Dec 9. Let them buy Modiglianis
–Continued pressure on EDZ5 reflects certainty of a Fed hike next week. I am amazed that I have twice in the past few days seen large buy trades go through in EDZ5 9950 puts that were essentially at parity; market makers must be having a holiday sale. “No MARK-UPS! How do we do it? VOLUME.” One was a 20k lot buy at 1.25 when futures were 48.75 bid with small 49 offer and the other was yesterday when there was a buyer of 15k for 2.0 with futures 48.0/48.5, and there were only 8k on the bid (which quickly disappeared). I apologize for starting out with a focus on the micro, but it relates to a broader picture that vol is perhaps being under priced, especially in the current environment.
–Yesterday the NFIB released its small business optimism index. From the release, optimism “collapsed in November after three stagnant months” to 94.8, the second lowest reading of the year. OK…it’s not a BIG data point. But BoC’s Poloz also brought up the idea of negative rates for our neighbor to the north. Canada $ unsurprisingly making new lows. As is well reported, junk bonds and leveraged loans are falling hard. CNY was again set lower this morning at 6.4277, and there are reports of China dumping commodities on global markets. So the Fed is going to hike against a backdrop of BAD global economic conditions. The one hike isn’t going to make a difference as long as the Fed goes to great pains to signal that other rates hikes won’t be so fast, if they come at all. And if the Fed DOES communicate that message, then red euro$’s will pop, and the dollar will fall, and there will be a brief commodity short unwind.
–Remember the Cramer rant when he screamed ” Bernanke has no idea how bad it is out there.” Well here’s the clip (with a bonus of Erin Burnett).
https://www.youtube.com/watch?v=rOVXh4xM-Ww
It was August 2007 and Bear was blowing up. I certainly am not suggesting things are that bad, but just remember, at the time Cramer engaged in that (correct warning) rant, SPX was near its all time highs. He implied that the Fed should toss out the academic models and throw a life line. Is there an echo in here? I am sure the energy producers and miners are feeling the same way, with Anglo American slashing payrolls by 85000. “Let them buy Modigliani’s”.
–Ten year auction today.
Dec 8. Oil spill (and spillover into other markets)
–With crude oil crashing to new lows below $38/bbl (-229 late at 37.68), the curve flattened and US interest rate futures rallied. The ten year lopped another 5 bps from the yield to close at 2.22%. 2/10 treasury spread closed down 3.6 at 129. Red/gold euro$ pack spread ended down 4.875 bps to close just above 100.
–This morning the Chinese yuan is weakening to new lows at 6.4179. Canadian dollar made new lows yesterday and stocks were crushed in sympathy with crude. Russian ruble weaker for the same reason. Disinflationary trends are apparent in many places. A friend pointed out that shipping stocks were being savaged, for example CMRE down 50% from June.
–High yield making new lows. JNK at its lowest level in over four years as the evisceration of energy re-focuses attention on companies that might not be able to service their debts. Speaking of servicing debt, Consumer Credit was released yesterday, up $16 billion but almost all of the growth was in non-revolving (autos and student loans). Student loan debt is around $1.3 trillion. Assuming an interest rate of around 6% that would be $80 billion just in interest. If it were actually being serviced. Revolving credit was up only 0.2% on an annual basis after strong growth in September.
–There was an interesting curve trade in 50k yesterday…buying EDM6 9912.5 puts which are 5 bps out of the money as of yesterday and settled 8.0, versus selling 2EM 9762.5 puts which are 51.5 out of the money, 7.5s. Early in the day the trade was done at 0.5 credit to sell green over, and flat.
Dec 7. EDZ5 drama
–The payroll data Friday cemented the prospect for a rate hike next week, and prompted buying of about 50k EDZ5 9950p for 0.5. That trade has worked out this morning as EDZ5 trades -1.0 at 9949.0, with a week to go before expiration. I skimmed several stories this morning on dollar funding problems for EM, and an additional reminder that GC is trading above Libor, so collateralized loans (GC repo) are trading above an unsecured lending rate. Not new, but another factor which may be putting some pressure on EDZ. Add in some uncertainty due to previous libor rigging and it gets interesting. EDZ futures have about 1m contracts outstanding, 9950 calls 571k and 9950 puts 463k.
–There are also a few articles about pressures in the corporate bond market, referencing the parabolic rise in CCC rates (while US stocks continue to levitate). The problem has expanded outside the energy sector, but with crude down another 50 cents this morning to new lows below 39.50, additional pressure will be seen in exploration and producers. One might think that implied vol in the euro$ curve would see some spillover, but straddles were crushed by 1.5 to 2.0 bps on Friday.
–Today’s news includes a Bullard speech at 11:30 ET and Consumer Credit at 2:00. The last Consumer Credit number was quite strong at $28.9B with a surge in the revolving credit growth rate of 8.7%.
Dec 6. Expectation Reversal
The week just ended was instructive in terms of just how much the market is dependent on Central Bank largesse. Thursday’s ECB disappointment sparked a stock market sell off and a jump in yields, along with a surge in the euro to over 109 from 105 early in the day. Draghi’s efforts to cushion the response on Friday (with comments that the ECB has more tools available and that potential growth in the balance sheet isn’t limited) reversed some of the moves, with US equities snapping back completely. However, EUR remained close to 109, closing the week at 108.85.
Friday’s employment report (NFP 211k) gave the Fed all the cover needed to raise rates on December 16. However, it’s worth noting that the only Eurodollar contracts that traded below the previous lows set at the November employment release were the front two contracts, EDZ’15 and EDH’16. One-year Eurodollar calendar spreads barely moved on the week and in fact declined on Friday, with peak spreads at only 5/8% (March’16/March’17 closed at 63.5). The red/green pack spread is still sub-50 bps. While German yields soared Thursday with bunds up 20 bps, the US Ten Year was up less than 5 bps on the week to 2.27%. The market is NOT expecting a stream of aggressive rate increases. If it were, then one-yr spreads would be closer to 100.
A while ago I recall JPM’s Jamie Dimon saying that if China says their GDP will be 7%, then it will be. The implication of course, is that the government can deliver any growth numbers that it wants to. Obviously, China is falling short. Over the weekend Ray Dalio said the ECB can reach its 2% inflation objective. Same implication. A headline on the Financial Times site read, “ECB head signals that he will get what he wants — higher inflation.” Certainly, Draghi’s comments on Friday suggest that he, at least, has the resolve. However, there was an article on Reuters over the weekend that said Thursday’s muted ECB action was due to a push back by the Governing Council:
(RTRS) “Hints by Mario Draghi ahead of last Thursday’s ECB rate meeting that the euro zone may need another big injection of money backfired, stiffening the resolve of more conservative central bankers who criticized him for raising expectations too high, sources familiar with the discussions said.”
One source with direct knowledge of the situation interpreted Draghi’s public stance ahead of the meeting as trying to pressure the Governing Council to take bigger action.
“Draghi raised expectations too high, on purpose, and attempted to paint the Governing Council into a corner,” the source said. “This was problematic and he was criticized for this by several governors in private.”
http://www.reuters.com/article/us-ecb-policy-draghi-exclusive-idUSKBN0TO0L520151205
After reading Draghi’s comments Friday, I was left with the thought that the ECB might eventually overshoot its inflation target. By a lot. However, the Reuters article is a reminder that while Draghi may be the world’s most influential central banker, his powers can still be curtailed. I also would note that the Bank of Japan, with zero rates, a huge QE program, and purchases of ETFs hasn’t been able to spark inflation. Efforts to depreciate currencies to generate export growth are being met with competition, lately by China with a weakening yuan. The risk is more of a disinflationary cycle.
As the Fed moves closer to lift-off, attention is shifting to increased stress in the US corporate bond market. For example there’s this from the FT:
More than $1tn in US corporate debt has been downgraded this year as defaults climb to post-crisis highs, underlining investor fears that the credit cycle has entered its final innings.
Analysts with Standard & Poor’s, Moody’s and Fitch expect default rates to increase over the next 12 months, an inopportune time for Federal Reserve policymakers, who are expected to begin to tighten monetary policy in the coming weeks.
A Bloomberg piece, $49 Billion Leveraged-Loan Hangover Awaits Wall Street notes that the demand to buy leveraged loans has diminished just as the supply has increased. “The financing glut comes as the appetite for riskier debt is drying up, with a growing number of debt offerings being pulled or postponed. Values of the lowest rated debt are plummeting… Speculative-grade bonds have declined 2.1% this year, putting the debt on pace for its first annual loss since 2008.”
Several analysts and central bank representatives have noted that the tightening in financial conditions has already served as a proxy for central bank rate hikes. Certainly deterioration has been obvious when looking at junk bond etfs, or at the chart above. However, broader indications as measured by regional Fed banks, for example Chicago’s Financial Conditions Index or St Louis’ Financial Stress, while having edged higher, don’t seem to be flashing warning signals. But the risk is increasing, and it’s not just due to troubles in the oil patch (January Crude down $1.74 on the week to below $40/bbl). The big question is whether compressed profit margins can cover increased debt service costs.
Data this week includes Consumer Credit on Monday and Retail Sales Friday. The Fed releases its quarterly Financial Accounts Z.1 report on Thursday. (Interesting summary of debt levels and growth rates for various economic sectors).
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| 11/27/2015 | 12/4/2016 | chg | |
| UST 2Y | 92.2 | 94.3 | 2.1 |
| UST 5Y | 168.5 | 171.0 | 2.5 |
| UST 10Y | 222.4 | 226.9 | 4.5 |
| UST 30Y | 300.1 | 300.6 | 0.5 |
| GERM 2Y | -41.7 | -30.3 | 11.4 |
| GERM 10Y | 46.0 | 67.8 | 21.8 |
| EURO$ H6/H7 | 61.0 | 63.5 | 2.5 |
| EURO$ H7/H8 | 49.0 | 50.0 | 1.0 |
| EUR | 105.92 | 108.85 | 2.93 |
| CRUDE (1st cont) | 41.71 | 39.97 | -1.74 |
| SPX | 2090.11 | 2091.69 | 1.58 |
| VIX | 15.12 | 14.81 | -0.31 |
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Dec 3. Yellen signals hike, Draghi’s turn to ease
–Yellen’s comments yesterday gave a green light for a Dec 16 hike. This morning it’s Draghi’s turn to move further in the opposite direction with more accommodation, (with the EUR at new lows 105.60).
–New lows as well in both 2/10 at 124, and 5/30 which was down 5 bps at 127.4. The oil market was hammered with Jan crude probing below $40/bbl and the front contracts sliding to new recent low discounts versus the back end. [CLF6 vs CLF7 chart attached, spread at -7.70]. Both the sell off in oil and the shooting in San Bernadino pushed stocks lower, but that weakness has been reversed this morning. A broader issue concerns the bond market. For example, Vodaphone pulled a 30 year bond deal which was being marketed at 250 over treasuries, because of investor requests for more protection and a juicier yield. http://www.reuters.com/article/2015/11/25/vodafone-group-bonds-idUSL1N13J1VQ20151125
I saw another story noting a new high in CCC bond yields at 16.6%. The point is that some areas of the market are becoming much less welcoming. Here’s a link to Fred chart. https://research.stlouisfed.org/fred2/series/BAMLH0A3HYCEY
–The idea of a Fed hike has pushed the dollar to new highs and was responsible for pressure on the short end yesterday with reds -4.25 and greens -5.25. January 3-month euro$ (after Dec FOMC) settled at 9944.5, exactly 25 bps below Jan FF at 9969.5, and I would say the EDF price almost fully reflects a hike. The question is, what comes after? Not only is there weakness in high yield bonds, but issues in emerging markets continue to percolate, with problems in Brazil (BTG Pactual and Rousseff impeachment) and Mexico, Empresas ICA SAB on verge of a bond default. The idea of pricing a hike in the US at every quarterly FOMC is simply not in the cards.
–Today’s US news includes Jobless Claims 270k, Factory Orders +1.4% and Service ISM, expected 58.2.
Dec 2. Transitory
The Fed has been saying subdued inflation is due to transitory factors at least since December 2014. Since that time the Bloomberg Commodity Index is down 25%. Stick to the story. That’s what my brother used to tell me when we were going to tell our mother a lie…
Dec 2. Atlanta Fed Q4 Nowcast cut to 1.4%. Yellen today
–Yellen speaks today at 12:25 EST at the Economics Club of Washington. ADP this morning expected 183k. Beige book released in the afternoon.
–Yields fell across the board yesterday with tens down 6.3 bps to 215.4, as ISM data submerged to below 50 (48.6). While some people shrug off the data as the US has become much more of a service economy, the Atlanta Fed GDPNow forecast doesn’t see it that way, slashing the Q4 number to just 1.4% from 1.8% a week ago, and 2.9% in the beginning of November. A paper from the NY Fed yesterday projected somewhat slower growth going forward due to tighter financial conditions. From Reuters this morning, small business borrowing posted a yoy decline:
“The Thomson Reuters/PayNet Small Business Lending Index dropped in October to 131.7 from a downwardly revised reading of 137.9 reading in September. October’s decline of 0.2 percent from a year earlier was the first year-on-year drop since March 2013.”
–The market is still expecting a hike, but all eurodollar calendar spreads made new lows yesterday. For example, EDH16/EDH17 fell 2.5 to just 59.5. Red/green euro$ pack spread closed just under 43 bps, down 2.125 bps. New lows in both 2/10 at 125 and 5/30 at 132.3. 2/10 spread has been lower 13 sessions straight, having been at 146.7 on Nov 11. The market seems to be telegraphing “one and done” from the Fed.
–Big end of day buyer of 50k Green Jan 9787.5p for 1.5. Exit trade.
Dec 1….Fed hike with ISM sub 50???
Attached is a chart going back to the early 1980’s. As a friend pointed out to me, the Fed doesn’t hike with ISM under 50 (at least historically). FF target is pink line, 50 level for ISM is red horizontal and ISM is white line.
Dec 1. Flat as a pancake
–Overall yields didn’t change much Monday, but the curve flattening has been relentless. New lows in 2/10 treasury spread to 128.7, down 1.5 bps and red/gold euro$ pack spread at 99.0, down 4.25 on the day.
–Green, blue and gold midcurve atm straddles are all around 14.5 bps, once again appearing cheap in front of Yellen and the ECB and payrolls.
–Chicago PMI yesterday was just 48.7. It had a lower mark this year in Feb at 45.8, but in this calendar year, it is as low as its been since 2009. (Another “lowest or highest” since the crisis of 2008/09, not a good sign). By the way, in 2009 it hit 33.1, so at least it’s well off that level.
–Below is a comparison of December euro$ contracts across the curve demonstrating the huge flattener since the last employment report. I have taken the Thursday close prior to NFP, then the close on employment day, then yesterday’s close:
| THUR PRE-EMP | FRI EMP CLOSE | YEST CLOSE | ||
| EDZ5 | 9958.5 | 9955.5 | 9953.0 | -5.5 |
| EDZ6 | 9892.5 | 9884.0 | 9888.5 | -4.0 |
| EDZ7 | 9837.5 | 9823.0 | 9836.0 | -1.5 |
| EDZ8 | 9798.0 | 9782.0 | 9802.5 | 4.5 |
| EDZ9 | 9768.0 | 9752.0 | 9777.5 | 9.5 |
| EDZ0 | 9741.5 | 9726.0 | 9754.5 | 13.0 |
I hope the table comes out, but if not, it shows EDZ6 having gone from 9892.5 to 9884.0 and now back to 9888.5, -4.0 net change. While red dec is down 4, gold dec is UP 9.5 over the same time frame.
–Data from China is apparently mixed this morning, but the prices of iron ore and steel show an unambiguous picture of decline. Jan crude remains under $42/bbl. And now that China has been admitted into the SDR, (delayed) depreciation of the yuan is likely to follow.
Nov 30. Since 2009
–Quiet session Friday, the largest feature was continued flattening in back month eurodollar spreads. For example, the red/green pack spread edged to a new low of just 46.5, down 0.5 on the day.
–It is of course, a big week with Yellen speaking Wednesday to the Economics Club of Washington and again on Thursday to the Joint Economic Committee. ECB meeting is also Thursday (as EUR presses to new lows this morning 105.75). Payrolls on Friday. Today is the Chicago PMI, expected 54.0 from 56.2.
–From this morning’s WSJ: “Emerging-market corporate-debt defaults reached their highest level since 2009, as economic conditions worsen for companies that spent years piling up their borrowings.” Business Insider has a piece this morning saying that “Investors are terrified by the “third wave” of the financial crisis,” that being a toxic mix of low growth and high debt in emerging markets. There are a lot of indicators that are as low or as high as they’ve been since 2009, around the nadir of the financial crisis. For example, the flatness of the yield curve (red/gold or 2/10), the level of commodities (which are actually lower), and now emerging market defaults. Good time for a hike…?
