Nov 10. Cheeseburger, cheeseburger

–On Monday March Euribor settled +2 at 100.15.  March Euroswiss +3 at 101.00.  March Eurodollar +1 at 9938.5.  The US is looking for a rate hike while negative rates prevail elsewhere.  I have attached a chart of the CRB and the Baltic Dry Freight Index, both plunging.  December Copper yesterday settled 223.0, the lowest settlement since late 2009, and just half the price seen on the bounce in 2011. Corn and beans and cattle all pushing lower, with hogs at new lows.  The Fed is set for a December hike but the dollar prices of commodities aren’t supporting the case.  Maybe today’s fast food strike will tilt the balance and force big raises economy-wide in a nation with a foundation of double cheeseburgers.  Maybe we’ll go with Billy Goat today…no strike there.
http://www.nbc.com/saturday-night-live/video/the-olympia-restaurant/n8658
–Correction from previous notes.  I had seen a calendar with tens and thirties both being issued on Thursday this week due to the bank holiday Wednesday for Veteran’s Day.  However, tens are being auctioned today.
–New recent high in red/green/blue eurodollar pack butterfly nearing 20 bps (19.375).  This fly is up 11.75 bps from Oct 27 (the day prior to the FOMC) as reds to greens have widened to new recent highs.  As an example, EDH17 to EDH18 settled at 59 yesterday while EDH18 to EDH19 is just 37.5.  The implication is that greens are a bit cheap, but perhaps a less risky play than selling the fly is to just buy some green midcurve call spreads.  Not exactly the same trade, but along the same idea.

Nov 9. Revisit the ‘conundrum”?

–Friday’s strong payroll data (+271k) solidified the prospects for December liftoff.  Euro$ calendar spreads made new highs, however, there is not a single 3 month calendar above 25 bps; the peak is Sept16 to Dec16 which settled 18.5. (Large buying in EDH16/EDM16 at 17.5 Friday). The peak one year is Dec15/Dec16 at 71.5 bps, which barely indicates three hikes for a full year.
–A couple of sources highlight comments from the largest shipping company Moeller Maersk, “We conduct a string of our own macro-economic forecasts and we see less growth — particularly in developing nations, but perhaps also in Europe — than other people expect in 2015,” Andersen said. Also for 2016, “we’re a little bit more pessimistic than most forecasters.”  As recently as October, the CEO of Fastenal’s CEO had this to say, “The industrial environment is in a recession – I don’t care what anybody says, because nobody knows that market better than we do. You know, we touch 250,000 active customers a month.”
–The US economy seems to be doing fine, though it’s faced with the increasing headwind of a stronger dollar.  However, world trade is soft, as indicated by the Baltic Dry Index scraping along near new lows.  The global situation appears to have to potential to stall the US, a risk that the Fed dismissed in the October statement.   Today, Boston Fed’s Rosengren speaks about the outlook at noon EST.
–Ten year yield closed up 8.4 bps Friday to 233.  5/30 spread made a new recent low marked just over 135.  The last hiking cycle began in 2004.  it’s interesting to note that by February of 2015, Greenspan noted the “conundrum” of long rates remaining stable or even declining in the face of Fed hikes.  Here’s a snippet of Greenspan’s testimony: “In the current episode, however, the more-distant forward rates declined at the same time that short-term rates were rising. Indeed, the tenth-year tranche, which yielded 6-1/2 percent last June, is now at about 5-1/4 percent. During the same period, comparable real forward rates derived from quotes on Treasury inflation-indexed debt fell significantly as well, suggesting that only a portion of the decline in nominal forward rates in distant tranches is attributable to a drop in long-term inflation expectations.” … “For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum.”
Is the same dynamic possible this time around?
Full link to speech: http://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm

……………………………

November 5. Yellen tilts toward December but doesn’t commit

–Yellen gently reinforced the idea of a December rate hike, “…moving in a timely fashion would be a prudent thing to do; will help the Fed move at a gradual pace.” Dudley didn’t really talk about policy aside from saying he agrees with Yellen.  Fischer’s speech was mostly about central bank independence, but included this snippet “…after much research on the effect of major financial crises on growth and on the dynamics of business cycles, we are focused to a much greater extent than in the past on the importance of financial stability.”

–The market responded to Yellen with a flatter curve.  For example, the red/gold euro$ pack spread closed at 114, down 5.625 on the day.  This spread is nearing support levels last seen in March (103.75) and mid-2012 (106.6).  The dollar index posted a new recent high and appears poised to test levels from early August. I marked the US 2yr vs German Schatz at a new high of 113 bps, further undermining the Euro.  Gold is nearing $1100/oz, having plunged $80 since mid-August. Crude fell as well, down 140 late to 4650, substantially reversing Tuesday’s strength.

–Eurodollars were steeper in the front, flatter in the back.  Near calendar spreads made new highs, with EDZ5/EDZ6, now the peak one-year, at 66 bps, up 3.5 on the day.  Back calendar spreads edged to new lows.  For example, the blue pack was marginally lower on the day, while the gold pack closed higher. (4th to 5th years).  USZ also closed slightly higher on the day.  Rather than really punch home certainty of a hike, Yellen is allowing upcoming employment reports to exert more influence.  I would guess it’s unlikely that Friday’s report will derail a hike, given solid ADP data yesterday.  There was also talk circulating yesterday that Bernanke was at an event and said that not even well below consensus NFP would stop the Fed from hiking, though we had the same sort of comments prior to September’s NON-hike.

–Jobless claims this morning expected 262k.  Several Fed speakers today, including Fischer again this morning, at a NY Fed Conference.

Nov 4. Strong rate hike signals for “the next meeting”?

–Yellen speaks at 10:00 EST, followed by Dudley at 2:30, with Fischer giving a speech after the US day session.  With stocks experiencing a new round of “risk-on” behavior, and oil jumping $4/bbl to over 48 in the past week, the most important voices on the FOMC have the chance to solidify rate hike expectations at “the next meeting”.  However, market odds still aren’t much different from 50/50 as of this morning.  EDZ5 should probably be more like 9954 rather than 9959, but some analysts are still pointing to Friday’s employment report as a critical piece of information.  We already know labor markets have substantially healed and that while the Fed acknowledged dis-inflation risks, they expect inflation to trend back to target.  In that sense, the employment report is superfluous.  Share buybacks with borrowed funds and M&A activity that weakens corporate balance sheets (leading to future instability) is moving up the ladder as a primary concern.
–Other news includes ADP expected 180k.  Trade expected -$41b and non-mfg ISM expected 56.5 from 56.9.  The delayed two year auction today as well.
–Yesterday featured new lows in swap spreads.  Late prints: 5yr -4.75 (!!), 10yr -9.5 and 30yr -39.9.  Treasury yields pushed higher, led by the long bond, with the 30 year yield just over 3%, up 4.4 bps on the day.  Large trade in euro$ was a seller of 100k EDF6 (Jan expiry on EDH6 underlying) 9937.5 straddle vs 9962.5c at 13.0 covered 9942 and 9943.  Straddle vs call settled 13.0 with futures 9943.5.  This trade is for one hike (or at least the perception of one hike) with max gain at the 9937 strike, 22 bps under the current EDZ5 price.

Nov 2. South Korea exports (and imports) continue to telegraph weak global trade

–Friday saw steepening at the front end of the curve and flattening from the reds back.  Near one-year eurodollar calendar spreads posted new highs, with March’16/March’17 for example, closing +1.5 to a new recent high of 61 (peak one-year spread).  However, red/gold pack spread (2nd to 5th year), closed at a new low just over 118, down 4.5 on the day.  The 5/30 treasury spread also fell, down3 bps to 140, a new recent low.
–This is a big week for news and data, with the big three, Yellen, Dudley and Fischer speaking on Wednesday.  Jobs data on Friday.  Today is the ISM Mfg Index (US), which has been steadily falling over the past several months, and is expected at the stalled level of 50, vs 50.2 last.  China’s PMIs were mixed but below 50, (PMI of 49.8 while Caixin Markit was 48.3, up from 47.2 last).   Eurozone PMIs mostly better than expected.  One other note about Asia with negative implications for global trade:  S Korea exports fell 15.8% (!!) yoy, the 10th straight month of decline and sharpest fall in six years.
http://www.bt.com.bn/business-asia/2015/11/02/s-korea-exports-fall-6-year-low-oct
Global trade is in retreat, but manufacturers of sophisticated weaponry are likely on the cusp of boom times.
–In last week’s FOMC announcement the Fed downplayed international concerns.  Probably a mistake.  This morning ZeroHedge has a piece citing the Fed’s website noting that the output gap has materially closed, justifying a rate hike.
http://www.zerohedge.com/news/2015-11-01/output-gap-appears-closed-feds-model-just-confirmed-december-rate-hike
As mentioned before, US labor data justifies a hike, market and survey based inflation measures don’t, and the tie-breaker is financial stability, which appears to have won out, with the Fed boxing itself in for a December move.  Unless of course, communications are further muddled this Wednesday.

Nov 1. Fed has the chance to get communication back on track

With the Fed specifically mentioning the “next meeting” in its deliberations on whether to begin lift off, the market raised the odds of an actual hike in the funds target. However, the odds still don’t reflect more than a 50/50 chance of a December move. For example, January Fed Funds settled Friday at 9975, exactly 12.5 bps below the expiring October contract. San Fran President John Williams said the Fed included the “next meeting” reference just so that markets wouldn’t be surprised if indeed the Fed does hike. Still a bit squishy, but Yellen, Dudley and Fischer all speak Wednesday, providing the strong opportunity for guidance.

I went back and reviewed Lael Brainard’s Oct 12 speech, which was quite balanced, but concluded that asymmetric risks suggest the Fed should refrain from an early hike. This paragraph sums it up:

Now, take the alternative risk: that the underlying momentum of the domestic economy is not strong enough to resist the deflationary pull of the international environment. A further step-down in global demand growth and a further strengthening in the dollar could increase the already sizable negative effect of the global environment on U.S. demand, pushing U.S. growth back to, or below, potential. Progress toward full employment and 2 percent inflation would stall or reverse. With limited ability to ease policy, it would be more difficult to move the economy back on track.

The FOMC responded by dropping the sentence that global economic developments “may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.” Dismissive of the risks.  It reminds me of (The Dictator) Admiral General Aladeen: “I love it when women go to school. It’s like seeing a monkey on roller skates – it means nothing to them, but it’s so adorable for us…”

Both market based and survey based measures of inflation are declining. I went back and compared the year 2012 with this year to date regarding economic releases. In 2012, NFP averaged 188k, this year 198k, a marginal improvement at best. Personal Income and Wages for both 2012 and 2015 look the same: sideways. PPI was positive throughout 2012, but this year has had two negative readings, the last being -0.3. The lowest CPI reading in 2012 was -0.2, the last in 2015 was -0.2. Industrial Production is weaker now than in 2012. So what’s stronger? Non-mfg ISM averaged around 53 in 2012 and this year 57.3. Auto sales (according to Wards) were around 11 million units in 2012, now 14.4 million. New home sales were running at a pace of 360k and are now 500k. Last but not least of course, is the stock market, with the SPX nearly 50% higher than its level at the end of 2012.

Let’s just consider car sales for a second. In 2012 (according to the Fed’s Consumer Credit release) the interest rate for a 48 month car loan was 4.91. Now? 4.11. In 2012 the maturity of a new car loan was 62 months. Now? 65 months. So, if the rate declines and the terms lengthen, the monthly nut declines. As they say on the floor, “It’s not rocket surgery.” But this trend also points up the loosening of standards that can lead to problems down the road. Which has been seen on a grander scale in the corporate bond market.

So the argument for hiking doesn’t really appear to be growth and wages, because those aren’t really making much of a move. It’s not inflation. It comes down to hoping that the ECB’s accommodation and China’s easing will spur the global economy, but more importantly in a domestic context, it’s about regaining a sense of financial risk and responsibility. As the Institute of International Finance succinctly puts it, “Easy policy has passed the point of diminishing return, and keeping it longer would only increase moral hazard and distort financial markets.”

What are the larger implications and ramifications of Wednesday’s speeches?   Yellen doesn’t really seem to have a bias to hike, but appears to have been swayed by the crowd. Dudley has already said his baseline scenario includes a rate increase this year. Fischer thinks zero rates are not normal, and that they could contribute to financial instability in the longer run. In assessing the market moves since the FOMC meeting, there was nothing to suggest that undue volatility would be associated with a hike. (First, do no harm). Stocks rallied. The curve flattened; ten year yields were up only 7 bps on the week. Crude oil closed up on the week. The dollar strengthened modestly. Even an average payroll report on Friday will provide the Fed with enough cover to pull the trigger. My implicit assumption is that the speeches this week will unify the Fed’s message and provide stable guidance.

It pretty much points to the inevitability of a hike even though the market may perceive it as a mistake. In all likelihood the dollar will strengthen a bit further. While the treasury curve may flatten initially, the promise of gradual or even glacial rate hikes will be repeated, causing any flattening to be short-lived. Spreads between corporates and UST will almost certainly widen. While an initial hike won’t do much to change short term funding rates, it may well signal regime change, putting financial stability right up there with growth and inflation mandates (in spite of what the Fed says). The window for borrowing to buy back shares may be closing. The goal is to let some air out of risk assets without engineering a reverse wealth effect on domestic consumption. It might end up being as important as hopes for a soft-landing in China.

One year Eurodollar butterflies jumped this week, as front one year spreads rose to new recent highs while back spreads remained idle. For example, EDH6/H7/H8 fly went to 10, having been as low as 2/2.5 early in the week. (EDH6/7 to a new high of 61, while EDH7/8 was unchanged on the week at 51). I am inclined to fade this move and would look to sell this fly if it can get back into the mid-teens.

In 2012 the average ten year yield was around 175. This year it’s just above 200. But the two year yield was around 20-30 bps and is now more like 60-70 (last at 73). The short end has generally adjusted higher. Indeed, the spread between the German Schatz and US 2 year widened to a new high this week of 105 bps. Regarding tens, I have often mentioned the midpoint of this year’s range, which is 206 and has acted as a magnet recently. In the longer term, the 2012 low is around 140, and the 2013 high is just over 3%, so that midpoint is 220, versus a close Friday of 215. For the rest of the year, I would look for a range of around 205 to 240. The caveat of course, is a big “risk off” scenario, caused by a global shock. There are plenty of imbalances out there that could act as a catalyst, both financial and geopolitical.

 

 

Net changes in selected markets below:

	10/23/2015	10/30/2015	chg
UST 2Y	63.7	73.2	9.5
UST 5Y	143.0	153.0	10.0
UST 10Y	208.1	214.9	6.8
UST 30Y	289.6	293.2	3.6
GERM 2Y	-31.9	-31.5	0.4
GERM 10Y	51.2	51.7	0.5
EURO$ H6/H7	54.5	61.0	6.5
EURO$ H7/H8	51.0	51.0	0.0
EUR	110.18	110.07	-0.11
CRUDE (1st cont)	44.60	46.59	1.99
SPX	2075.15	2079.36	4.21
VIX	14.46	15.07	0.61

—————————————————————————————

Oct 30. Rates pushing higher in US, but the move will likely stall

–In spite of Q3 coming in at only 1.5% with prices +1.2%, interest rate futures continued to sell off.  Ten year yield jumped 8.4 bps to 217.4.  Interestingly, the curve was a bit steeper as 2 yrs only rose 2.2 bps to 72.5.  Red/gold pack spread gained 1.75 bps to 122.625.  There was a large exit sale of 0EZ 9900p at 9.0 bps, however, straddles remained well bid with a late trade in 0EZ 9900 straddle at 19.0.  Another large trade on the day was a buyer of 50k EDM16 9912/9900p 1×2 for 1.0, paying for the 2 legs.  According to prelim sheets, both options gained open interest, 41k and 77k.  In treasuries, implied vol is still rather muted.
–Near eurodollar calendars made new highs, for example, EDZ5/Z6, EDH6/H7 and M6/M7 all closed at 59.5.  So these spreads are currently indicating 2 to 3 hikes of 25 bps per year.  If the Fed were to hike at the next three quarterly meetings in Dec, March and June, then the above mentioned June put spread would probably work out.  But the one-year calendars aren’t really indicating the same tightening path, nor is the Fed.
–The Bank of Japan refrained from further stimulus.  US news today includes Personal Income and Spending, both expected +0.2, ECI at +0.6, Chicago PMI at 49.2 vs 48.7 last.  Fed speakers include SF John Williams (10:00 EST) and KC Esther George (11:25).  George is rather hawkish, but a note published on the KC Fed website Oct 27 had these conclusions about the agricultural economy (relatively important in the KC district).
“Uncertainty abounds, but the risk profile of U.S. agriculture has increased, and appears poised to increase further.  Current conditions highlight liquidity as a key indicator of future financial stress in the farm sector.  Cash flow is steadily becoming a more significant concern.”
Further a USDA report today noted that ag “Prices Received Index is down 8.4% yoy.  Food Commodities index…is down 13% from September 2014.”  http://www.usda.gov/nass/PUBS/TODAYRPT/agpr1015.pdf
–Obviously i-phones are much more important than food, and you can take pictures of food with your i-phone, which apparently has become critical, however, stress in the ag sector and other businesses tends to work its way through the system slowly, and requires a longer time to heal.

Oct 29. Market still can’t fully believe a hike is coming

–In the old days, a statement with a specific mention of tightening “…at its next meeting” would have taken the odds for a hike at that meeting to 60 or 70%.  Yesterday, January Fed Funds settled 9975.5 and EDZ5 at 9959.0.  With the expiring October FF at 9987.5, and Jan just 13 bps lower, the odds for a hike are slightly above 50%.  With 3 mo Libor around 32.5 bps, and EDZ5 at 41 bps, that contract reflects even smaller odds of a hike at around 35%.  Of course, 3mo libor itself has some percentage of expected tightening built in, so EDZ odds are a little higher, but the point is that the market isn’t giving the Fed much respect.  In fact, it’s probably worth looking at selling EDZ to buy FFF.  After taking heat last time about giving too much emphasis to overseas spillover, the Fed softened its reference by simply stating it is “…monitoring global economic and financial developments.” So the dollar strengthened, and gold was hammered from its early high.  Oil however, surged 6% from its low, and stocks leapt to victory, shrugging off the idea that the Fed would willingly try to stop the merry-go-round of share buybacks and merger activity funded by low rates.
–The curve flattened with 2/10 at a new low 138.7 and 5/30 down 8 bps at 141.  Red/gold packs spread posted a new low just under 121, down 1.875 bps on the day.  Five year (old) yield was up 10 to 145.6.  The buyer of 0EZ 9900 puts for 4 prior to the Fed was rewarded with a settlement of 7.25.  Though 45k were sold at 7.0 after the FOMC, open interest sheets indicate that positions were added, not closed (OI prelim +8500).  Jobs data now looms large, with Yellen speaking on the Wednesday (Nov 4) prior to payrolls, which will be an ideal time to solidify the market’s expectation for a hike.
–Q3 advance GDP today expected +1.7, though Atlanta Fed’s GDP Now is tracking at 1.1%.  Jobless Claims expected 265k, though in related news out this morning, DB is slashing its workforce down to the CEO, 4 tellers and a security guard.  Seven year auction this afternoon.

Oct 28. FOMC today

–I received this text from a friend in the ED option pit yesterday: “At 1:01 tomorrow there will be a huge exchange of funds between the pit and the short put buyer.”
–At 1:00 PM Chicago time the Fed announces its interest rate statement.  Yesterday, Short Dec (0EZ) 9900 puts were bought in size of 100k (actually over 200k traded) and open interest increased 88k.  (ref 9913.5/9914).  There has been sizable put buying apart from today’s 0EZ  puts, including 100k 0EZ 9887p for 1.5 and over 50k EDF 9950p for 5-6 in the past few sessions.
–Could the Fed possibly hike today?  It would most certainly jolt the markets, and create a more circumspect “investing class” going forward, but the odds are miniscule.  US data continues to come out on the soft side, as evidenced by yesterday’s Durables data which included large downside revisions to the previous month.  In another sign of increased global CB accommodation, Sweden’s Riksbank expanded its QE program.  Is the Fed destined to buck the trend?
–Breadth in the stock market continues to be narrow.  Yesterday AAPL reported with Q4 revenue of $51.5 billion.  I was amazed by this quote from Tim Cook, “Looking at our sales trends I wouldn’t know there’s an economic issue at all in China.”  However, IBM yesterday was down 4% to a five year low.  VRX again closed lower on the day.  The latter two companies are under scrutiny for creative financial engineering.
–The US ten year yield fell 3 bps yesterday to 202.6.  The curve flattened with the red/gold pack spread -1.75 to just 122.75, near recent lows.  The peak one-yr eurodollar calendar spread is  EDM16/EDM17, down 2 yesterday and just barely holding above 1/2% at 53 bps.

Oct 27. Animal spirits

–Biggest moves yesterday were in energy, where NatGas made significant new lows and Dec Crude was also under continued pressure, (down 57 cents late to 4403, and lower yet this morning).  Nov Nat Gas is around 2.00 while Dec is 2.34, a huge discount for one month, which indicates a lack of available storage/oversupply.  EUR rebounded slightly.  Interest rate futures were lethargic at best, treasury straddles compressed by a few 64’s.  Stocks were also quiet, though it’s worth noting that Valeant (VRX) closed lower despite their press conference to assuage investor fears…doesn’t look like anyone was convinced, which is a huge red flag.  AAPL reports earnings today.  After last week’s tech surge spurred by GOOG, AMZN and MSFT there are probably high expectations for AAPL.  However, JPM announced it’s creating a competitor to Apple-pay, and other key areas of the business also face increased scrutiny.
–The market appears to trust in a debt limit deal, as one month t-bill rates have come right back down toward zero, having spiked above 10 bps last week.  However, there is an increase in tensions between China and the US, as the US Navy has sent ships into the South Sea to test territorial and shipping rights.  With the economy going south (as China’s appears to be/ see chart below) it might not be the best idea in the world for the US to serve up a ready made distraction for China’s leadership in the form of a military skirmish.  I prefer financial threats, for example, ‘China will sell its US treasury holdings and drive up rates.’  Oh, already happened?  And US rates didn’t move?  Let’s try something else.  Oh, look, is that a US Navy destroyer on our coast?
–US news today includes Durables expected -1.5% and 0.0 ex-transportation.  Richmond Fed expected -3, only important in light of continued regional weakness which was highlighted by a dismal Dallas number yesterday.  Consumer Confidence also out, a coincident indicator that says nothing about the future but does give a glimpse about the current price of gasoline at the pump. In other words, the same number that is crushing Dallas’ activity is giving drivers a few spare bucks to buy a bag of Doritos. Not exactly a precursor of a surge in animal spirits.

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.

  The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.