Nov 29. A Simple Framework
Moving into the last month of the year let’s just take a step back and look at the big picture. The dollar index is near a new high, testing the high from March of this year, which is the highest in a dozen years. Commodities are at new lows, with the BBG Commodity Index 20% lower than the crisis low in 2009 and only 1/3rd the price of the peak in 2008 (associated with the oil spike to $140). Stocks are near all-time highs, especially some of the large tech companies. The divergence between commodities and stocks is nothing short of stunning.
Maybe it’s just this simple: The world, especially China, wants a safe haven for wealth, and that translates into a bid for longer dated USD assets. So the dollar goes up, stocks go up, and long dated treasuries find a bid relative to short dated ones as the Fed has fully telegraphed its intention to hike. Commodities are going down because of overcapacity built on the assumption of Chinese demand which has now withered. Fracking technology in the US has contributed to energy over supply. The beginning of December will likely see more accommodation from the ECB and tightening from the Fed, underpinning USD strength and exacerbating all of the above trends.
When considered in that simple framework, other things fall into place. CNY (yuan) fell to its lowest level since the August devaluation. Chinese stocks were hit last week and appear vulnerable to further weakness. Bitcoin is near the highest level of the year (~360), except for the November spike above 430. I would judge the move in bitcoin as another safe haven indicator, at least in part. Junk bond spreads continue to widen. “That is underscored by the extra yield that investors are demanding to hold CCC rated credits relative to those rated BB. This spread has jumped to the most in six years.”
There is now more open interest in the Ultra Bond future than there is in the US 30 year contract, i.e. more interest in long dated assets. (669k in the Ultra and 522k in the US contract). In the ten year note (TY), there are 2805k contracts open. Actually, on a dv01 basis, there is almost as much open interest in the Ultra as there is in tens (the CME is using a ratio of 3 to 1).
Measures of the curve are pretty much at the lows of the year. 2/10 treasury spread is just 130 bps, having been as high as 175 in the summer. The area from 110 to 120 bps represents the low since 2008. As highlighted in last week’s note, the red/gold Eurodollar pack spread just above 100 bps (103.25 settle Friday) its lowest level since the beginning of 2009. [red Eurodollar pack is 2nd year, gold pack is 5th year]. In looking at the US curve, one would be more inclined to view monetary policy as somewhat tight rather than loose. In fact, the red to green Eurodollar pack spread settled at a new low of just 46.5 bps on Friday, suggesting only 50 bps of tightening between 2017 and 2018.
None of the above illustrates underlying strength in the US economy. Maybe the bid in stocks does to some degree, though I would note that the Russell is still 7% off June’s highs, even with the rally of the last two weeks in the wake of the Paris terrorist attacks. The US job market is reflecting strength, though that may be in part due to the transition to a “gig” or UBER economy. Perhaps it represents flexibility of the US workforce, which may be a longer term benefit. In any case, the Atlanta Fed GDPNow estimate for Q4 fell to 1.8% on Nov 25, from 2.3% on Nov 18.
Weakness in primary manufacturing still has the potential to spill over into the broader economy. Here are a couple of weekend snippets.
Copper smelters in China, the world’s biggest producer of the refined metal, are weighing cuts in production next year as they respond to prices that have tumbled to six-year lows, according to people with knowledge of the matter. (1)
The US [energy exploration and production] sector could be on the cusp of massive defaults and bankruptcies so staggering they pose a serious threat to the US economy. Without higher oil and gas prices — which few experts foresee in the near future — an over-leveraged, under-hedged US E&P industry faces a truly grim 2016. (2)
Looking forward to this week, it will likely be more of the same. Yellen is slated to speak both Wednesday at the Economic Club of Washington, and Thursday in testimony to the Joint Economic Committee. Beige book summary released Wednesday afternoon in preparation of the Dec 16 FOMC. The ECB meeting is Thursday with high expectations for further accommodation. The US Employment report is Friday.
In terms of setting up for the potential lift off, there has been a tremendous amount of put spread and put butterfly buying in the last two weeks, which was absorbed fairly easily. In keeping with the “simple” framework, in the early part of this year prior to the idea of Fed hikes, three month Eurodollar contracts were settling around 9975. Now with lift-off expected in December, EDZ5 is near 9950. If one assumes “gradual” to mean one hike per quarter, then that would put EDH6 at 9925, EDM6 at 9900 and EDU6 at 9875. Perhaps unsurprisingly, those are the put strikes with the most open interest (H6 9925p 602k, M6 9900p 346k and U6 9875p 270k) as those strikes have been sold as the midpoint of put butterflies in simple target strategies. (For example EDM6 9925/9900/9875 put fly, which settled 6.75).
In a slightly longer view, there has been continued discussion about the “terminal rate” for Fed funds. According to the last dot projection in September, the terminal rate is around 3.5%. In reviewing the last hiking cycle, from 2004 to 2006, the terminal rate was fairly accurately forecast by the ten year treasury yield, which was around 4-4.5% for the first year of hikes and moved to a bit over 5% by the middle of 2006. The actual high FF rate was 5.25%. Currently, the ten year yield is around 2.25 and hit a high of 3% at the end of 2013, associated with tapering prospects. Probably makes sense to target the terminal rate from 2.75% to 3%.
I often find that year end can provide turning points in markets, and the upcoming year has potential for several reversals, as some markets appear stretched and new money comes in with the new year, with perhaps a bit of a cushion to express contrary views. A friend sent me this snippet that may contribute to a bounce in swap spreads: “At an annual private meeting between industry participants and the US Treasury Department last week, discussion focused on a proposed solution of placing repo trades between banks and investors, such as money market funds, into a clearing house.” Conclusion: the dislocations in the repo market are likely to be addressed, which could alleviate swap spread pressure.
In terms of the dollar and commodities, the Dollar Index made a high of 121 in 2001, went all the way down to 70.70 in 2008, and is now right around 100, near a 12 ½ year high. The 61.8% retrace is 101.80, which I would expect to hold. If the dollar does stall as Fed hiking prospects are trimmed, then commodities also have a chance to bounce from low base levels.
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Net changes in selected markets below:
| 11/20/2015 | 11/27/2015 | chg | |
| UST 2Y | 93.7 | 92.2 | -1.5 |
| UST 5Y | 169.5 | 168.5 | -1.0 |
| UST 10Y | 226.2 | 222.4 | -3.8 |
| UST 30Y | 302.1 | 300.1 | -2.0 |
| GERM 2Y | -38.9 | -41.7 | -2.8 |
| GERM 10Y | 47.9 | 46.0 | -1.9 |
| EURO$ H6/H7 | 61.5 | 61.0 | -0.5 |
| EURO$ H7/H8 | 51.0 | 49.0 | -2.0 |
| EUR | 106.47 | 105.92 | -0.55 |
| CRUDE (1st cont) | 41.90 | 41.71 | -0.19 |
| SPX | 2089.17 | 2090.11 | 0.94 |
| VIX | 15.47 | 15.12 | -0.35 |
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In: Eurodollar Options
Nov 27. China down 5.5%, black Friday mark-downs
–Dull session on Wednesday, volume was light. Slight new low in 2/10 at 130 bps, with twos unch and tens -1.
–This morning China stocks are -5.5%, contributing to a pullback in US index futures, and supporting a grudging bid in treasuries. Crude under pressure, with CLF near $42/bbl.
–Skimmed a few articles yesterday. One was about the ex-CEO of Barclays saying that headcount in the big banks may need to be slashed by 50%.
http://www.businessinsider.com/ex-barclays-boss-anthony-jenkins-on-fintech-and-bankings-uber-moment-2015-11
Not surprisingly this prediction is based on new financial technology: payment systems, new start-ups for lending, technology systems for ‘wealth management’, and on regulatory burden. Additionally mentioned is the fact that new start-ups require much less initial funding than previously (a thought that has also been articulated by Marc Andreessen). Also noted is that financial professionals that have already been axed have valuable experience in the field and abet the rise of new competitors. There’s nothing particularly earth-shattering about these projections, except that [cost] barriers to entry have declined across the globe. (I would note that financials comprise 16.2% of the S&P 500, with only Info Tech higher at 20.8%).
–The other was an article on Bloomberg about the debts coming due for Puerto Rico, and the various underlying bonds.
http://www.bloomberg.com/news/articles/2015-11-25/puerto-rico-s-dec-1-deadline-a-guide-as-possible-defaults-loom
It looks like a lot of payments are coming due in the next three months. Obviously PR is close to default. What I thought was interesting is that the actual upcoming payments indicate an interest rate of about 5%, while actual market rates as quoted in the article are 9.2% to 10%, and in some cases much higher. Clearly unsustainable.
–Which brings out to the tie-up. Central banks have engaged in QE, encouraging risk taking, forcing yields down to justify unsustainable projects both public and private. When yields float back up, cracks appear. At the same time, the most nimble of the private sector needs less capital because of technology and therefore invites even more disruptive competition, driving down prices. Companies like old-line banks become much less relevant, and regulatory burden is relatively high. At the same time, their emphasis on ‘wealth management’ pretty much goes out the window in a new world of 2-3% yields (on the high end). Now too much capital is chasing too little opportunity.
–QE creates its own trap.
Nov 23. Industrial commodity smackdown
–The main feature this morning is the plunge in industrial commodities, with copper, zinc, nickel, iron ore, oil all making new lows. Copper is near 2.00 and has fallen 18% just since the high made last month. Oil is at a new low for this move and near the lows made in August (CLF 40.68, -1.22). Might as well note that soybeans too, are at new lows today. China has labored to win inclusion into the SDR, but these commodity moves appear related to a hard landing in China, with risks of a weaker yuan.
–The dollar is again stronger this morning with EUR testing 106 and notable weakness in CAD. Once again, the dynamic seems to be a deflationary pall, emanating from China, but exacerbated at the margin by terrorist concerns which impede the free flow of goods and services. The crackdown on the outflow of yuan is also having a negative impact on high end real estate and other conspicuous consumption. Last week an illegal bank specializing in shipping money out of China was shut down. This morning the head of a brokerage firm has gone missing.
–The effects seem to be a flatter US curve, with red/gold euro$ pack spread at a new low of 106 Friday, and red/green (2nd to 3rd year) holding below 50 bps. High yield is negatively impacted as energy based companies struggle, while at the same time firms are rushing to lever up before the Fed starts a tightening cycle, further diluting balance sheet strength. Longer dated dollar based assets are likely seen as a relatively safe haven for global investors.
–News today includes Chgo Fed Nat’l Activity Index, which has printed negative 7 out of 9 releases this year with August and Sept particularly soft at -0.37 and -0.39. PMI Mfg as well, along with Existing Homes expected 5.4 m.
Now 22. Weekly summary
Nearly everything I thought or wrote last week just after the Paris attack was wrong last week. I thought that the US would see safe have flows into 2 year notes and that German/US 2 yr spread would decline. I thought VIX would continue to move higher after the previous Friday’s strong close. I thought 30 year treasury vol was likely to move higher. Instead the US two year note ended at a new high yield of nearly 91 bps. German/US 2yr spread went from 123 to 130. VIX fell back to just 15.5 from over 20, nearly the same levels from two weeks ago. SPX gained 3.25% on the week. Treasury vol remained pressured.
On the other hand, there have been many surprising market moves that have found the ‘wrong’ (or early) camp in good company. For example, swap spreads continue to collapse into deeper negative territory. Industrial commodities are making new lows. Flows did go into the USD, but appear to have favored longer term assets (both bonds and stocks) as the short end remains under the cloud of an impending rate hike.
I had also thought the odds for a Fed hike in December might lessen. However, there is a (closed) meeting Monday at the Fed to review and determine the advance and discount rates to be charged by the Federal Reserve Banks. At the last couple of such meetings, there were “requests by six Reserve Banks to maintain the existing rate; request by one Reserve Bank to decrease the primary credit rate; and requests by five Reserve Banks to increase the primary credit rate.”* Minneapolis of course, was the bank voting for a decrease. But Kocherlakota is leaving, and it’s quite likely in my opinion, that the vote could swing to 7 for an increase and 5 for maintaining existing. I am not sure if that would instantly change the rate. But it’s a pretty clear precursor for a rate hike. The new Minneapolis head, Neel Kashkari is taking over starting Jan 1.
I suppose the other thing likely to occur with Kocherlakota’s replacement by Kashkari is that the average dots in the Fed’s SEP (Summary of Economic Projections) are likely to move up. According to a Bloomberg article, Kashkari referred to previous monetary accommodation as “morphine” and is likely to favor monetary restraint just because of financial stability concerns. Of course, the broad picture has little to do with the MN Fed, and everything to do with a change in sentiment about an initial rate hike. However, once over that hurdle, the question becomes trajectory. The nearby one-year Eurodollar calendar spreads at around 5/8% (peak EDH16/EDH17 closed at 61.5 bps) forecast hikes of two to three 25bp moves per year. Boston’s Rosengren, in a recent FT interview, said he thought the market had it about right, and that the Fed’s SEP would be important as a communication tool. SF’s Williams said this weekend that there’s a strong case for a December hike, and also referenced the SEP and dot plot.
From September, if one throws out the low dot of -0.125% and the high of 2.875%, the mean projection for the FF target at the end of 2016 as determined by the dots was 1.5%. EDZ’16 settled at 98.905 or 1.095%, so there’s clearly a disconnect which will likely continue. Even with the shallower path expected by the market, the curve is pushing to new recent lows. For example, the red/gold Eurodollar pack spread closed at just 106 bps. Seems more consistent with a Fed that has already been tightening, which in this case the onset of the taper.
To conclude the section about the path of hikes, the question is, are we going to get Donald or Jeb? Full steam ahead and hike at every meeting? Or plod along cautiously? The market says the latter.
There have been several trades in the near part of the dollar curve to peg the FF rate next year. But let’s just consider the 150k position taken in the 2EG 9787/9775/9750/9737 put condor, bought for 1.5. This condor expires in Feb 2016, but has EDH’18 as an underlying contract (98.255s) and would max its payoff with a settle between 9775 and 9750, or 2.25 to 2.5%. These levels are consistent with a FF target perception of around 2% to slightly higher (as opposed to a Sept dot plot of 2.7% for the end of 2016).
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On the broader topic of asset markets in general, El-Erian wrote this weekend, “…two factors have consistently been major price setters since the global financial crisis: corporate cash and central banks.” He tepidly concludes that these factors will continue their influence, with M&A continuing and Draghi pledging to do what the ECB can to hit 2% inflation. On a more restrained note, the ECB’s Coeure said this weekend that “the capacity of the global economy to generate growth is under question” and that “there is a risk monetary policy may become ineffective.” Pick your poison.
What I would note is that the US Fed is moving towards less accommodation, and corporate buyback strategies are feeling it, with high yields moving higher and debt markets becoming less welcoming. For example, JNK on Friday had its lowest settlement since 2009. That’s not the case for HYG, but the trend is the same.
David Stockman on his Contra Corner blog refers to FANG stocks, FB, AMZN, NFLX and GOOG, and notes that their combined market cap is up $450 billion this year (!), and that without these four stocks total stock market cap FELL by nearly 2.5%.
Stock market breadth has been narrow. No secret. Financial conditions are tightening. The renewed USD bid is a restraint on US exports. But for the time being, it’s steady as she goes. As for possible negative catalysts, there are, as always, plenty of them. Terrorist events in Paris and Mali, with additional threats in Brussels are at the top of the list. Japan may send warships into the South Sea. Puerto Rico is on the verge of default. The point is that asset markets are a major determinant of economic activity, and risks abound.
In terms of trades, in the big picture I favor fading the commodity vs stocks trend, and like the former over the latter. The dollar may have already priced the tightening cycle and a pull back could help support commodities in dollar terms. At the Robin Hood gathering, Boone Pickens said oil could hit $70 next year; one could be in worse company than that.
In terms of the pace of Fed hikes and picking a target, my scenario is two to three hikes between now and the end of 2016. One in December, and the next not until June. I think that puts EDM’16 at 9922.5 at around the right price, and considering the EDM6 9925 straddle at 23, I am more inclined to be a seller than buyer. Last week I suggested buying EDJ 9925/9937/9950 call fly for 2.25. Possible grind higher if data disappoints. I wouldn’t exactly call front end downside trades crowded, but if I were looking to buy puts, it would be on the bond. Vol is low and the curve is flat. I think 3% is too low of a yield for the long bond going forward.
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Net changes in selected markets below:
| 11/13/2015 | 11/20/2015 | chg | |
| UST 2Y | 85.5 | 90.9 | 5.4 |
| UST 5Y | 166.8 | 168.5 | 1.7 |
| UST 10Y | 228.0 | 226.2 | -1.8 |
| UST 30Y | 305.8 | 302.1 | -3.7 |
| GERM 2Y | -37.0 | -38.9 | -1.9 |
| GERM 10Y | 55.8 | 47.9 | -7.9 |
| EURO$ H6/H7 | 64.0 | 61.5 | -2.5 |
| EURO$ H7/H8 | 51.5 | 51.0 | -0.5 |
| EUR | 107.74 | 106.47 | -1.27 |
| CRUDE (1st cont) | 42.00 | 41.90 | -0.10 |
| SPX | 2023.04 | 2089.17 | 66.13 |
| VIX | 20.08 | 15.47 | -4.61 |
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- http://www.federalreserve.gov/newsevents/press/monetary/monetary20151013a1.pdf discount rate press release from September
- http://davidstockmanscontracorner.com/when-wall-street-gets-defanged-look-out-below/
- https://www.ecb.europa.eu/press/key/date/2015/html/sp151121.en.html Coeure speech
- http://www.businessinsider.com/el-erian-market-paris-tragedy-shooting-2015-11 El-Erian
Nov 20. Away from zero
–“In the relatively near future probably some major central banks will begin gradually moving away from near-zero interest rates,” Fischer said Thursday. What?! You mean the ECB is going even MORE negative? Sure enough, Draghi today pledged “to do what we must” to attain 2% inflation, and the German 2 yr went to nearly -40 bps. Yup, that’s getting away from zero.
–Of course, Fischer is talking about the US raising rates, and there were a couple of big trades yesterday trying to peg those hikes. Buyer of EDM6 9925/9900/9875 p fly (6.0s) and EDM6 9912/9900/9887p fly (1.75s) and EDU6 9900/9875/9850p fly (4.25s) and U6 9887/9875/9862p fly (1.25s). 25k each of the wide ones and 50k each of the 12.5 flies. So the targets are the middle strikes, which in Sept’16 is the 9875 strike or 1.25% goal for 3 month libor. A fairly aggressive projection, in my opinion. Without an official hike ever having occurred, back month spreads are making new lows. For example, red/gold euro$ spread fell another 5 bps yesterday to just over 106 bps, a new recent low. 2/10 treasury spread also hit a new recent low at 136.2, down 3.4 on the day. Way back ten years ago there was a conundrum because the curve was flattening and long rates weren’t going up on rate hikes. BUT THAT WAS WHEN FUNDS WERE BEING RAISED TO 5%, not sitting at zero.
–In the meantime commodities continue to be pressured. The Baltic Dry Freight Index made a record low and China ‘uncovered’ a $64 billion shadow bank designed to get money OUT of China. Which suggests to me that the yuan should be moving even lower. Which makes it even more imperative for the ECB to get the Euro down. Which further reinforces a disinflationary pall. And makes it less likely for that Chinese money seeking a home to find it in a US luxury condo project.
–But we’re not seeing disinflation in insurance rates. United Health Group is threatening to pull out of Obamacare because the company is losing money there and can’t jack up the rates fast enough. “Every health plan I talk to tells me that they don’t expect their Obamacare business to be profitable even in 2016 after their big rate increases.” http://healthpolicyandmarket.blogspot.com/2015/11/unitedhealth-group-losing-big-money-and.html
–So what do the wealth managers advise? Buy stocks. And, (and this is inside info…) there just might be some good opportunities in junk bonds. Shhh.
Nov 19. Back eurodollar spread collapse
–Wednesday featured little change in interest rate futures, but a spirited rally in stocks with SPZ up over 30 points. Tens ended up 1.4 bps to 2.268. The curve flattened with the red/gold eurodollar pack spread down 1.375 to 111.5.
–The October FOMC minutes released yesterday revealed that the language change referencing the “next meeting” was to give the market notice that conditions could be met for lift-off in December. Reaction was fairly muted. However, it’s instructive to look at markets since the actual meeting took place on October 28, followed by the strong employment report on Nov 6. Back month eurodollar spreads have been crushed and the dollar index has strengthened, re-testing highs set in March. I have attached a chart of EDZ’19/EDZ’20 one year calendar spread (blue/gold Dec). Prior to the FOMC this spread was 32.5 to 34. Yesterday it closed at just 23. To my way of thinking, it simply looks as if the global market wants to own longer dated dollar assets, be they stocks or bonds, and squeeze term and inflation premia out of the market. Implied vol is also deflating. When looking at individual contracts like EDZ6, it closed yesterday at 9891.0, down only 0.5 on the day despite huge put buying.* In fact, the day before the employment report, it closed at 9892.5. On the day of the report it traded as low as 9877.5, but since then is almost right back where it was. The USZ bond contract this morning is slightly above its pre-employment level. The market and the Fed may be on the same page in terms of the odds for a Fed liftoff in December, but it appears the market is guiding to an even shallower pace than the Fed’s “gradual” path. It might be a return to the conundrum of the 2004 tightening cycle where the yield on back contracts barely responds to hikes.
–News today includes Jobless Claims expected 270k. Philly Fed at 0.0 vs last at -4.5. Leading Indicators +0.5.
–Square IPO priced at $9 and begins trading today. IPO price set 42% lower than the last private round funding. It’s a mobile payment company that is now allowing you to pay into its loss making operation.
*New buyer of 60k 0EZ 9887/9875/9862 put flies for 2.5 and a buyer of 25k 0EZ 9875p for 1.5.
Wanna see a stark picture of QE’s “success”?
Below is a graph of SPX divided by BCOM, the Bloomberg Commodity Index. (thanks for idea RW). The glorious success of central bank policies which serve to pump up paper assets relative to unimportant THINGS (like food and energy).
Nov 18. Bbg Commodity Index. Fed’s gonna hike???
–Treasury yields ended the day modestly lower with tens at 225.4 at the floor close, down 1.7 on the day. Markets are now subject to being rattled by terrorist reports, both real and false, with yesterday’s being in Germany at Hannover Stadium, which was evacuated due to reports of explosives.
–I think there are other factors worthy of consideration which are as important to the health of the markets and the global economy as terror events. These relate to the decline in global trade, and the increase in financial market stress. I have attached a long term chart of the Bloomberg Commodity Index (BCOM). It has plunged to well below the low of 2009 and has lost more than 20% this year alone! The Baltic Freight Index is also making new lows. A lot of the predictions for increased inflation depend on the idea that when these prices stabilize, inflation measures must go up. Maybe, but I would simply note that rental inflation has been running well above the Fed’s target, and may begin to sharply decelerate just at the same time that commodities turn.
–The second more immediate concern is the health of financial markets in general. Gundlach noted that credit downgrades are becoming more prevalent than upgrades, a red flag. Veritas had to pull a debt offering yesterday. This is a VERY negative sign of a turn in investor appetites for over-levered companies. Note that Square is scheduled for IPO today. It was already marked down, and will provide a litmus test for all the other absurdly valued start-ups hoping to actually monetize their theoretical prices. The window appears to be closing against the oncoming winter wind.
–The NY Fed issued an economic snapshot of the US yesterday. Here’s a summary link where you can also also find the report itself: https://www.newyorkfed.org/research/snapshot/index.html
If you didn’t know which way the Fed was leaning, and simply skimmed through the report, you would never conclude that a rate hike is under consideration.
Nov 16. Attack on civilization
As of Monday morning, the reaction to the horrific attacks in Paris were muted. US equities trading well above late Friday levels as of Monday morning. Not much response in EUR.
Japan has relapsed into recession, another cautionary signal for the Fed as it contemplates lift off. FOMC minutes are out on Wednesday.
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Below comments are from Sunday.
Though there were some notable market moves and soft economic data surprises during the week, the horrendous attacks in Paris overwhelm all other considerations on a human scale. I will still jot down some themes, but the dominant thought will be one of ‘risk off’ and volatility in both financial markets and global geopolitics.
Before Friday’s attacks, there were already signs of risk off, and US economic data showing weak retail sales and negative PPI reduced the certainty of Fed lift-off. US stocks closed on the lows of the week, with SPX down 1.1% on the day and 3.6% on the week. SPX, Nasdaq and DJIA are all around the levels that preceded the cascade in late August, and look similarly vulnerable. VIX surged 40% on the week and closed back above 20. Commodities, notably oil, were hit hard this week. While previous sentiment seemed to tilt toward the idea of the worst being over, I think this week smothered any optimism on that score. For example, high yield ETFs HYG and JNK are again setting up to test October lows and are through lows related to the August equity market sell off. Ironically, one of the catalysts for the August plunge was the Chinese devaluation, while now the IMF is giving the green light to include the yuan in its SDR basket (case). However, looming concerns about asset deflation won’t dissipate. While many note that weakness in high yield is energy related, the damage is becoming more widespread. For example, in the ag sector, Cargill is reportedly cutting 4000 jobs or 2.5% of its workforce. Though Cargill is private, weakness is reflected in public companies as well. ADM was 53 in May and is now 38, a loss of 28%. In retail, Nordstrom, Macy’s, Target and the Gap are all at new lows for the year. Cracks are even more evident with Icarus-like tech stocks. Twitter closed at 25.18, down over 50% from its high in April. As noted previously Square cut its IPO price to a level below its last round of private financing (slated for IPO Monday*). And Fidelity marked down the value of its investment in Snapchat by 25%. Clearly there has been amazing strength in GOOG, AMZN, FB and even MSFT. But undercurrents of weakness must give rise to caution.
There is an extremely interesting post on ZeroHedge citing JPM research, with this passage:
Over the past year, macro momentum trades increased exposure to various liquid assets in anticipation of a rise in US rates. Example trades include going long USD and Developed Markets, and short Commodities and Emerging Markets. These macro trends have also percolated into equity long-short momentum trades which are currently short Energy, Materials and Industrials, and Long Health Care and Consumer Discretionary sectors. Several of these macro and stock trends are relying on an anticipated Fed tightening that would boost the USD and further weaken commodities and EM assets. The risk of this increasingly one dimensional positioning across CTAs, Macro and some of Equity Long-Short managers is that these trends don’t materialize and trades become too crowded. The result could be a sharp reversion as positions are exited.
http://www.zerohedge.com/news/2015-11-13/jpmorgans-gandalf-quant-nailed-it-again
I know a lot of people don’t care for ZeroHedge but the passages from JPM are interesting in that analysis of direction is model driven and JPM breaks down flows from option hedging, CTA trend followers, and risk parity strategies. Well worth reading. Here’s another snippet.
Summarizing technical flows from option hedges, volatility targeting, CTA and Risk Parity funds, we believe that these strategies largely re-levered to pre August crash levels. This was a significant driver of the S&P 500 performance in October and hence poses some downside risks.
Given the events from Friday, my thoughts are that Fed tightening is again questionable, that the ECB will lean toward more accommodation than previously thought. The USD will almost certainly be the recipient of safe haven flows. I would think spreads like the Schatz vs US 2 year note, which ended the week at a new high near 123 bps, having been in the mid-80s in October, will have to come in though there will likely be volatile adjustments across asset classes this week.
In terms of trades, the huge buyer (280k open interest) of January 9950 calls for 1-1.25 bp certainly looks prescient. EDH6 settled 9940.0.
I tend to think that US vol is too cheap at 10.2% with 20 day historical just under 10. As is well known swap spreads are quite negative; a prolonged risk off period could spark widening.
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Net changes in selected markets below:
| 11/6/2015 | 11/6/2015 | chg | |
| UST 2Y | 88.6 | 85.5 | -3.1 |
| UST 5Y | 173.7 | 166.8 | -6.9 |
| UST 10Y | 232.9 | 228.0 | -4.9 |
| UST 30Y | 308.9 | 305.8 | -3.1 |
| GERM 2Y | -29.1 | -37.0 | -7.9 |
| GERM 10Y | 69.3 | 55.8 | -13.5 |
| EURO$ H6/H7 | 69.0 | 64.0 | -5.0 |
| EURO$ H7/H8 | 57.0 | 51.5 | -5.5 |
| EUR | 107.42 | 107.74 | 0.32 |
| CRUDE (1st cont) | 45.47 | 42.00 | -3.47 |
| SPX | 2099.20 | 2023.04 | -76.16 |
| VIX | 14.33 | 20.08 | 5.75 |
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http://www.theguardian.com/business/2015/nov/14/square-ipo-unicorns-silicon-valley-tech-bubble
Nov 13. Factors restraining inflation are transitory. Still?
–Modest rally in fixed income yesterday with green euro$ pack +2.25 and golds +4.875. There continues to be buying in EDF 9950 calls for 1.0 (January expiration, EDH6 underlying), as open interest rose 40k yesterday to 279k. Copper fell to new six year lows as commodities remain under heavy pressure.
–Early in the day Dudley said, “I see the risks right now of moving too quickly versus moving too slowly as nearly balanced.” He also said “…after lift-off the upward trajectory of the short term rates is likely to be quite shallow.” In other words, we’re going to have to ease after we tighten (sarcasm).
–Fischer followed yesterday evening with these comments: “There is good reason to expect that the drag on GDP growth from the stronger dollar will persist well into next year and likely spell continued weakness in the traded-goods-producing sectors of the economy that are especially exposed to the exchange rate,” Fischer said.
“Some of the forces holding down inflation in 2015 — particularly those due to a stronger dollar and lower energy prices — will begin to fade next year.”
–Both Dudley and Fischer suggest that eventually the dollar will top and oil prices will stabilize, causing a transition to higher inflation. But that argument is starting to lose some of its punch. For example, Cisco yesterday, like other companies, blamed its miss on the stronger dollar. Macy’s reported a miss earlier in the week and is down nearly half from its July high and lost 25% from just last week. Nordstrom’s also reported weak results, saying that people simply aren’t shopping for apparel. (I thought the lower gas prices were supposed to boost spending on other things).
–Today we have PPI expected +0.2 with Core +0.1. Retail Sales expected +0.3 and +0.4 ex-autos. I don’t know how it could be possible for autos to hold down retail sales given the explosive increase in auto loans.
