Vote of No Confidence by US Interest Rate Contracts
When I write my thoughts for the weekend, I usually refer to snippets of information that I have taken from various sources. I start by trying to verify some of the things that I have read. For example, Used Car prices are falling, or Consumer Credit as a % of Disposable Personal Income is rising. As we all know, you can’t believe everything you hear, even from ‘experts’. For example, the Fed’s Dennis Lockhart said growth this year will gravitate towards 2-3%. Well, to me gravity usually pulls things DOWN. In looking at some of the recent data, that’s how it currently appears. Lockhart himself noted that “consumer activity is slowing.” He’s the head of the Atlanta Fed whose own GDP Now forecast for Q1 is only 0.3. It doesn’t seem to make much sense to think that 3% is anywhere near possible…but he still maintains that 2 to 3 hikes could occur this year. This, in spite of the fact that the April to October Fed Fund spread is barely 11 bps, encompassing 4 FOMC meetings. Or the fact that no near one-year Eurodollar calendar spreads are above ¼%. The market is pricing ONE hike.
So, here is what I gathered about autos. (Links are at bottom). First, undeniably the sales are well off the highs in terms of number of units, from an 18 million rate to 16.5. Second, in terms of Used Car prices, according to last year’s summary by Edmunds, Used Car prices hit a record in 2015, at $18,500. Therefore, it’s not too surprising to see some softening. What is fairly interesting in the report is the growth in new car leasing, from 2.6 million in 2012, to 3.2 in 2013, 3.6 in 2014 and 4.0 in 2015. Given the three year lease cycle, that means a lot of used cars are going to be coming on the lots in the next few years, which likely foretells a lack of pricing power and a cloud over new car sales. In terms of Consumer Credit, in looking at the Fed’s Financial Obligation Ratio (a measure of debt service obligations as a % of disposable personal income), it simply doesn’t seem to be an issue. From 2012 to 2015 this ratio has been between 14.93 and 15.53, last at 15.38. Household finances are in reasonable shape, with the exception of student debt, and even there, it has been more of a change in composition of debt rather than a change in aggregate. One might even conclude that’s good: a better educated population will make America great again. But anecdotal evidence seems to argue the other way…
The problems are the following: retail sales in total have simply leveled off. In July of 2015 the monthly seasonally adjusted level was $188.06B, and the last data for March is $187.83B. Flatlining. Retail Sales were part of the data set this past week, and came out weaker than expected. From the Nat’l Ass’n of Restaurants, “…the 1.0 percent first quarter increase was the smallest sales gain since the first quarter of 2014 (+0.2 percent), so it does indicate a degree of softening in trend”.
Consider the revenue declines in several of the major banks that reported last week. Earnings beat lowered expectations, but in terms of yoy revenues, JPM down was 3%, BofA down 6.5% and Citi down over 10%. It’s difficult to put a positive spin on those numbers.
Industrial Production is another big red flag. Capacity utilization has been on a steady decline since the end of 2014. Labor markets seem to be showing consistent improvement, so perhaps it looks as if I’m (sour) cherry-picking bad data. However, the markets only show price, and the curve is near the flattest it has been since 2008 (red/gold pack spread or 2/10 treasury spread). Bond rates are lower now than they were in December when the Fed decided lift-off was prudent. The 30 yr bond was around 3% in December and is now 2.56%. This yield is near the lowest it has been since the crisis. As can be seen on the chart below, in 2008 it fell to just above 2.5%. In 2012 during the EU debt debacle it got just below 2.5. In the beginning of 2015 it spiked down to around 2.25%. Yields continue to press lower despite formerly misplaced fears of China selling reserves, and the new threat of Saudi Arabia dumping US bonds. Compressed yields are not a vote of economic confidence.
While equity markets have strongly bounced back due to the Fed’s backpedaling on rate hike prospects, (which in turn weakened the dollar and supported emerging markets and crude oil), there are still strong undertones of nervousness, mostly being reflected in a growing chorus of voices questioning Central Bank policies.
Blackrock’s Larry Fink: ‘We have become too dependent on central bankers’ to boost the global economies, he said, stressing easy money policies were supposed to be a temporary healing. ‘I don’t call seven, eight years temporary… I don’t see how that [still] has a positive impact.’
‘Both households and businesses have become skeptical about the effectiveness of policy measures to address the current economic problems,’ Nobuyuki Hirano, president of Mitsubishi UFJ Financial Group Inc., said
Kyle Bass: “We have pulled all of the demand forward that we can.” Just let that last line sink in for a moment. The primary complaint about the global economy is that there is a lack of demand. All of the policies of Central Banks are designed to spur consumer demand…NOW. It’s theft of future demand, and it’s beginning to look like the future is here.
April 15. Fixed
As you can see from the chart below it’s fixed now. The roof no longer leaks. White line is Crude Oil and red is HYG, the hi-yield etf. Identical recovery since the mid-Feb scare. There was also reassuring news from China, with Q1 GDP as expected 6.7%. However, debt growth in China is exceeding growth in the economy; incremental additions in debt are buying less GDP gains, but that’s a story for another day.
–Interesting item from Lance Roberts (link below) notes that Consumer Credit continues to grow as a % of Disposable Personal Income even as retail sales growth declines. The author suggests “…consumers are struggling just to maintain their current living standard and have resorted to credit to make ends meet.”
—In the US today we have Empire State, expected 3.0 vs 0.62 last, and Industrial Production, expected -0.1 with Capacity 75.4. Like many other data points, capacity utilization has been declining since late 2014, when it was just over 79. Yesterday’s Core CPI was only +0.1, but Jobless Claims were only 253k, indicating further strength in the labor market.
–With a headline grabbing quote, “Let them sell their summer homes”, the NYC employee pension is withdrawing from hedge funds. My understanding is that the pensions reduced their investment return assumption last September from 7.5% to 7.0. I suppose the hedge fund community might come back with the rejoinder, “Let them buy treasury bonds.” No matter what, it’s still a difficult task to generate 7% returns with a long bond yield of just 2.6%. Actually, just under 2.6% as the auction was bid through by a couple of bps and went off at 2.595. No wonder the Fed wants to juice stocks, even if it’s just through encouragement of buybacks.
–On the day, yields were up a few bps, with tens +2 at 178. Blue ED pack weakest on the board, closing down 3 bps.
April 14. Curve flatter despite stock rally
–Although stocks had another strong day, (SPX +1.0%, Hi Yld and EEM at new highs for the year), interest rate futures remain well bid. Economic data yesterday was disappointing, with Retail Sales -0.3% and just +0.1 ex-auto and gas. PPI -0.1%. The euro$ strip ended slightly higher and flatter…once again I would note that essentially all ED one-year calendars are between 22 and 26 bps. Ten year auction was solid at 1.765%, 1.3 bps through the pre-auction level. Even with equity markets retracing all of the year’s early sell off, the curve simply does not have any inclination toward steepening, and in fact the 2/10 treasury spread (101.4 bps) and red/gold ED pack spread (73 bps) are close to the flattest levels they have been since the crisis. Additionally, the 5y5y inflation swap forward has retraced a good part of its recent bounce and, at 200 bps, is at the lowest level of the past seven years, except for spikes lower late last year and in February. Implied vol in treasuries edged to new lows for the year.
–Underlining weakness in Asia, Singapore cut rates. The Atlanta Fed GDP Now estimate for Q1 GDP was revised slightly higher, but is still barely positive at just 0.3. From Reuters: “You can’t create demand from thin air. What’s needed is to create an environment in which companies and households feel confident to spend,” said a senior Japanese policymaker directly involved in Group of 20 negotiations that will continue in Washington this week.
–Interest rate markets do not appear to be endorsing the current central bank induced rally. Relatively heavy debt loads globally require a bit more growth and inflation for sustainability.
April 13. China turning?
–Stocks are up this morning and bonds are lower, partially in response to an increase in China’s exports of 11.5%, the first rise since June. At the same time BBG reports that “Euro-area industrial production fell the most in 18 months in February, giving up some of the surge seen at the start of the year. Data from Eurostat showed output declined 0.8 percent…” I’m certain this is too simplistic, but it’s almost as if all the strings are pulled by the Fed: Yellen shifts dovish, the dollar falls and takes pressure off the yuan, allowing Chinese exports to become more competitive, while the associated stronger euro diminishes competitiveness of the Eurozone. The Fed helps in one area, hurts another.
–Yesterday, oil was the big story, with CLK +177 late to 4213. Yet another beneficiary of a weaker dollar, as was silver, which broke out to new highs. Oil has been helped by the softer dollar, and the Saudis, facing budget problems, having just been downgraded by Fitch, also welcome the increased price of their major export, (it just might allow them to hold the USD peg).
–Yields were higher across the board yesterday, with tens up 5.8 bps to 178. Ten year auction this afternoon. Open interest in treasury contracts increased, giving a bit more significance to the move. Weak NFIB small business optimism was ignored, though it did come in weaker than expected at 92.6, and has been trending down for the past 14 months. Small business is not a concern when the big gears of buybacks and M&A are oiled by the Fed. However, Reuters notes an area of the market that seems to be seizing up: “About one in 10 Treasury-backed repo trades failed in early March, compared with one in three during the crisis. …
The amount of deals where one party failed to deliver the government debt pledged as collateral jumped to $456 billion in the week ended March 9, the most since a record $2.6 trillion during the financial crisis, according to industry and New York Federal Reserve data.”
http://www.reuters.com/article/us-usa-markets-repos-idUSKCN0XA0QO
Probably mostly regulatory in nature, but in an environment of lowered liquidity in general, it’s something to note.
–Today’s news includes Retail Sales expected +0.1, ex-autos and gas +0.3. PPI expected +0.3 and Core +0.2. Business Inventories -0.1. Ten yr treasury auction, followed by the Beige Book. JPM releases earnings.
April 12. Obama and Yellen
–Though interest rate futures barely moved, other markets continue to suggest a bias toward risk off. For example, stocks snatched defeat from the jaws of victory, having been trading positive virtually all day and then closing down 6 at the low end of the day’s range (ESM). Gold was up over $14/oz late, and silver surged 59 cents. however, copper was unchanged to slightly lower at the end of the day. Alcoa kicked off earnings season by warning of subdued global growth.
–The WH press sec’y suggested O and Y would talk about the trajectory of the US and global economy. Again, back to the Bernanke blog, “The most difficult practical issues surrounding MFFPs involve their governance—who decides, and how? Unlike orthodox fiscal and monetary policies, MFFPs would seem to require close coordination of the legislature [or PRESIDENT???] and the central bank, which may be difficult to manage in practice. To the extent that that coordination is successful, some worry, it might put at risk the longer-term independence of the central bank. Another concern is that the option of using money finance might be a “slippery slope” for legislators, who might be tempted to use it to facilitate spending or tax cuts when such actions no longer make macroeconomic sense.” Well, I for one, certainly would never think that the President would try to influence monetary policy….
–Interview with Bill Gross in Barron’s over the weekend. Sort of instructive in that he says that tens and bunds yield nothing, but if you sell strangles you can pick up extra yield and get a decent return as long as the market remains stable. All very reasonable, but this line of thinking points up, to some degree, the reach for yield which has vol suppressing characteristics. Right…to get a yield we have to introduce leverage and writing options.
—Little net change in interest rate futures yesterday. There were several large trades in options with EDU6 as the underlying contract, targeting the 9925 strike (EDU6 settled 9924.5). For example July 9937/9925/9900 p butterfly (broken) ppr paid 1.25 for 50k. There was also a buyer of 10k or more EDU6 9912/9925/9937 put fly for 2.0. Taken on their own, these trades would seem to indicate no chance of a hike in June. After all, EDH6 settled just above 9936.0 and the libor setting on Monday was 0.6299…call it 63 bps or 9937.0. Since the beginning of the year 3m libor has varied between 0.642 and 0.6126, or in futures terms 99.355 and 99.3875. So, if the Fed does not hike in June (or is not expected to, as the meeting is right after June expiry), then EDM should go out around the 9937.5 strike, leaving the July or Sept meeting for a possible hike. As this point, that idea seems reasonable. If the Fed WERE to hike in June, these trades do NOT look good, EDU would instantly trade 9912.5 or below.
–Again, the idea is that the Fed does NOT hike in June, but the market assigns 50/50 odds of a hike either in July or Sept. In that case these trades work, though an actual hike in July would hurt the Sept expiry. As I have mentioned previously, I think a better structure is to sell EDM6 9937p and buy EDU 9925p for 1.75.
–Below is a chart of May Vix. Appears to be breaking out of downward sloping channel. Another hint of risk-off to come.
April 10. Carry trade…carry what?
Last week I started with a sentence noting that the Nikkei was down over 15% on the year. It was slightly lower again this week. But the real action this week was in the currency, with $/yen having broken 108 before ending just above that level. Last Friday it closed just under 112. A concurrent market theme is weakness in global banking stocks. I recreated the chart below from BofA research. I’m not even sure of the context – correlation isn’t necessarily causation, even with carry trades- but these two were moving along on the same track this year, until the last two months. Red line is the Japanese yen and white line is XLF, the financial sector SPDR.
I suppose the idea is that the financial stocks will ‘catch up’. These guys at BofA have some pretty good research. On the other hand, this is the same place that instructed staff not to use the word Brexit. As if the problem is going to go away if we don’t mention it. I’ve tried that. Doesn’t work. Anyway, the larger point in my opinion is that unlike the broad SPX, financials haven’t come anywhere close to retracing the drop from December to mid-Feb. I would make the argument that the broader market is likely to ‘catch down’ to financial stocks.
Here’s how I would frame that notion. QE had the effect of spurring corporate borrowing, but it mostly went towards stock buybacks. That dog will no longer hunt. Corporate debt has become bloated, at a record nominal level $8.097T. The growth rate of corp borrowing has decelerated in the last three quarters of 2015, from 8.6 in Q2, to 4.6 in Q3 to 2.7 in Q4 (from FRB Z.1). Obviously the well-advertised junk bond scare served notice that credit markets aren’t quite as welcoming as before; the propensity to borrow has declined. And while commercial and industrial loans from banks have grown smartly, capex remains weak. Low rates along with a flat curve aren’t doing the financial system any favors as can be surmised from those stocks. As I have mentioned previously, the red/gold Eurodollar pack spread (2nd to 5th year), is only 74bps and hit 71.5 during the week, the lowest since 2007. Recall that the last hiking cycle was from 2004 to 2006 and culminated with a FF rate of 6.25%. In August of 2007 the Fed began to ease. My contention is that a curve this flat near zero rates is a much worse signal for the economy than it is with high rates. Previously I have used the tube of toothpaste analogy with the curve, noting that when a series of hikes were expected in the near term, the front part of the curve would steepen but the back end would flatten. Conversely, if no hikes were expected in the near term, then the front spreads would be flat but the back end would steepen. Now it just seems like the toothpaste is gone, and the tube is flat no matter where you press.
In any case, the Atlanta Fed GDP Now estimate for Q1 was revised to a barely positive +0.1 at the end of the week, having been as high as 2.75% two months ago. Earnings for financial stocks are expected down 9.2% according to Reuters. In terms of the broad market, this is what FactSet says: ‘For Q1 2016, the estimated earnings decline is -9.1%. If the index reports a decline in earnings for Q1, it will mark the first time the index has seen four consecutive quarters of yoy declines in earnings since Q4 2008 through Q3 2009.’
A friend (thanks CL) sent me a note that the word “global” was cited 22 times in the FOMC minutes that came out last week. Dudley said Friday that rate hikes would be cautious and gradual, inflation remains a concern, and there’s uncertainty abroad. Circling back to financial stocks, this global uncertainty is glaringly obvious in non-US financials. Deutsche Bank, HSBC, Credit Suisse, Nomura, etc, are all probing new lows and have been halved from last year’s highs.
In terms of the Fed’s impact on various markets, tens bottomed on FOMC day, 16 March, and got another boost from Yellen’s speech on the 29th of March. SPU’s were already on the upswing and were jolted higher both times as well, but this week closed below the March 29 close. While crude oil had a solid bounce last week, copper plunged and is now around the 61.8% retracement of the year’s rally. Most markets are signaling a risk off posture. EEM, the emerging markets etf, had been supported by the weaker dollar, improvement in commodities, and more lenient Fed. However, this week it traded soft, and also closed below the March 29 settle.
This week includes inflation data, with PPI and CPI on Wednesday and Thursday, expected +0.3 with +0.2 Core and +0.2 both headline and core on CPI. Retail Sales Wed expected +0.1. Earnings season kicks off Monday with Alcoa.
April 8. Yellen: “2% a target not a ceiling” Better watch for trap doors in the floor…
–Big risk off yesterday as $/yen plunged, with US equities falling in sympathy. JPY hit 108, while SPX fell 1.2% on the day. Note that even with today’s bounce, the Nikkei is down over 20% from the end of the year. Yellen yesterday afternoon said the US is near full employment and that the 2% level for inflation is a target, not a ceiling. This, on a day where the red/gold euro$ pack spread made another new low of just 71.5 bps, down 3.75 on the day. The ten year yield fell 6.5 bps to just 168.5. The April/Oct FF spread which encompasses the next 4 FOMCs closed at just 10.75 bps, down 2 on the day. All near euro$ one-year calendars are at new lows, with Sept’16/Sept’17 and Dec’16/17 at just 19 bps. Copper was crushed yesterday, and while oil has rebounded this morning, copper remains mired near yesterday’s low.
–Financial shares are still underperforming, with one client noting that DB is the canary in a coalmine, right at the year’s low, having been halved in the last 5 months. A canary? More like a cave full of bats that swarm out to darken the dusk sky. CS, UBS, UniCredit all have suffered large stock drops and pressing for new lows. Flatness of the curve in the US and negative rates in Europe are huge challenges.
–Just a couple of notes about yesterday’s euro$ option trades. First, 100 calls (zero % strike) had been quiet over the past few weeks after a flurry of trade earlier in the year. Yesterday, there was decent activity once again, for example, long March’17 and June’17 were rolled into Sept’17 (EDU7 100c settled 3.5). Appears to have been a new buyer as well in EDZ’6 100c for just under 0.5 synthetically. Also in EDZ, there was a new buyer of 40k 9912/9925/9937/9950 c condors for 4.0 covered 9921 and 20.5. Another interesting trade was a new buyer of 12k 0EZ 9900/ 3EZ 9850 straddle spreads for 13.0, bought blue, settled 48.0 and 61.0.
–Today NY Fed’s Dudley speaks at 8:30.
–Consumer credit (Feb) yesterday was stronger than expected $17b with the previous month revised higher as well. Growth rate of 5.8% still represents deceleration from 2015’s 7%.
April 7. Land of the rising yen
–$/yen breakout yesterday with further gains this morning, now nearing 108 from 109.70 yesterday. Precious metals also seeing a bounce this morning. After a strong close yesterday, equities are pulling back, and treasuries are modestly bid. Today’s news includes Jobless Claims expected 272k and Consumer Credit late in the afternoon. January data showed a surprising decrease in revolving credit, and a deceleration in non-revolving as well. Skimming through the last report it’s an interesting side note that new car loans extended one month per year over the last five, from 61 months in 2011 to 65 months in 2015. By the end of 2015, the amount financed had risen to $28k.
–Crude oil posted a strong rally yesterday on the decline in DOE inventory levels, up 186 late to $37.75. However, that’s still over $4 lower than late March and the market is little changed this morning. High yield has mirrored the rally in crude, but may have run its course as financial shares in the US (and more so in Europe, have been badly lagging.
–Fed’s minutes were uneventful. Rates edged slightly higher across the curve, with the ten year yield up 2.4 bps to 175.1. Just prior to the minutes, there was a buyer of 20k 0EU 9875/9850/9825p fly for 3.0, settled there vs 9902.5. Reasonable trade for a turn to more bearish sentiment.
April 6. Public finance/tax fury
–The Atlanta Fed GDP Now forecast for Q1 was revised down to a new low of +0.4 from 0.7 last Friday. In February it was above 2.5%. Clearly ices the Fed if that information is correct, and that’s what the market is reflecting. All near one-year calendar spreads in ED made new lows. For example, June’16/June’17 settled 22.5, down 2.5 on the day. The lowest one year spread is Dec’16/Dec’17 at just 20 bps. On the Feb 11 panic this spread had spiked down to 13 during the day. There are no one-yr spread over 1/4% until greens to blues. Red to blue pack spread closed at a new low of just 48.5 bps.
–Today the Fed minutes are released. Prior to that Mester speaks at 12:20 EST. More importantly, Dudley speaks tomorrow on the economy at 8:30, Q&A expected. However, I saw a clip after Yellen’s speech where he said he agreed with everything she said.
–China’s Service PMI better than expected 52.2. US stocks have bounced slightly and treasuries pulled back.
–Is it just me, or did a LOT of tax grab and tax haven fury news come out over the past two days? Obviously the Panama Papers have tax officials scrambling to collect what has been misappropriated. Iceland’s PM forced to resign. Several politicians have weighed in on tax inversion schemes; Pfizer / Allergan deal deep sixed due to new rules. CA signed the $15 minimum wage. News stories indicate that David Tepper moving himself and his firm to Florida will blow a hole in NJ’s budget. Kashkari continues to drone on about too big to fail. Just seems like a convergence of tensions starting to simmer in a big way, magnitudes of Occupy Wall St. Group hug and buy some treasuries.
April 5. Declare the pennies on your eyes.
–It’s a risk off morning with ESM -17 as of this writing to 2040.50, and $/yen at a new low of 110.41. Interest rate contracts are rallying, with the Green pack (3rd year) up 5.75 bps. The possible failure of the Pfizer Allergan deal due to new Treasury rules to curb tax inversions is likely one reason, and newly inspired tax collection efforts as a result of the Panama Papers leaks probably doesn’t help. Nor does weak oil, etc.
–Today’s news includes Internat’l Trade expected -46.2, JOLTS and ISM non-mfg expected 54 from 53.4. As noted previously, the employment sub-index has been weakening in both mfg and service ISM, and the Fed’s Labor Mkt Conditions Index released yesterday was -2.1. This index has been on a decline as well, and hasn’t been this low since the middle of 2009. Perhaps that’s one reason the market immediately dismissed Friday’s solid payroll report.
–Implied vol continues to seep out with FVM at just 2.9 and TYM at 4.6. Not much change in the curve as green pack was the outperformer, up 3.25 bps, while golds were +2.0. The spread mentioned yesterday, April/October FF, settled at 14.75, so 0.75 bp cheaper than yesterday, as the market continues to squeeze out rate hike prospects (Time period encompasses FOMC meetings in Apr, June, July and Sept). Crude again closed near the daily low yesterday, and is more than $6/bbl off the high print from mid-March, having retraced around half the rally from Feb 11 to March 18.
–The subject line is from the Beatles song Taxman:
If you drive a car, I’ll tax the street
If you try to sit, I’ll tax your seat
If you get too cold I’ll tax the heat
If you take a walk, I’ll tax your feet
