Sept 18. The Fed takes a pass
–Not only did the Fed pass on a rate hike, but the press conference was quite dovish, with Yellen at one point saying it might take years to reach the inflation target. From the statement, “The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad.” Tightened financial conditions and international turmoil not only stopped the Fed from hiking, but prompted one member (Kocherlakota) to register his vote for an even more accommodative policy with a negative dot at -12.5 bps. On the whole, the the dot plot (where the 17 members of the FOMC identify the FF target they think is appropriate at year end) averaged about 30 bps lower in yield for the end of 2016 and 2017 from the last plot in June. Lacker was a dissenter, preferring a rate increase.
–About a month ago, I saw a piece of research (GS?) which highlighted a question that several clients had posed about the possibility of a near term recession. The authors emphatically said that a recession was NOT on their radar. Obviously though, there has been concern about slowing growth globally, which was reflected by the Fed yesterday.
–The two year yield, which had been pushing to higher yields, plunged 11 bps yesterday to 69.8. Tens fell 8.4 bps to 221.5. The curve steepened, with both 2/10 and 5/30 making new highs, +2.5 to 151.7 and +5.9 to 153.7. Implied vol was immediately offered, for example, 0EZ 9887 straddle which had settled 30.5 on Wed, was instantly 28.5 offer after the announcement. TYZ vol went from 5.5 to 5.1, probably too cheap here.
–Interestingly, the Oct/Nov FF spread, which had been trading 4.5 prior to the Fed, remained 4 bid even after the announcement, though late in the day it was 3.0/4.0. This spread reflects odds of an October 28 FOMC rate hike. All it would take is a 350k+ NFP on October 2nd to renew the focus on a Fed hike. However, the failed rally in stocks late afternoon may portend more weakness over the near term. Equity option expiration today. Nikkei was down 2%.
–Leading indicators today expected +0.2%.
In: Eurodollar Options
Sept 11. Treasury auctions over. Risk off day
–Curve steepened a bit as the treasury wrapped up auctions with the 30 year bond. The ten year yield was up 3.2 to 222.4, while 2/10 treasury spread rose 4 to 149. Red/gold euro$ pack spread up 3.75 to 134.625. September midcurve euro$ options expire today.
–US stocks were weak early yesterday as Appaloosa’s David Tepper said that “flat is an ok place to be” regarding US stocks. (He had previously sparked buying when he pronounced himself “balls to the wall long”). However, ESZ closed positive on the day and the chart continues to coil.
–Roubini was out recently saying that concerns about China were overblown, as opposed to RBNZ’s Stevens who said two days ago that he feared China might set off another wave of global deflation with yuan weakness. I suppose it’s much more important to get it right for Stevens, though he might think of the world in a tighter geographical sense than Roubini. In any case, it’s hard to argue with US Import price data yesterday of -11.4%, the lowest since 2009. It certainly doesn’t speak of inflation. Today we get PPI expected -0.2 with Core +0.1.
–Today is the anniversary of 9/11. I would expect the day to lean risk averse. Given that treasury vol is at the low end of the range, may make sense to own some calls as a hedge. Iran has sent ground troops to Syria in support of Russian efforts to save the Assad regime…glad that’s not escalating. Sunday is Shemitah, 7 year cycle mentioned in the Bible and loosely associated with previous financial stress episodes. Might add to ‘risk off’ mentality for today at the margin.
In: Eurodollar Options
Sept 10. One week until FOMC announcement
–JOLTS data was higher than expected, showing impressive job openings of 5.75m, however, the ratio of hires to openings continues to make new lows. There was a lot of press coverage on Chipotle’s plan to hire 4000 workers in a day, but colleague Tim Dibadj noted that Lockheed Martin is cutting 500 information service jobs. I wonder which ones are higher paying.
–Brazil cut to junk by S&P. New Zealand cut rates, joining Canada and others on rate increase reversals. Japan’s Nikkei fell 2.5%, reversing some of Wednesday’s explosive 7.7% rally. Amazing that with Japan’s surge, US stocks couldn’t manage to hold on to early gains with SPX closing down 1.4%. Some are blaming AAPL’s underwhelming product presentation as a reason for late selling.
–A good ten year auction sparked a spirited rally from new lows in treasuries, though those gains are being trimmed this morning. New lows in some one-year ED calendars, first two reds to first two greens; EDU16/EDU17 -2.5 bps to just 60.5. Thirty year auction today wraps up this week’s refunding.
–Today’s news includes Jobless Claims expected 275k. Also Import and Export prices, expected -0.4% and -1.6%. Sept midcurve option expiration in eurodollars tomorrow. Red, green, blue and gold Sept atm straddles all settled 7.0 to 7.5 bps.
In: Eurodollar Options
Sept 6, 2015. Does the Fed want to re-live the 1997/98 Asian crisis?
THEMES:
- Employment report, something for everyone
- USD strength against all EM; Fed hikes into that environment?
- China. Sell reserves or devalue. My money’s on the latter
- Risk aversion
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Again from Fischer’s CNBC Jackson Hole interview, “WE’D BE ADJUSTING THE KNOB SLIGHTLY AND WILL PROBABLY WAIT AWHILE BEFORE DOING SOMETHING ELSE.
-There’s something for everyone in the employment report. Headline number was only 173k, bad, but the previous number was revised up 30k to 245k, good. The rate was just 5.1, good, but the labor force participation rate was 62.6, bad. Average hourly earnings were +0.3, good, but QoQ Unit Labor Costs in Wednesday’s data were -1.4%, bad.
All in all, the Fed still seems to be on course for a hike, perhaps in September or, in my opinion, a greater likelihood in October. In either event, the trajectory of rate increases is likely to be gradual, as Fischer apparently emphasized to a group at the G20. Certainly, the market has bought into the idea of graduality (is that a word?) as can be seen in Eurodollar calendars. The peak one-year calendar had been bouncing around ¾% to 7/8% all year, (though it started the year near 100bp). More recently it seemed anchored at 75 bps, and now can barely stay above 5/8%. EDH6/EDH7 declined by 7.5 bps this week to just 65.5, signaling between 2 and 3 hikes per year. Low implied vol in interest rate futures – even in the face of significant equity market turbulence – is another factor that reinforces the idea of little movement by the Fed.
In terms of timing of the first hike, in my opinion it’s just as likely to occur in January of next year as it is in September. Here is the problem with a move in 11 days. No matter which EM currency one looks at vs USD, they are either at or near new lows. In Asia, one can look at Indonesian Rupiah (IDR), the Indian Rupee (INR), Malay Ringgit, (MYR) Thai Baht (THB), Korean Won (KRW). Same with Turkish Lira (TRY) and S Afr Rand (ZAR). Same with Brazil (BRL), Mexican Peso (MXN). Same with Canada and Aussie. The Brazilian real has lost about 45% of its value this year, Aussie’s down 16%, Copper 25%. Equity markets are shaky at best. Many Fed members love to talk the hiking talk, but when it comes right down to it, do you really think they want to face down a firestorm of political criticism if stocks plunge and emerging markets crumble based on an initial hike? Does the Fed want the blame for a replay of the 1997/98 Asian crisis? By the way, these adverse market moves may occur no matter what the Fed does, so why should the Fischer stand up and take that bullet? I say Fischer, not Yellen, because for all practical purposes he is the Fed chair. He’s the one out front discussing and forming Fed policy.
It’s more about China now than the US anyway. The G20 gave China a pass on its fx devaluation. But without further weakening the currency, China is spending reserves, supposedly $60-80 billion per month. As Doug Noland of the Credit Bubble Bulletin says, “How long will Chinese officials tolerate spending international reserves to allow “money” to exit China at top dollar?” Even with the drawdown in reserves in the form of treasury selling, US rates are falling. The idea that China will be selling into a black illiquid hole and drive US long end rates up is simply not occurring. What we’re more likely to see is a controlled devaluation of the currency.
Of course, China is taking other steps to help its economy. (Reuters) – Finance Minister Lou Jiwei said that central government spending will rise 10 percent this year, more than the 7 percent growth budgeted at the start of the year, according to a statement late Saturday on the People’s Bank of China website. China will raise dividend payments from designated state-owned enterprises to make up for any shortfalls. http://www.reuters.com/article/2015/09/06/us-g20-china-economy-idUSKCN0R604T20150906
Grand Keynesian fiscal measures in China to boost internal consumption and (mal)investment are more of a threat to US treasury bond values than reserve sales. Reserve sales and devaluation both admit to a weak, disinflationary global economy. US treasury prices do not go down in that environment, unless temporarily. This week’s auctions of 3’s, 10’s and 30’s in the absence of economic data will be the litmus configuration as to whether the US bond rally is true or fake.
Much of the demand for bonds is wrapped up in total portfolio allocation. This was a week when we heard about “Risk Parity Funds” exacerbating selling pressure, (being compared to “Portfolio Insurance” of the late 1980’s). Calstrs is reportedly looking at “Risk Mitigating Strategies”. Bill Gross says short term corporates may be the best chance to eke out returns. A WSJ headline Sunday morning says, “Pensions roll back return targets” noting that assumed returns of 7.5 to 8.0% aren’t happening (not exactly news). Some of the ‘strategies’ might have fancy names, but the theme is clear: pare risk and preserve capital. A change in the aggregate allocation decision, even at the margin, can further undermine support for equities.
September 4. Set the cat amongst the pigeons
–Aussie at new low. Nikkei at new low. Hong Kong PMI dismal at 44.4.
–Draghi was dovish yesterday and said inflation risks were to the downside. There was heavy buying of FVZ prior to the press conference, which appears to be new positioning, as total FV open interest rose by 27k. In eurodollars some of the near spreads are making new lows. For example, EDZ5/EDZ6 spread slid 3 bps to a new low of just 63. EDZ5/EDH6 is just 11.5! Ten year yield fell 2.4 to 216.7. Implied vol pounded to stupid levels. USZ atm straddle marked at just 12.6. All euro$ straddles lost 0.5 to 1.5 bps. I understand taking out the long weekend time value, but 3EU 9800 straddle (ref 9795) at just 13.5 in front of employment with another week to go seems a bit compressed. All other markets are a sea of instability, the euro$ curve is fearless.
–Late in the day a note by JPM suggested that stock market selling due to adjustments by various strategies was only half over, causing some late weakness in ESU. http://www.zerohedge.com/news/2015-09-03/jpm-head-quant-back-new-warning-only-half-selling-completed-expect-downside-price-ri
–Employment data expected 220k with rate of 5.2%. Treasury shorts are being squeezed pre-data; a soft number would “set the cat amongst the pigeons” as a friend of mine likes to say…
Sept 2. Quantitative Tightening and Risk Parity
-Ten year yield fell just 2.8 bps to 217.2 as oil and stocks tumbled. Curve was slightly steeper as 5’s led the move to lower yields, -3.8 bps to 150.2.
–Bonds have been trading poorly, without much of a ‘flight to quality’ bid as stocks have shown increasing vulnerability. A BBG piece this morning cites Quantitative Tightening (coined by DB) noting that “…central banks are either paring their reserves to offset an exit of capital or manage currencies, have less money flowing into their economies to salt away or no longer need to sit on as much. Whichever it is, the shrinking of reserves means much less money flowing into the financial system given authorities tended to recycle their cash piles into local currency or liquid assets such as bonds.” Global trade flows have shriveled, as evident by S Korea’s 15% decline in exports yesterday and by the ISM New Export Orders sub-category, which is at its lowest level since 2009.
–The other explanation for bond weakness is ‘risk parity’ funds, covered in the FT. As I understand it, these funds blend a stock portfolio with a levered bond fund, with the thinking that if stocks fall, the bond side over compensates. But in more volatile markets, apparently both asset classes need to be sold in order to maintain ratios. In any event, there are now two very public explanations for why bonds are weak. And when the easy explanations pop-up, then it’s almost certain that the weakness is over, and stronger hands are there to accumulate the weakness. EM currencies are weak. That’s been going on for a while…Brazil real at new low this morning 3.6987…but at some point the reserve selling eases. If a true financial crisis is again lurking, bond yields will fall. And the Fed will not tighten in two weeks, regardless of NFP.
–Today’s data includes Factory Orders expected +0.9 and ADP expected 210k
Sept 1. POTENTIAL effects from China…
At this moment, we are following developments in the Chinese economy and their actual and potential effects on other economies even more closely than usual. Stanley Fischer, from his Jackson Hole speech.
–What are some of the potential effects? As an example consider that S Korea’s exports in August, (often considered a canary in a coalmine), fell 14.7% in August. China’s Caixin PMI was only 47.3. Global stocks are down, and US treasuries, having suffered a weak close and early downside follow-through last night, are now higher. ESU -47.00 as of this writing. Still think the Fed is going to tighten in 16 days?
–The big news yesterday of course was oil, which rallied 30% from the absolute low to high in just five sessions. However, it’s having a setback this morning due to China. In terms of other broad trends, many have NOT reversed. For example, the Brazilian real is still making new lows, and other EM currencies remain under smothering pressure. Going into today’s Construction spending data, lumber is at multi-year lows.
–Eurodollar curve was slightly flatter yesterday with reds -2.125 and golds -0.75 for a pack spread of 134. Volume yesterday was fairly light, with bunds leading the way lower for the US, supposedly due to China selling.
–News in the US today includes mfg PMI expected 53 and ISM at 52.8.
August 31. Fischer and the China Shock
THEMES:
- Inflation transitory but China is a new potential shock
- Even observers in China think the devaluation might be underestimated
- The one constant Fed theme is that of GRADUAL tightening
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I think there are only three voices that matter on actual timing of the US rate hike: Yellen, Fischer and Dudley. Yellen is seen as more dovish, Dudley walked back from a Sept rate increase this week, which leaves Fischer, and my belief is that if he says no to a hike in September, then it won’t occur at that meeting.
From Fischer’s comments on CNBC Friday and his speech Saturday, it’s pretty clear that his main concern is about China and international developments. He also continues to see factors holding down inflation as transitory, but clearly global stability and US inflation are intertwined, notably through the dollar, which he highlighted in his speech Saturday.
On the CNBC interview with Steve Liesman, Fischer pointed clearly to China as the cause of renewed volatility. Here are some excerpts:
THE CHANGE IN THE CIRCUMSTANCES WHICH BEGAN WITH THE CHINESE DEVALUATION IS RELATIVELY NEW AND WE ARE STILL WATCHING HOW IT UNFOLDS. [US wealth effect?]
WE HAVEN’T SEEN MUCH EVIDENCE OF THOSE DANGERS INCREASING [of staying at zero]. WE ARE OBVIOUSLY WATCHING THEM VERY CAREFULLY BECAUSE WE ARE BEING TOLD ALL THE TIME THAT THEY ARE THERE, BUT WE HAVEN’T SEEN THEM IN A MAJOR WAY.
IT WAS A REACTION TO SOMETHING WHICH HAD THE POTENTIAL TO BE VERY BIG, AND WHICH WE’RE STILL LOOKING AT. CHINA HAS BECOME THE SECOND LARGEST ECONOMY IN THE WORLD.
And here are a couple of quotes from Saturday’s speech:
Thus, it is plausible to think that the rise in the dollar over the past year would restrain growth of real GDP through 2016 and perhaps into 2017 as well. The rise in the dollar since last summer, of about 17 percent in nominal terms, with its associated declines in non-oil import prices, could plausibly be holding down core inflation quite noticeably this year.
At this moment, we are following developments in the Chinese economy and their actual and potential effects on other economies even more closely than usual.
In terms of inflation being transitory, the first big leg lower in crude oil was in January. The dollar index topped in March. One would think that by Q1 of next year, inflation measures associated with both oil and with import prices due to dollar strength would dissipate. If not for China’s devaluation, the case for a rate hike would be clear.
In terms of policy choices for China, it appears they can either use reserves to try to stem capital outflow, or let the yuan slowly depreciate in a controlled manner. Of course they are also taking other policy steps, for example (Reuters) “China’s parliament approved on Saturday a cabinet plan to cap total outstanding local government debt at 16 trillion yuan.”
Another interesting Reuters story has this passage: http://www.reuters.com/article/2015/08/27/china-yuan-idUSL4N1102SL20150827
An influential economist at a top government think-tank said policymakers may have underestimated the global impact from the yuan devaluation, which happened when jitters about China’s slowdown had intensified due to a stock market plunge.
“You chose the timing as the economy weakened and the stock market plunged, sending out a wrong signal to foreign countries that you want to spur the economy through devaluation and leading to competitive devaluations,” said the economist, who last month discussed policy issues with Premier Li Keqiang. “This put us on the defensive; it looks like China is the trigger.”
Just one other note that was NOT directly mentioned by Fischer, the “change in circumstances” includes a potentially large drop in US stocks, which we’ve had a taste of in the past two weeks. BAML notes that the US is 52% of global market cap, and the second largest country by market cap is Japan. US $19T and Japan at $3T. http://www.businessinsider.com/map-countries-scaled-to-equity-market-capitalization-2015-8
IF US equities continue their volatility due to uncertainty about CHINA’S policy choices and the related responses of other countries, then the Fed will be patient. Whether the hike occurs in September or not, the key will be a gradual trajectory. Again from the CNBC interview, “WE’D BE ADJUSTING THE KNOB SLIGHTLY AND WILL PROBABLY WAIT AWHILE BEFORE DOING SOMETHING ELSE.”
In terms of trading strategies, there have been many trades that have become focused on the odds of a hike at the Oct 28 FOMC rather than September. For example, over 100k traded in the EDV/EDX 9950 put calendar, paying 1 for November. This trade settled 1.0 with EDZ5 9953.0. If there’s no hike in Sept, then Oct puts should expire worthless, leaving the November puts long from a cost of 1 going into the Oct FOMC. Even if there is a hike in Sept, EDZ could easily hang around the 9950 strike, allowing at least a scratch on the position. In a similar trade, Oct/Nov Fed Fund spread went out Friday 4.0/4.5. After the initial stock market volatility, this spread was trading only 1.5. The bid in this spread is predicated on no hike in Sept and a chance in October. With the FOMC on Oct 28, the FFV can only price about 13% of the hike, or about 3.25 bps given a move of 25, and November gets the whole enchilada, or 25 bps. The spread would probably be 0.5 bp without any Fed odds, so a 4 bid represents odds of about 16-17% that the Fed skips Sept but goes in October.
With regard to the longer end of the curve, there was week over week steepening, for example red/gold pack spread gained 10 bps on the week. Once again, eyes are on the Chinese, as the concern is that they have sold long dated treasuries and may have considerably more to go. The nearly $5 jump in oil on the week is another factor which tempers the deflation argument and erodes the support for the long end.
On the other hand, if China were to signal further yuan depreciation, the market would likely conclude that currency wars could accelerate, with rather deflationary consequences. The fact that USZ vol remains at the upper end of its range, over 13%, is likely a reflection of that uncertainty, and will probably retain a bid even after Friday’s NFP. Employment is, of course, the big data point of the week, expected 223k with a rate of 5.2%.
August 28. China selling treasury reserves = reverse QE >>>bond yields should FALL
–US interest rates were almost unchanged yesterday despite a 10% jump in oil and a related bounce in stocks (SPX +2.4%). Q2 GDP was much stronger than expected at 3.7%, though Atl Fed GDP now is tracking Q3 currently at just 1.4%. Today’s new includes Personal Income and Spending (both expected +0.4) with Core PCE prices +0.1. The KC Fed’s Jackson Hole Conference has begun. On Saturday there’s a panel consisting of Carney, Constancio, Fischer and Rajan on global inflation dynamics.
–There’s a lot more press about China selling treasuries, and hand wringing about what would happen in China sold its $1.1 trillion in holdings. A bit overdone. Just remember this: in the US, with QE bond buying programs, STOCKS go up and BONDS go down. Without the overt government purchases, bond yields tended to fall because the economy was seen as fragile, and inflation expectations actually fell. Yes, $1 trillion is a lot of money. But why would China completely sell down reserves? It’s a lot easier to simply let the yuan depreciate, which is disinflationary for the global economy. To put China’s reserves in another perspective, they’re about the same size is student loan debt in the US, which is in default to the tune of 17%. What’s the bigger problem? That China might pare back reserves or that $1 trillion of paper is valued a LOT lower than the government is carrying it? I think US auto loans are right $1 trillion as well. Inflation and growth are the main determinants of interest rates; the effects of China selling are likely ‘transitory’, to use one of the Fed’s favorite words.
–Hilsenrath piece yesterday afternoon says many global central bankers and pundits are urging the Fed to hike and get it over with… Not going to happen in September.
August 27. Volatility and risk priced more appropriately
–Yesterday featured a much steeper curve, in follow through from Tuesday, as NY Fed President Dudley walked the market back from the edge of the cliff, saying that a rate hike was “less compelling”. (Actually, a 25 bp hike should be more like stepping off a curb, but such is the fragility of the global financial system that small acts are magnified). Though stocks jumped, many commodities closed at or near new lows…copper, silver, oil. (Seeing a bounce this morning). Sept Copper settled -6.55 or 224.8, the lowest settle for this contract. In terms of the curve, Dudley’s comments helped spark an 8 bp surge in 5/30 to 146, in addition, talk of a GS re-allocation trade with $20 billion to be deployed into stocks by month’s end naturally weighs on the long end (…out of bonds, into stocks). Red/gold euro$ pack spread settled at a new recent high of 140.375, up 5.5 on the day.
–January ’16 Fed funds settled 9972, more or less indicating only a 50/50 chance of a rate hike prior to year end. Though Dudley mentioned “the data”, it’s not about the data anymore, it’s all about financial stability and the price of risk. Today the KC Fed’s Jackson Hole Symposium starts, “Inflation Dynamics and Monetary Policy”. Perhaps I can sum it up…a zero rate policy destroys capital, promotes excessive risk taking in financial assets, and casts a deflationary pall over the economic landscape.
–Today’s news includes Q2 GDP expected 3.2%, Jobless Claims 270k, and the 7 year auction.
–As an aside, there is an article about tech start-up trends on Business Insider, and there was an interesting point: “Security is the new hot ticket”…protection against hacks. The other note is “Social start-ups are dead”. Maybe part of a broader trend a bit more toward reality and away from frivolity?
http://www.businessinsider.com/lessons-from-146-startup-pitches-in-a-row-2015-8
