January 8. NFP today.
* BoC’s Poloz: we’re expecting the world economy to continue to gather strength
http://www.reuters.com/article/idUSS0N14P00120160107
Yeah…like a hurricane. At least Canada’s central banker has his finger on the pulse of the global economy.
–Here’s another headline, from BBG: CHINA LOCAL GOVTS MAY SELL 1T Yuan NEW DEBT THIS YEAR: INFO DAILY.
To who?
–Previously I thought yuan devaluation would export deflation to the rest of the world. But its bigger than that, it’s exporting financial instability. All of the Fed’s and ECB’s (and BoC’s) communication efforts fall short in the face of such turmoil. CB’s can only respond to incoming data. Which will be further muddled by increased prospects of military conflict. Global trade has been declining, and with that goes global cooperation.
–Since the end year, EDH17 has rallied 19 bps and EDH18 24.5 bps. Essentially lopping off one 25 bp rate move. All of the near euro$ calendar spreads notched new lows yesterday, with EDH6/EDM6 for example, at just 12 bps. The peak one year spread, EDM16/M17 is barely holding above 1/2% at 53 bps, down 3 yesterday. I don’t care how many times analysts say the Fed is hiking 3-4 times this year. The market isn’t having it.
–Employment day with NFP expected 200k and Avg Hourly Earnings +0.2%.
January 7, 2016. Global turmoil
–Don’t worry. Low inflation is transitory. In August the initial China devaluation took ESH to a spike low of 1840. We are still 100 points above that level, even with ESH down 49 as of this writing. China shares were halted again today after an opening plunge. Fed minutes yesterday revealed that some members had some trepidation about raising rates. Probably doesn’t matter, but certainly the trajectory for future rate hikes as embedded in futures prices is getting shallower. Yesterday almost all euro$ calendar spreads made new lows. EDM6/EDM7 spread fell 4.5 bps to 56. It’s down another 2 this morning. Red/gold pack spread closed down 2 at just 87.5.
–Stronger than expected ADP was meet with an exceptionally brief flurry of selling, instantly reversed. Tens closed at the high with the ten year yield falling 7 bps to 217.5.
–Soros: “I would say it amounts to a crisis. When I look at the financial markets there is a serious challenge which reminds me of the crisis we had in 2008.” In 2008 I recall people being astonished at just how quickly the economy ground to a halt and how orders were cancelled. We seem to be moving closer to that environment.
–Surprisingly, VIX and interest rate vol didn’t get much of a boost yesterday. FVH still closed only 3.2 vol, should probably be more like 3.6 to 3.8 given global markets. Friday’s employment data becomes much less significant at this point with NFP expected 200k.
Jan 6, 2016. Butterflies and rainbows
The butterfly effect – the flutter of a wing in one part of the planet altering the course of seemingly unrelated events in another part – is on center stage.
That’s kind of a cool quote on ZH from an article citing Nomi Prins’ pontifications. Except for one little detail, it seems to understate the start of 2016 which is decidedly less nuanced than the flap of a butterfly wing. N KOREA TESTED A HYDROGEN BOMB WHICH CREATED A SEISMIC EVENT. Doesn’t take a genius rocket surgeon to get a little unnerved by that. But let’s just jump right in with a few other strands of thread. The Chinese yuan is making a new low at 6.56. (More on this below). Aussie has fallen 2 cents since the beginning of the year. Canada and Mexican Peso are making new lows. Oil is making new lows as the Saudis appear to want to flood the market in their geopolitical cage match with Iran. US stocks are jittery. The euro has fallen more than halfway back from Draghi’s tepid measures announced in the beginning of December. Bravo, the goal of euro depreciation is back on pace despite the ECB. Except that the only thing it’s depreciating against is USD (oh, and the yen). Every other currency is racing lower too.
–The FT had this little headline this morning: Renminbi Poses Communication Challenge. I didn’t read the article. Perhaps there were some gems in it. However, I am starting to wonder why people in high places think that “communication” serves as some sort of elixir to cure stupid policies. China just extended its ban on short selling that was set to expire. China is depreciating its currency after having made it into the SDR and now NEEDS to recapture global market share of exports so its economy doesn’t implode. It will also continue to claim more territory in the South Sea in provocation of its neighbors and the US. Seems pretty clear, there are problems there. Bigger than a butterfly. And we can include the Fed’s communication policies as well, but that’s for another post.
–Sorry this is getting long and I am afraid, a bit tedious. So I might as well continue. As Obama finished wiping his tears away 4 were shot dead overnight in Chicago including two teenagers. Nine others wounded. 480 homicides last year in Chicago. Getting an early start on a record for 2016. Matter?
–Back to markets. Large buying in FV call flies yesterday: The five year yield closed at 172.4 with FVH6 closing 118-17.5. DV01 in FVH is $50.4, so it’s approximately 20 bps per point in the contract. There were two large call flies that traded in FV. FVH6 118.75/120/120.75 c fly 1x3x2 was bought for 14/64’s covered 118-19. Excluding the futures, this fly has max value at 120.00 which is around 28 bps lower in yield or around 1.44%. The range in fives in 2015 was 1.155 to 1.795, halfway back is 1.475 which is fairly close to the 120 strike. This traded 8-10k. The other similar idea is 118.75/120.75/121.75 c fly 1x3x2. No risk on this one besides premium paid, which was 23 to 23.5 covered 118-195. Max profit is 120.75 strike which is around 43 bps away or around 129 yield…closer to the lower end of last year’s range.
–Today’s news includes the ADP report expected 198k. Trade Balance expected -$44 billion. ISM Services expected 56.0 and Factory Orders expected -0.2%. Fed minutes from Dec 16 released at 2:00 NY time.
Jan 5, 2016. Q4 GDP estimates revised lower in spite of booming gun sales
–Heck of a way to start the year. Global stocks trailed China lower with most US indices down 1.5 to 2%. DJ Transports closed at their lowest level since early 2014 and are now around 20% off the high from the start of last year. Bad PMI in China was followed by weak Mfg ISM in the US at just 48.2, lowest since 2009. Prices paid were just 33.5, also lowest since ’09. JPM cut their Q4 growth estimate from 2% to 1%, while the Atl Fed GDP Now forecast was slashed from 1.3 to just 0.7%. Keep in mind that the original Atlanta Fed estimate in early Nov was as high as 3% and as recently as mid-December was 2%. And there’s no bad weather to blame.
–Unsurprisingly, there are reports that China is intervening to hold up stocks after yesterday’s 7% rout. I saw an interesting contributing factor regarding the sell off, which is that a rule instituted last year to prevent large shareholders from selling is set to expire January 8, leading some to step in front (Daily Shot). I would also guess that the Chinese authorities might want to have words with front runners. “Hey, where’d they go?”
–Besides paper financial claims, real commodities also sold off. March Corn and Wheat made new lows, beans within a whisper. Maybe buying farmland with leverage wasn’t such a great idea after all.
–For me, the broad points regarding China are the following: as the currency weakens, China’s mfg exports again become cheaper, regaining market share from other Asian nations, and imparting a disinflationary cloud. The Chinese gov’t is clamping down on financial outflows, which cuts off investment flow into US assets. The end of US QE has forced the markets to price risk more realistically…probably near the end of that process at this point but no way to know for sure. And the Fed continues to jawbone about further removing accommodation (again, probably close to the end of the ‘tightening cycle’).
Jan 4, 2016. All about China…
–Well Happy New Year to the stock shorts as China’s shares plunged 7% on weak Caixin PMI of just 48.2. ESH down 30 (currently 2005.25) as of this writing, nearing the bottom of the range for the past 2.5 months.
–There was a good summary of China’s debt on Business Insider, link here:
http://www.businessinsider.com/asian-debt-and-gdp-stats-2015-10?r=UK&IR=T
$28 trillion in Chinese debt. Big numbers… This morning the yuan is at a new low 6.5344. One of the big events of 2015 was China’s surprise August devaluation. The currency is below that level and gaining steam, which is, of course pressuring neighbors. For example, over the weekend South Korea (the globe’s sixth largest exporter) released its export figures. Down again, for the 12th consecutive month.
–Speaking of bad neighbors, tensions are flaring between Saudi Arabia and Iran. Possible disruption to oil flow? Or does it mean the Saudis will pump flat out? Under/over on regime change in Syria versus Saudi Arabia?
–Today’s news includes ISM, expected 49.2 from 48.6.
–Buyer of 60k EDH6/M6/U6/Z6 9950c strip (cover) on Thursday for 3.0.
Jan 2, 2016 Back to 2009
At this time of year, inboxes are crammed with projections and predictions. No real predictions here. I’ll only bring up three quick themes worth keeping in mind as January unfolds, and a few trade ideas.
- Many indicators are back at 2009 levels. Maybe that’s good because we’re back at a low base and will see better comparisons this year. But maybe it’s bad because the Fed is in the midst of a campaign to remove accommodation. Manufacturing vs service.
- China’s outflows continue, and the currency is weakening. Maybe that’s good because a weaker currency and other stimulus measures will restart the engine of Asian growth. Maybe it’s bad because rather than accelerate reforms, China is falling back on an export model which accentuates global deflationary pressure.
- US debt levels. Passing the hot potato. Will the household sector re-lever?
Back to 2009
On Thursday, Chicago PMI was released at 42.9. The last time it was this weak was in 2009, as the economy tentatively emerged from the worst of the crisis. On Thursday morning there was a post on ZeroHedge citing FTR Transportation Intelligence, indicating that orders for trucks haven’t been this soft since, you guessed it, 2009.
FTR has released preliminary data showing November 2015 North American Class 8 truck net orders at 16,475, 59% below a year ago and the lowest level since September 2012. This was the weakest November order activity since 2009 and was a major disappointment, coming in significantly below expectations. All of the OEMs, except one, experienced unusually low orders for the month.
There was an article on Bloomberg earlier in the week which also cited 2009: US Junk Bonds See Highest Distressed Ratio Since ’09, S&P Says. “The ratings firm’s so-called distress ratio increased to 20.1 percent in November, up from 19.1 percent in October and the most since September 2009, when it hit 23.5 percent. The ratio is calculated by dividing the number of distressed securities by the total amount of speculative-grade debt outstanding.”
In fact, there are a lot of indicators and market prices that haven’t been this low or high since 2009.
For example, the inventory to sales ratio at 1.38*, highest since ‘09. Some measures of the curve are at the lowest levels since ‘09, for example, red/gold eurodollar pack spread at 89 and 2/10 treasury spread at 122. The 2 year yield is at its highest level since 2009. Same with BAML Hi Yld CCC Effective Yield at 18%! ISM, Dec 48.6, lowest since 2009. Dallas Fed Mfg Outlook (essentially at the bottom of the past five years’ range). Most commodity indices are at 2008 levels or lower. The Baltic Dry Freight Index is sub 2008/2009.
Given the horrendous winter weather of the previous couple of years that restrained Q1 growth, perhaps this year will see a large rebound, helped by the “broken window” growth of rebuilding after the midwestern and southern floods.
What’s it going to be? New single family home sales (closer to the nadir) or New Car Sales (which are at their peak around 18 million units)?
China’s Reserves Decline
At the peak of the 2006 mortgage withdrawal orgy, I believe the US consumer was pulling something like $60 billion per month from the housing piggybank. When it stopped the economy went into a tailspin. The gov’t plugged the hole by replacing private debt with government debt which is illustrated by the flow of funds table (attachment).
According to the FT, [China’s] “Forex reserves fell $87bn in November, near the record $94bn decline suffered in August — the same month that the central bank surprised global markets by allowing the renminbi to depreciate by 3 per cent in three days.” Since the high in 2014, China’s reserves have declined by about $550bn. These are big numbers, perhaps comparable to the mortgage withdrawal phenomenon. Anecdotal reports indicate Chinese outflows have supported high end condos in a lot of major metro areas. The outflows also pressure the currency, (which closed at the low of the year) and reduce China’s reserves. The gov’t is clamping down and financial executives keep disappearing. So what happens to high end projects? They’ll flame out faster than a Dubai hotel.
China reserve chart
Flow of funds Z.1
Since 2007 let’s consider debt levels of the three major sectors. First, households. Total debt has fallen by $55 billion since ‘07. Mortgage debt FELL by a whopping $1.16tn. Consumer credit rose $881bn, but $716 of that is student debt. So, the household sector is in relatively good shape. The high non-payment rates on student debt shifts the burden to gov’t, and, in a way, as the home ownership rate fell from 68% to 63.7%, household renters shifted long term ownership obligations onto the business sector. What happens when homeowners don’t pay? The government steps in to help. What happens when renters don’t pay? Crickets.
Now let’s consider the business and corporate sector. Since 2007, debt there has risen to a record $12.6tn, having gone up by $2.5tn. In 2015 S&P 500 corporate revenue declined and in the first 3 qtrs profits fell by about $25 bn. This, at the same time the market is demanding higher interest rates, and labor is pushing for higher wages. The tailwind of lower raw materials prices is likely behind us. Is it any wonder lenders are demanding a higher risk premium?
Finally, the gov’t. Since 2007, fed’l gov’t debt increased $8.4tn. This growth is slowing. Is the household sector going to re-leverage and pull the economy forward? Obviously, it’s not showing up in charts like new single family homes (above). The multi-unit rental places are getting built, as are high end condos. For now.
2016…the year of bitcoin?
This is a chart of Bitcoin (BBG symbol XBT). The chart immediately below follows a very similar pattern. It’s a chart of gold. The 1979/80 spike higher unraveled over the next 6 years or so, just as the spike high in XBT from Nov/Dec in 2013 has taken about 6 quarters to unwind.
So, in the modern rapid-fire technological world, the “tech” currency compresses movement to about 1/4 of the timeframe. It’s like dog years. And probably accelerates (or compresses as the case may be) in accordance with Moore’s law, or Einstein’s theory of relativity or something like that…
Now, in order to determine where bitcoin MIGHT go, all we need to see is where gold went. The bottom chart shows us: it took about 10 years, 1986 to 2006, to revisit the peak, and then another 6 years to go another 2.5 times higher. So maybe it will take another 10 quarters or two and a half years for bitcoin to jump back up to 1100, or probably less as the time space continuum implodes.
Obviously I am just joking about making price projections. However, I absolutely believe that bitcoin will maintain underlying support as some countries attempt to stem currency outflows and others try to outlaw cash altogether.
aaaa
In: Eurodollar Options
Dec 30. EU Bank rules: Lose slowly by depositing at negative rates, or all at once in a bail in
–Happy New Year!
–Little net change in rates yesterday. As has been a recent pattern, as the treasury ended the last leg of the weekly auctions, yesterday being the 7 year, treasuries rallied. Some of that support came from weakness in equities, though open interest is SPH was down, suggesting modest end of year liquidation.
–Today’s news includes Chicago PMI, expected at the noncommittal level of 50.0, having been 48.7 last.
–Russian Ruble made a new low yesterday, in part related to oil. Similarly, Mexican Peso is going out at its lowest level of the year, and Canada is close, making imports from immediate neighbors cheaper.
–I saw a couple of references yesterday to a bank in Portugal (Novo Banco) being bailed out, with large losses for bondholders.
http://www.ft.com/intl/cms/s/0/da45fb10-aede-11e5-993b-c425a3d2b65a.html#axzz3vtaqFsK6
The key point here is that actions were taken before year end because new EU ‘bail-in’ rules take effect in 2016, which will mean losses for depositors when banks fail. As opposed to losses which now occur simply due to negative rates. The US policy is to keep the banks financial strong and stable to provide support for the financial infrastructure of the economy. Well, I guess that’s the policy. It might also be to concentrate power in the biggest banks and provide them with zero funding rates in order to extract repayment in the form of multi-million dollar fines every now and then in an effort to make the legal and regulatory apparatus appear as if it has some value. In any case, the EU bail-in rules almost seem preordained to failure. I suspect we’ll see at least one high profile episode sometime in the first half that will test this rule.
Dec 29. Themes continue into year end
–Quiet day yesterday, but there are a few interesting notes. First, the Dallas Fed came out at -20.1 versus expected -7.0, another in a string of weak data releases. To add insult to injury crude oil fell 1.29 to 36.81 (CLG6), reversing about half of last week’s rally. March Corn made a new contract low at 3.60.
–Second, the eurodollar curve fell to new lows. Red/gold pack spread fell 3.5 to 89.75, its lowest level since 2008. Red/green pack spread (2nd to 3rd year) closed at just 40.25 bps. These are not levels that suggest economic vibrancy.
–Third, China continues a slow depreciation, which is almost certain to pressure Asian neighbors to lower export prices in order to remain competitive.
–Fourth, hi-yield again turned down, casting doubt on the tentative bottoming from mid-December.
–Even on a slow day, these factors tie into a theme of declining inflation and growth. However, the turn of year can often point to a change in trend, and certainly the flattener is becoming crowded. If the Fed were to pull back from its narrative of removal of accommodation, then a rebound in the curve would surely follow.
Dec 27. Spectrum of outcomes widening
It was a fairly quiet week. Treasuries added 4-6 bps in yield and stocks shook off the Fed rate hike and pushed higher. VIX and other volatility measures declined, while commodities had a tentative bounce with WTI up $2 on the week (CLG6 settle 38.10).
However, on the year, both tens and SPX are about where they started. A quick skim of hedge fund performance data reveals many results with negative signs. We know that commodities have had a brutal year, and that equity earnings have declined, and junk bond rates have surged in an environment of crashing energy prices and generally tightening financial conditions. While tens ended the year unchanged (2.22% on 12/29/14 vs 2.26% Friday), the two year note reflected the tighter Fed, ending Friday at 1% vs year ago at 72 bps. Similarly, stock indices were mixed with the Russell down about 4% and Nasdaq up around 5%. Just a quick footnote here, many underfunded public pension plans (and Illinois is the poster child with less than 40% funded), assume returns of 7.25 to 7.5%. The gap is supposed to be filled by taxpayers. Those gaps grew.
One of the important events of the week was the downgrade in the Q4 Atlanta Fed GDP Now forecast on Wednesday from 1.9% to 1.3% with the release of this week’s data. Apart from some labor indicators, data has been coming out soft, a challenge for the Fed. One of the most important events of the year was the Chinese devaluation in August, with CNY having been around 6.21 prior to the devaluation, and ending the year at a new low of 6.48.
This is where I am going to veer off from quantitative and ramble a bit about more qualitative concerns. I am often chastised for being negative on stocks and on the US economy, etc. It doesn’t particularly bother me as long as I think I am bringing up salient and thought-provoking points. However, colleague JA suggested I should consider the other side: What if the rout in commodities has ended? What if junk bonds stabilize and begin to turn higher? What if the dollar doesn’t push higher? (the implication being that deflationary forces will abate considerably). What if the labor market continues to improve and spurs wage gains? Might it not be the case that stocks take another leg up and the Fed is thus encouraged to embark on a slightly more aggressive rate hike path? All clearly possible.
Actually I do think the commodity rout is close to its end. And I do think the dollar weakens into the early part of the year. However, I think the extreme divergence between stocks and commodities is likely to close to some degree, a negative for stocks.
What I often remember is Stanley Druckenmiller saying that central bank liquidity is the most important consideration in investing, and outweighs earnings, etc. This is a quote from a speech SD gave Jan 18, 2015. “…earnings don’t move the overall market; it’s the Federal Reserve Board. And whatever I do, I focus on the central banks and focus on the movement of liquidity. Most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.” On a more personal level but more succinctly, the most successful individual trader I know (who I happen to have met on the CME floor) told me around the time of the crisis, “The Fed is going to cut and stocks are going to go up, just like always.” And he was right, although it took a while to play out.
So who is going to be the liquidity provider in 2016? Doesn’t seem like it will be the Fed, and the rally in the euro after Draghi disappointed on his stimulus announcement suggests that the market is wary of putting too much faith in the ECB. We know China has been trying to spur growth; the devaluation of the yuan is an overt sign (and likely quite deflationary for the US and other global manufacturers). We know that China was responsible for the seemingly insatiable demand for raw materials that has now stopped, sending emerging economies into tailspins. There’s a chart on BI from Chinese analyst Charlene Chu that puts growth for China’s Secondary Industry at just 1.2% this year. Is China just like the US, ease financial conditions and a positive feedback loop takes hold? I don’t know, but I think it depends an awful lot on the degree and quality of previous growth. Japan’s stimulus after its crash in the 1980’s never really hit the mark, and seems to have problems with effectiveness even to this day. And I would say that actions like detaining financial executives and militarily staking territorial claims isn’t exactly a sign that the leadership in China thinks they have full control. When it looks like things are getting a bit shaky economically, provoke your neighbors and instill nationalism.
Here are a couple of interesting snippets from George Friedman (formerly Stratfor): “Last week the South Korean president called for the development of an economic contingency plan to brace for a possible crisis” He adds, “Exporters of industrial goods are hostages to their customers… problems can rapidly move from economic issues to political and social instability.” Friedman also of course, talks about Germany facing export dependency challenges. And he ends with, “This is not an economic problem in itself by any means. It is a social, political, and cultural shift of the first order.”
How does the above fit into US interest rate markets? Perhaps it doesn’t. However, I would note that the US curve remains quite flat, especially given the low nominal level of rates across the curve. Eurodollar one year calendars are holding below 5/8% (2 to 3 hikes a year). I would suggest that the red/gold Eurodollar pack spread at a new low Friday (for the year) of just 93 bps is dismissive of inflationary possibilities, and embeds a forecast of tepid growth. Liquidity policies are seen to have run their course.
When there’s a virtuous feedback loop, gains in employment feed gains in consumption and production. Asset prices like homes and stocks hold or rise in value because of growth prospects. Public finances improve due to increases in collected taxes. There are many reinforcing aspects. It is, of course, the same way on the downside. Drops in the prices and/or volumes of goods sold causes layoffs and bankruptcies, and risk aversion in credit markets. We’re seeing some aspects of both positive and negative recently, the latter in US manufacturing. The rates market seems to be tilting that way in spite of the Fed’s vote of confidence. Maybe it all just muddles along.
However, if Friedman is right and we’re on the 2016 cusp of social, political and cultural shifts, then institutional responses may prove ineffective. I think this may be a year of significant political upheaval globally, providing the main source of risk in financial markets. Probably not much of a forecast; we’ve obviously been in a period of geopolitical uncertainty for some time. The point is that such uncertainty may accelerate beyond the abilities of official responses, while the world appears to be up against liquidity constraints. The spectrum of outcomes has widened. From a market perspective it seems as if implied vols should generally be firmer and risk aversion may continue to trend higher. On that score we saw good buying Friday in TYG 128c for 7/64’s with open interest rising 9500. It might just be that we’re seeing hedge replacement purchases given the expiration in Jan options. Again, at this time of year it’s probably not worth reading much into particular trades or recommending new ones.
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Here is a very interesting link on cyber attacks relating to the power grid. http://www.bigstory.ap.org/article/c8d531ec05e0403a90e9d3ec0b8f83c2/ap-investigation-us-power-grid-vulnerable-foreign-hacks?utm_source=fark&utm_medium=website&utm_content=link
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