely caps wage growth as well). I suppose a related point is one that Kyle Bass made about China… The existing debt is outstanding to the ‘old economy’ which is being pressured from all sides. That debt has become riskier, so flows seek safer havens and accept lower yields. For example, every morning it appears that the US equity market is the beneficiary of flows from Asia.
–There was a late buyer yesterday of 20k EDU6 9912 put for 2.25. There was also a large (new) buyer during the day of the Aug/Oct FF spread for 4.5 (settled there). Both of these trades work as the market hones in on the Sept 21 FOMC as the next Fed hike. The longer term problem would appear to be that as odds go up for a hike, the curve will be forced flatter, creating challenges for banks. Buts that’s down the road….
May 11. NEWSFLASH: Stocks may not reflect the economy
–In spite of a surge in stocks, US interest rate futures traded tight ranges on small volume. However, back month euro$ calendar spreads edged to new lows. For example, red/green (2nd to 3rd year) pack spread settled at just 22 bps, down 0.5 on the day. Red/gold settled just above 71, -0.875. The magnitude of the moves is not large, but the implications of an ever flatter curve given robust equity and energy prices is surprising. I would go so far as to say something looks wrong. I suppose my instinct is corroborated by the Fed: (from BBG) “Benchmark gauges such as the S&P 500 Index are such flawed mirrors of the economy that they probably fail as predictors of gross domestic product, according to a new paper by Julieta Yung, an economist in the research department at the Fed Bank of Dallas. Half the components are manufacturers, for one thing, much more than is reflected in GDP.” I suppose one would almost be forced to extend the reasoning to its logical conclusion: IF the S&P 500 does not appropriately reflect the economy, and the primary goal of all the Fed’s QE programs and other stimulus is to spur stocks and other asset prices higher, then QE has little effect on the economy.
http://www.bloomberg.com/news/articles/2016-05-11/fed-economist-says-stop-relying-on-stocks-for-recession-signals
–In contrast to the lethargic interest rate market, soybeans are on a holy tear. Since the beginning of March, July beans have rocketed over 25% to 10.89. Precious metals are also bid this morning. So the reflationistas can still point to some evidence of potential strength. But for now, bonds aren’t buying it.
The fundamentals looked stable….
Interest rate futures continue to be well bid, with calendar spreads compressing. Ten year yield fell 1.7 bps to 175.8 in spite of auctions this week in 3, 10 and 30 years. Sept’16/Sept’17 euro$ spread fell 1 bp to 22.5; the first ten one-year spreads are between 21.5 and 25; little slope and repressed volatility (more on that below).
–There was (delayed) talk yesterday about large hedge fund losses that occurred as a result of a soybean calendar spread, July to Nov. In looking back historically, it doesn’t appear as though recent volatility in this spread is huge in comparison to former years. Which brings us to the point: there was almost no movement in the spread from last November to April, it traded in a sideways range of about 5 cents. As colleague SB mentioned to me, lack of movement “lulled everybody to sleep.” Then, in late April, it surged 30 cents instantaneously on perceptions that carry-overs and the crop from SA might not be as large as expected. Apparently it’s beyond the purview of Central Banks to limit ALL volatility. Obviously, narrow and clearly identified ranges require larger position size to extract profits. Then KABOOM. It happens all the time in markets, seismic shifts. Just that it has been a while since it has occurred in interest rates….
–NFIB small business optimism today (it’s been declining) and JOLTS (solid labor markets).
May 9. The Fed weighs domestic and internat’l concerns…
–There’s an article on Bloomberg this morning: ‘Gross and El-Erian warn against counting the Fed out’, with Gross saying June is still possible and El-Erian looking for two rate hikes. Another article in Reuters cites the People’s Daily, the official newspaper, where a high ranking official is calling not for a V or U shaped recovery, but an L …I guess meaning a leveling off. “Recovery hopes were further dimmed by an article on Monday in the People’s Daily, the Communist Party’s mouthpiece. It cited an “authoritative source” saying China’s economic trend will be “L-shaped”, rather than “U-shaped”, and definitely not “V-shaped”, but the government will not use excessive investment or rapid credit expansion to stimulate growth.” http://www.reuters.com/article/us-china-stocks-idUSKCN0Y00L2
In any case, China stocks have been hit, and commodities such as iron ore and steel, crushed. The Fed has overtly and repeatedly talked about China as a concern. If China is accepting a retrenchment, can the Fed pull the trigger? The market isn’t ready to make that leap, but if YOU are, then sell FFN(july) at 9960.5. It’s only 3.25 bps from FFK, and even if there isn’t a hike in June, the July meeting is on the 27th so a bit of premium will remain for hike odds at that time.
–If the Fed were to hike in June, the curve would surely flatten even further…probably not what the Fed wants at this point.
–This morning US stocks are pushing higher, again taking on the characteristics of a global safe haven play. And, on the domestic side, while the somewhat soft employment report had many shops pushing their call for a hike back to Sept, the Consumer Credit number released late Friday was a stunner! Revolving credit up at a blazing 14.2% annual rate. Non-revolving up 8.5% rate. I saw a little blurb by an analyst saying that credit growth is outpacing incomes. Really? If income growth was anywhere close to those numbers we’d be quoting the at-the-money 95.00 puts instead of wondering if another round of QE is on the way. A continued battle between US data and global headwinds….
May 8. Locked and loaded
“The springs on the San Andreas system have been wound very, very tight. And the southern San Andreas fault, in particular, looks like it’s locked, loaded and ready to go,” Jordan said in the opening keynote talk.
It has been quiet since then — too quiet, said Thomas Jordan, director of the Southern California Earthquake Center.
http://www.latimes.com/local/lanow/la-me-ln-san-andreas-fault-earthquake-20160504-story.html
The above quote is from the National Earthquake Conference last week, held, of course, in Long Beach CA. (I’ll bet that’s a fun one to go to…) It is such an obvious comparison to today’s investment landscape that I would bet someone has already made it, but I didn’t find the reference, so I’m just going to run with it.
On the other coast, another event was being held, known as the Sohn Conference. No less dire of a warning was given by Stanley Druckenmiller. Quickly summarizing, he mentions several dislocations in the current environment: 1) the peak in profits has passed, but leverage has increased to dangerous levels 2) the Fed has knowingly borrowed from future consumption 3) debt has not been used productively 4) China is facing similar problems and is at a more precarious stage. (link to speech below) Like the San Andreas fault, the timing of an unwind is uncertain.
It was late 1996 when Greenspan mentioned irrational exuberance. “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?” After a brief hit in response to that comment, SPX promptly rallied from 800 to 1200 within two years. So, it’s clear that even the experts have a hard time identifying the timing of major moves even when they have accurately assessed the fault lines (and the current Fed can’t even seem to do that). As Jeffrey Gundlach noted, (paraphrasing) Druckenmiller’s theme doesn’t lend itself to an instantaneous trading position.
I would simply say that the spectrum of risk/reward now appears to be past orange and into the red. Most of the market isn’t using a prism to differentiate, but is just seeing the category of “visible light”. The question is, why? After all, it’s not just Druckenmiller providing a ‘heads up’. Many luminaries of the investment world have been warning about the current DM situation and about China. For example, from a BBG story on April 20: “Billionaire investor George Soros said China’s debt-fueled economy resembles the U.S. in 2007-08, before credit markets seized up and spurred a global recession.” …What’s happening in China “eerily resembles what happened during the financial crisis in the U.S. in 2007-08, which was similarly fueled by credit growth,” Soros said. “Most of the money that banks are supplying is needed to keep bad debts and loss-making enterprises alive.” Kyle Bass has made the same warning with regard to US policies pushing consumption forward (as much as it possibly can) at the expense of the future. Bass is also a China bear, noting that while China is supposedly transforming into a new economy less dependent on manufacturing, the (bad) debt is still outstanding to the old industries. Jeffrey Gundlach “…reiterated his view that negative and low interest rates on bonds, especially in Europe and Japan, are deflationary and do not promote growth. “ Bill Gross says to prepare for renewed QE from the Fed. While these sentiments may not suggest imminent doom, they certainly don’t give confidence that the global financial system is on the bedrock of stability.
There’s a famous quote from Bill Clinton: “You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of f’ing bond traders?” (Supposedly asked of Robert Rubin, who nodded in the affirmative). Greenspan had counselled Clinton to focus on reining in the deficit. The implication was that the market (and the Fed) imposed a certain amount of discipline on political decisions. That discipline has been lost and replaced by intransigence.
The US investor or retiree may rhetorically ask a similar question: “You mean to tell me that my investment results and future income stream hinges on what happens in China?” It’s hard to assess the information out of China, but over the weekend the news wasn’t particularly encouraging with yoy exports -1.8% and imports -10.8%. China’s exports to the US fell by 9.3%. On Friday, there was a BBG story (link below) citing brokerage CLSA Ltd, that estimates, “Chinese banks’ bad loans are at least nine
times bigger than official numbers indicate, an “epidemic” that points to potential losses of more than $1 trillion.”
Last week I mentioned that the SPX had two recent declines of 11-12%, one sparked by the Chinese devaluation in August, and the other at the beginning of the year, following the Dec Fed hike. Many found these sell offs very unsettling. Well, look at a stock market chart from 1965 to 1982.
There are four declines over 25% over a dozen years, the largest coinciding with the oil crisis in 73-74. By the way, the Saudis just dumped long-time oil minister Al-Naimi, with Mohammed bin Salman consolidating power under his vision to diversify away from energy and into (uh-oh) finance.
The point is that prudent risk posture at this point can only be tempered (or overwhelmed?) by additional central bank gymnastics. However, on Friday, NY Fed President William Dudley said that it remained a “reasonable expectation” that the Fed would increase the fed funds rate two times this year. This remark immediately prompted several large sales in the Eurodollar strip (which were nonetheless easily absorbed). The first 5 ED contracts added more than 50k in open interest, likely new shorts. However, on the longer end, between Thursday and Friday, open interest in TY increased by over 100k, which suggests a safety migration. New supply of 3’s, 10’s and 30’s starting on Tuesday will likely sail through without a ripple.
In summary, many have noted the disconnect between market pricing and the Fed’s pronouncements and dot plots. The market obviously is NOT expecting two hikes this year with January’17 Fed Funds at 9945.5, a spread of only 18.25 to the current May’16 contract. At the same time, contradiction abounds between stock market pricing and the ever more vocal warnings of respected asset managers. In any event, a shift toward risk aversion appears to be the prudent stance.
May 6. Longshots
–First, a bit of good news! Zimbabwe issues new currency tied to the US dollar. http://www.bloomberg.com/news/articles/2016-05-05/-zombie-currency-printed-by-zimbabwe-draws-scorn-from-critics
So, assuming the normal one to one swap, my One Hundred Trillion Dollar Zimbabwe note (picture attached) now means I’ve achieved financial independence!
–Perhaps I’ll use some of the proceeds to buy US treasuries, like everyone else did yesterday. The contract pushed to a new recent high, and open interest in TY rose a whopping 63k. The buyer of TYU 133 calls was back in as well, bringing the total long to about 40k. The 133 strike is around 1/4% away in terms of yield, so a bit under 1.50% in terms of the current ten year, which closed yesterday at 174.5, down 3.7 bps on the day. The curve flattened with 2/10 down 1.7 to just over 102 bps. Red/gold made a new low during the day and closed just over 72.
–Nonfarms expected 200k with hourly earnings +0.3. As indicated by yesterday’s price action, the risk appears to be a lower number.
–October Fed Funds closed at the highest level since early March at 9953.0, which is less than 11 bps underneath the front May contract. That is to say, there is less than 50% odds priced into a rate hike at ANY of the next three FOMC meetings. Somewhat boring. So, instead, order yourself a mint julep, find yourself in the company of a girl with an outlandish hat and bet it all on Trojan Nation to win. It’s a year for the longshots!! (Leicester, Trump…)
May 4. The Trump effect
–Yields reversed Monday’s rise, with the ten year yield falling around 7 bps to 179.6. The curve flattened, with red/gold ED pack spread in by 2 bps to 76. One year eurodollar spreads edged lower, with many under 25 bps. Call it the Trump effect. Mainstream power-broker republicans are having a hard time accepting the fact that Trump is the nominee. But according to a graphic on the Chicago Tribune, Trump got 589k votes in Indiana, almost as much as Clinton and Sanders COMBINED, 302 and 334. Along the same lines, many Fed officials are having a hard time accepting the fact that the market won’t give their rate hike threats any respect. Yesterday it was Williams (San Fran) and Lockhart (Atl), both indicating that the June FOMC is live. About as live as Jeb. June eurodollars closed higher on the day at 9933.5 (+1). And voting in treasury options was fairly unambiguous, new buying of 15k TYN 131.5c and continued accumulation of TYU 133c, yesterday about 7k bringing the total to 25k. (TYU settled 130-06).
–At the same time, many economists and central bankers are panning the negative rate experiment. Yesterday I noted the St Louis Fed blog, and during the day it was Canada’s CB head Poloz, who said ‘Negative interest rates turned out not to work.” Interesting quote from an investment fund Fasanara Capital: “Picking up carry has been the mantra of the asset management industry for as long as the industry existed. Today however, as $7 trn bonds are trading negatively, as equities expanded multiples on rising prices and contracting earnings, picking up what is left of carry today is like willfully trading what used to be good yield for illiquidity premium and bad credit risk: a value trap, if not a financial guillotine.” We have no carry, we have no curve, we have no capex; the gears of modern finance are gummed up. On the other hand, auto sales rebounded to a 17.4 million rate.
–Plenty of economic data today: ADP expected 193k. Productivity expected -1.3% from -2.2% with unit labor costs 3.3%. Non-mfg PMI expected 54.7 was 54.5 last. Factory Orders expected +0.6 from -1.7%.
May 3. A central bank guy pans negative rates
–Christopher J Waller, Director of Research at the St Louis Fed (link to blog below):
“At the end of the day, negative interest rates are taxes in sheep’s clothing. Few economists would ever claim that raising taxes on households will stimulate spending. So why would they think negative interest rates will?”
https://www.stlouisfed.org/on-the-economy/2016/may/negative-interest-rates-tax-sheep-clothing?&utm_source=Twitter&utm_medium=SM&utm_term=monetary&utm_content=oteblog&utm_campaign=8387
–The Caixin Manufacturing Purchasing Managers’ Index for China (PMI) fell to 49.4 in April from 49.7 in March. It was expected 49.9. Australia’s RBA unexpectedly cut rates to record low 1.75%. The Japanese yen continues to strengthen, with $/yen trading as low as 105.60 today.
–From Treasury Sec’y Lew’s letter to Congress on Puerto Rico….pretty blunt: “Going forward, Puerto Rico’s $70 billion of debt is unsustainable by any measure. It simply cannot afford to pay its debt. And, with a shrinking economy because of people leaving Puerto Rico, further reductions in government spending will be difficult to implement. Government expenditures, net of debt service, already have been reduced to the lowest level since 2005.”
–Remember…it only becomes a crisis when debts can’t be serviced, and bonds that were once thought to be assets evaporate.
–From BBG: “The European Commission told the euro area’s largest economies to reduce debt and modernize labor markets as it again slashed its inflation forecast…” to 0.2 for 2016.
–As of this morning, Monday’s moves in stocks and treasuries have been completely reversed, with ESM 2062.00 -12.25 (settled Friday 2059.00), and TYM 130-01.5 (settled Friday at 130-02). Vehicle sales today expected 17.3 million unit rate, versus 16.6 last.
May 2. China NPL
–The Financial Times continues to warn about China’s bond markets. As mentioned over the weekend, it ran this piece last week, ‘China’s bond market is on edge’
http://www.ft.com/intl/cms/s/0/7246cf2c-0a95-11e6-9456-444ab5211a2f.html#axzz47P4eaX5S
And today the FT has a story with this headline ‘Worries mount over China’s bond market’ …rising defaults and monetary easing sap investor appetite. There’s a visual in the Daily Shot today that shows a steadily increasing amount of non-performing loans. When we get down to the core of a crisis, it occurs at the tipping point when debts can no longer be counted as assets, because there is no probability of full repayment. Despite monetary stimulus that has juiced some commodities, both by China, and the US (in the form of inaction), China seems to be lurching towards that tipping point. On a smaller scale of course, we see it in Puerto Rico, which is missing a payment today. Banking shares globally reflect these concerns, and negative interest rates combined with flat curves augment the challenging environment.
–On the other hand, gold bugs are delighted to see new highs, with another $10 tacked on this morning to stand just over $1300/oz. Additionally some pressure has been alleviated throughout the financial system as a result of oil’s rally. However, stories are now appearing about significant forward hedging sales at these levels, which should cap the surge for now.
–Friday ended with a modest decline in yields, with tens down almost 2 bps to 182. Once again, besides EDM6/EDM7, the next ten one-year eurodollar calendars are between 25 and 26.5. Linear. The delegate count is pretty clear: one hike.
–One other note, which may or may not be of importance. ZeroHedge ran a piece saying that Chas Schwab, due to new regulations, is sweeping non-individual accounts from money mkt funds into US treasury govt money market vehicles. Here’s the link. http://www.zerohedge.com/news/2016-05-01/schwab-quietly-forcing-cash-out-money-market-funds-and-treasurys
The outcome could be a bit of pressure on libor vs short term bills.
