Feb 4. 5 yr echoes start of 2015
–From a Bloomberg article this morning: “Goldman Sachs Group Inc. and Pacific Investment Management Co. say bonds are poised to fall and traders aren’t prepared for how far the Federal Reserve will raise interest rates.” From Bill Gross’ monthly missive: “…don’t go near high risk markets, stay safe and plain vanilla.” Dudley yesterday leaned towards the latter viewpoint, suggesting that tightened financial conditions are more than just a “blip” intimated by Esther George on Tuesday. The market has clearly squeezed out tightening expectations, with near euro$ calendar spreads again falling to new lows. EDH16/EDH17 settled at just 19 bs, down 4.5 on the day and 45.5 bps since the end of the year! EDM16/EDZ16 traded as low as 8.5.
–It was a volatile session Wednesday across many assets, clearly driven in part by position exits. In terms of data, non-mfg ISM was weak at just 53.5 vs 55.1 expected. ADP data was in line at 205k. The five year note trade as low as 1.20. The low (close) since the mid-2013 taper tantrum was 115.6 on Jan 30, 2015. In fact, the magnitude and speed of this year’s move in fives has been similar to the start of 2015 as shown in the attached chart. So perhaps a bounce in yields is coming, certainly there is plenty of hope for a change in this year’s trend. The risk is that the general anti-establishment social mood evidenced in the rise of Trump and Sanders has spilled over into financial markets, where faith in central bankers and their policies may further crumble.
–In the latter half of the session crude oil mounted a strong rally, apparently on renewed talk of production cuts. By the end of the day CLH had traded to 32.75, the exact 0.618 retrace from Thursday’s ‘production cut’ rumor high of 34.81 to yesterday’s o/n low of 29.41. Amazing swings! Oil has the appearance of trying to put in a bottom, this time helped by a hefty decline in the dollar, with the dollar index falling right to its 200 day moving average, down 1.9% on the day at the 200 day and ultimately ending down 1.6%. A weaker dollar and stronger commodity complex would likely go a long way in arresting January trends in many markets.
–Today’s news includes Jobless Claims at 277k. Nonfarm Productivity -2.0. Factory Orders -2.8%.
Feb 3. Hey Esther, grab a mitt
–Hard to know where to begin today, but I’ll start with the continued implosion of eurodollar calendar spreads. New lows in everything nearby, with March’16/June’16 at just 4.5 bps and March/March (EDH16/EDH17) just 23.5 bps, down 6.5 on the day. Peak one year spd is just 35 bps. New low in red/green (2nd to 3rd yr) pack spread at just 34.375 bps. New low in 2/10 at 111.6, down 4.3 on the day. However, Esther George, head of the KC Fed, insists that the Fed should still be raising rates. Fed policy “cannot respond to every blip in financial markets,” she said of recent volatility. Hey Esther, grab a mitt and catch a clue. There are over 500k contracts of 100 calls in open interest across the euro$ curve. Japan just went negative, and the possibility of negative rates has become an open question in the US (except in Kansas City). Speaking of which, Kuroda indicated that Japan may not be done with ‘stimulus’ measures; the Nikkei fell over 3%.
–In treasuries, fives, tens and bonds all fell about 10 bps yesterday, with 5’s at 128, essentially back at the low yield of October after the Fed had disappointed by not tightening in September. I still think 122 to 125 is a big support level, but when compared to other 5yr yields around the world it looks strangely out of place.
–Carnage in financial stocks continues. As a few examples, Morg Stanley closed at a new low yesterday, GS and BAC are getting close. But the real damage is in some large european names which gapped lower and are being gutted. CS, DB, UBS. And Kuroda isn’t helping either. Nomura is pressing for new lows, and Mizuho is already there. I think the financial stocks are pretty much all in that Japanese candlestick formation called ‘the toilet’.
–In spite of renewed pressure in oil and in stocks, VIX remains just under 22. Signs of panic are mostly absent.
–News today includes ADP expected 190k and non-mfg ISM expected 55.5.
February 2. Looking for the ballpark
–Rates pushed higher yesterday with tens up nearly 4 bps to 196.4. On the eurodollar strip, reds through golds were down 4 to 5.5 bps as longs pared back. Volume was light, with a stubborn bid in stocks despite a renewed sell off in oil. Economic news was soft, with Mfg ISM at only 48.2, and prices still stuck at last month’s 33.5.
–Fischer was pretty balanced, saying that previous bouts of volatility had “left little permanent imprint on the economy.” But he noted the Fed is closely monitoring global economic and financial developments and assessing their implications…for the balance of risks to the outlook.” On January 6th, he said that four rate hikes in 2016 were in the ballpark. Less than a month later, things are back to being data dependent, and, with EDH16/EDH17 one-year calendar at just 30 bps, the market is leaning towards one or maybe two hikes over the year. So now he barely knows where the ballpark is.
–Item on Reuters says that more than just energy companies are cutting back on capex plans.
http://www.reuters.com/article/us-usa-results-capex-idUSKCN0VB0CZ
–Bloomberg reports that China is allowing home down payments as low as 20% in a bid to spur the real estate market. Conservative, as compared to the US. However, there was another article that said Hong Kong real estate prices had fallen 10% from their peak just four months ago. So maybe 20% isn’t quite as large of a cushion as it seems.
–DB’s Jim Reid raises the possibility of negative rates on european corporate bonds. Capitalism turned completely on its head? It would seem to be a simple admission of no opportunities for growth. By comparison 80 bps for US 2’s seems downright generous.
Feb 1. EDH’16/EDH’17 at just 1/4% in a tightening cycle?!?!
–Strong rally in fixed income Friday as Japan cut to negative rates. Near euro$ calendar spreads made new lows, with March’16/June’16 settling at just 5 bps and March’16/March’17 at just 27 bps, barely above 1/4% for an entire year. Stocks and oil also continued to rebound, though both are giving some back this morning. Five year yield on Friday closed at 133, very near the low end of the range for the past two years; should be strong support around 122-125. Japan’s 5 year yield is plunging, now -13 bps. Given the overt efforts of Japanese authorities to weaken the yen and the huge interest rate differential, one would expect Japanese inflows into treasuries to accelerate. $/yen has moved from 117 to 121.28 (as of this writing) in a couple of weeks. However, the area of 123 to 125.60 is also a major area of resistance for $/yen…essentially the same numbers as five year yield support.
–Today’s US news includes Personal Income and Spending expected +0.3 and +0.1. ISM mfg for January expected 48.3 from 48.2. And Stanley Fischer speaks at 1:00 NY time.
–Interestingly, the was a recent Pew Research poll that shows the economy and health care as the top two concerns of voters. It doesn’t seem as if Obamacare has alleviated concerns over high health care and insurance costs, a point driven home for many individuals with premium hikes in the new year.
Jan 31, 2016. Central bank desperation
“And then, depression set in” -Bill Murray as John Winger in Stripes
Last week’s title was “Central Banking Confidence Game”. This week it smells more like desperation. Consider the recent chain of events: two weeks ago Draghi signals further easing in March (bullet spent), and then Kuroda suggests China implement capital controls. Last week the Fed back-pedaled from the idea of a hiking campaign (bullet spent). Friday the BoJ went negative (bullet spent). Take a step back and what does it mean? It means that central banks are desperate to force consumer spending, the last game in town. And they are running out of ammo. Consider the chart below (from dshort.com):
“As for the role of Personal Consumption Expenditures (PCE) in GDP and how it has increased over time, here is a snapshot of the PCE-to-GDP ratio since the inception of quarterly GDP in 1947. To one decimal place, latest ratio of 68.9%. From a theoretical perspective, there is a point at which personal consumption as a percent of GDP can’t really go any higher. We may be approaching that upper range.”
http://www.advisorperspectives.com/dshort/updates/GDP-Components
This chart is only for the US. As I have mentioned previously, household balance sheets aren’t in bad shape. There are some positive notes from labor markets (aside from the obvious drop in the unemployment rate). For example, the WSJ says “Income for Recent Graduates the Highest in Over a Decade”… stereotype of college graduates working in coffee shops is fading. However, there’s only so much that can be squeezed from consumer spending.
So if this chart is just for the US, doesn’t it mean that other consumers in other parts of the world can pick up the slack? For example, we’ve all heard that China is trying to transition more to a consumer led economy. Perhaps true, but then why is every bloc trying to depreciate their currency vs the dollar? It’s so the US consumer can ride to the rescue.
In terms of the business sector, there’s this note from Bloomberg (Jan 28): “Credit-rating downgrades account for the biggest chunk of ratings actions since 2009; corporate leverage is at a 12-year high; and perhaps most worrisome, growing numbers of companies — one third globally — are failing to generate high enough returns on investments to cover their cost of funding.” FAILING TO COVER THE COST OF FUNDING. That’s the sort of problem that gets a central banker’s notice. The corporate borrowing binge has made this sector the largest source of fragility.
I’m all for government deficit spending on infrastructure as a means to spur immediate growth and set the framework for future growth. And I’m not talking about painting bike lanes on Chicago’s pot-holed streets. But the political will doesn’t seem to be there for an infrastructure investment initiative.
What are markets saying?
There was huge short positioning in December ’16 eurodollars prior to the Fed. Someone obviously believed Fed officials in terms of hiking plans and the perceived strength of the economy. [Jobs report this Friday]. However, this contract closed at its highest level since the October spike, at 9918.5. At the end of December it was 9875, so we’ve seen a 43.5 bp drop in yield in one month! The market continues to tell a different internal story than the Fed, warning of bankruptcies and a lack of growth and inflation. Sure, stocks had a spirited rally Friday. The same “wealth managers” that were saying ‘stocks don’t reflect what is going on with the health of the economy’ when near the lows, are going to come out this week and say ‘See? The stock market now “gets it” and is back to pricing in our glorious fundamentals.’ Interest rate markets across the globe whisper a different narrative. German 2 year notes made an all-time low at -49 bps. Same for Japanese twos and tens, record lows at -8 bps and +9.5 bps. There is no way to escape the twin overhanging problems of aging populations that demand expensive medical care and extreme global debt levels. Reuters had this headline: “US economy hits a soft patch in Q4.” As you know, Q4 GDP was released Friday at 0.7%. Perhaps it IS just a “soft patch.” But since the beginning of this year, the US five year treasury yield has also fallen 43 bps. Calendar spreads on the Eurodollar curve have imploded. EDH’16/EDH’17 (March/March) closed at just 27 bps, down 8.5 on the week and barely holding above ¼% for a full year. 2/10 treasury spread remains pinned to the lows just above 115 (ended last year at 122). However, 5/30 ended the week at a new high, just over 142. The bond yield this week only fell 7 bps to 275.
In terms of negative rates spurring bank lending, there are constant stories about European bank problems. Regarding Kuroda’s move to negative, Bloomberg had this to say: “When it comes to bank lending, however, the central bank’s announcement will probably have more of a dampening effect than a stimulative one. Shares of Mitsubishi UFJ Financial Group and Mizuho fell in the wake of Kuroda’s announcement.”
Pushing on a string.
Jan 29, 2017. Under water
–There was a Pimco piece by Harley Bassman circulating the last few days entitled “Finding Sea Level for Interest Rates”. It wasn’t really about the absolute level of rates, more about the correct benchmark, but it’s a little ironic that Japan just went below sea level, cutting their excess reserves rate to -0.10%. Funny that a few days ago Kuroda suggested China adopt capital controls to defend the yuan, and then turned around and moved to devalue the yen. So this is what the currency wars are coming to. Hmm, maybe those 100 calls in the euro$ strip aren’t looking so bad after all. (There was a buyer yesterday of 10k EDM7 100c for 1.5).
–In response to Japan, US stocks and interest rate futures are both higher, in spite of Amazon’s beat down after missing growth targets. (Stock was immediately down $70 after hours).
–Today the advance estimate of Q4 GDP is released, expected +0.8%. The Atlanta Fed GDPNow estimate which was released yesterday was 1.0%, so there’s probably not much drama associated with this report. However, yesterday’s Durable Goods Orders were rather weak, and previous data was revised lower. For example Capital Goods Orders (core, non-defense, ex-air) were -4.3% following a revised -1.1%. The other big feature of the trade yesterday was the rally in Crude oil as rumors swirled about the possibility of Saudi production cuts. CLH immediately rallied from just below 33 to 34.82, but pulled back from there and traded a fairly tight range. Some assets are seeing hopeful bounces related to energy stabilization, including high yield etfs.
–On the dollar curve, action continues in EDZ6; there was a seller of 100k EDZ6 9862/9837 put strip at 4.5 to 4.0, the last being sold at 4.0 vs 9911. So the long put spread owner (of 250+ k EDZ 88/90 and 87/86 put spreads), took in downside premium to help pay for the wait, which may be a long one, in the process crushing vol further. EDM6 9925 straddle settled at just 16, having lost over 20% of its value in a week. EDM6/EDZ6 went as low as 16 offer. The BoJ is no friend to the EDZ shorts.
–It was pretty surprising a few days ago to see that American Express missed on earnings and was savaged. It continued lower yesterday and made a new low. Discover Financial Services (DFS) suffered the same fate on its earning release. In fact, a quick review of US financial names reveals quite a bit of weakness. Citi is holding in a tight range near new lows, Wells has taken out the August low and has rebounded to just above, BAC is well below Aug and Sept lows, JPM is trying to fight off the lows. Capital One lost 1/3 of its value since July; seeing a small bounce in the last two days. Morgan Stanley is pressing to a new low just above 25, it has lost over 20% of its value this month. I’m not an analyst of financial stocks, but the weakness in AXP, DFS and COF doesn’t appear to reflect a strong consumer, and the flat curve is no friend to banking spreads.
Jan 28. The Holy Grail
–From the Fed’s statement: “The committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook. Now go away, or I shall taunt you a second time.”
–Well the second sentence isn’t really in there, but it is becoming rather like a Monty Python skit. “Sir Galahad: Is there someone else up there we can talk to?”
—Big trade of the day was in EDZ6, heavy selling on blocks and screen with a total volume of 540k (prelim open interest shows a rise of only 38k contracts this morning). In addition, there was a new buyer of 200k EDZ6 9900/9887ps WITH 9875/9862ps for 7 to 8 bps. Well sure, if the Fed were to confirm its tightening campaign, it makes perfect sense. Certainly EDZ6 should not be less than 25 bps away from EDH6 (24.5s in spread). At the end of last month EDZ6 was as low as 9875. The sales yesterday started at 9910.5 and pushed to a low of 9905. However, in the aftermath of the FOMC’s backpedal, EDZ was 11 bid.
–Oil has been one of the big drivers and is trying to find a bottom, having probed as low as 28 and now holding above 32. It may be too late for an oil rally to save equities from the sentiment of financial stress, but a rebound in energy could well steepen out the front end of the curve a bit, which has become remarkably flat.
–Premium was heavily offered yesterday, in a continued unwind of the month’s surge. For example, the TYJ 128 straddle was 2’12 mid-market on Tuesday morning, but traded down to 2’02 early Wednesday. As mentioned yesterday, EDM6 9925 straddle was 20.5 a few days ago, settled 18 on Tuesday and 17 yesterday.
–Today’s news includes Jobless Claims expected 280k and Durables, expected -0.7 and -0.1 ex-transportation. First estimate of Q4 GDP comes out tomorrow.
Jan 27. TraderPlanet Post
http://www.traderplanet.com/commentaries/view/169273-could-china-officially-devalue-in-front-of-the-lunar-new-year/
Jan 27. FOMC day
–FOMC announcement today. The last statement acknowledged low inflation, “Market-based measures of inflation compensation remain low; some survey-based measures of longer-term inflation expectations have edged down”, but lift-off occurred anyway. As of now, market based measures of inflation are also trending lower. The key will likely be the balance of risks. From the last statement: “The Committee sees the risks to the outlook for both economic activity and the labor market as balanced. Inflation is expected to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.”
–Eurodollar options are viewing today’s FOMC as a non-event. For example, EDM6 9925 straddle yesterday settled at just 18, having been 20.5 a few days ago. Implied vol was hit across the curve yesterday.
–AAPL released earnings after the close, with shipments generally below expectations, and a nod to challenges in China. Stocks are lower this morning as a result, but in addition, crude oil is down over $1 as of this writing at 30.42, on higher than expected inventory data. There has been heightened attention on the extreme correlation between crude and stocks. When the press in general locks onto a particular aspect of the market as if the deepest secrets have been revealed, you can bet that it’s in its terminal phase. I would suspect the correlation is about to break, though in my estimation, the outcome will favor the physical, rather than paper claims.
Jan 26, 2016. Friday’s rallies evaporate
–By the end of the day Crude oil had completely erased Friday’s rally, with CLH down 2.49 late to just 29.70. Weakness transferred to stocks, which also had a soft close in a reversal of Friday’s gains, and Chinese shares fell 6% today. Risks are likely increasing for another official “one-time” devaluation by China.
–Yesterday’s action in interest rates was lackluster; ten year yield eased 3 bps to close at 202. Premium offered. Today’s news includes the 2 year auction and AAPL releases earnings after the close. Yesterday AAPL closed below 100 and is off over 23% from the high in July.
–Dallas Fed mfg data yesterday was horrible at -34.6. The pressure is on the Fed to lighten up on the tightening theme; the fact that stocks are trading lower going into Wednesday’s announcement isn’t a particularly encouraging sign. More buying of EDZ6 100 calls yesterday, solidly 0.5 bid at the end of the day. EDZ6 9975c were small 1.5 bid.
