July 26. Negotiations stall, leading to an economic disaster? Yup, that’s Chicago…
–Yields closed the day a bit higher with tens up 2 bps to 239, even as Greek and Chicago Teacher’s Union talks stalled. Twin economic disasters, but I’d rather negotiate with the Greeks. Perhaps more importantly, US equities are starting to slip. Though there was a lot of coverage given to the surge in healthcare stocks as Obamacare held up to a Supreme Court challenge, the Dow Jones Transports closed at a new low for the year. The Dow Jones Composite isn’t quite at new lows, but it’s close. And of course the Shanghai Composite continues to flare out, down 7.4%. The easy assumption today is that US fixed income will maintain a bid as fears of failure in Greece dominate. However, the long end of the market continues to struggle. It’s July treasury option expiration today, and while there have been some buyers of the 126 strike, tens look to peg 125.5. (The July, today’s expiry, 125.5^ settled 21/64’s). But beware of the possibility of USU breaking through the 149 strike.
–There was a time, I think back in 2013, when green midcurve straddles were higher in absolute price than blues and golds as tightening fears first gripped the market. Recently all the blue midcurve atm straddles have traded 2 higher than greens, and now more like 3. For example, Green Sept 9800 straddle settled 34.5 while Blue Sept 9750 settled 37.5. Gold Sept, (5th year out) settled 39.0, 4.5 over the green. Seems a bit high to me, but given a gradual pace of expected tightening and weakness in the long end of the curve, it makes sense.
–From BBG today on EZ lending: “Bank loans to companies and households increased 0.5 percent in May from a year earlier, the most since February 2012, European Central Bank data showed on Friday. Loans posted annual declines every month from May 2012 until February 2015.” Signs of improvement…
June 23. Copper and the curve
–The euro is down 116 this morning to 1.1234 as the realization sinks in that europe is stuck with Greece. Monday’s trade was mostly related to an unwind of positions associated with the possibility of a Greek accident. 2/10 spread jumped a whopping 5.7 bps as tens completely erased Friday’s move, rising 9.3 bps to 235.8, right back to where they were at the end of Thursday (234.9). 5/30 closed at 150, threatening the top end of its recent range. Gold as well gave away a substantial amount of last Thursday’s rally, falling $17.
–Today’s news includes Durables expected -1.0 but +0.5 ex transportation. New Home Sales expected 523k. Treasury auctions kick off with today’s 2 year.
–Chart below shows Copper (red) versus 5/10 treasury spread. Copper has been quite weak since mid-May, and falling copper typically seems to be associated with a flatter curve. Probably of little significance on its own, though falling industrial commodity prices are a red flag regarding US growth.
June 21. Kruger Industrial Smoothing
KRUGER INDUSTRIAL SMOOTHING
Themes
1) Fed’s fear of commitment
2) Greece
3) Eurostox/VIX, Global stocks
4) Bond Street
Week to week changes on selected prices:
| 6/12/2015 | 6/19/2015 | chg | |
| UST 2Y | 72.2 | 61.7 | -10.5 |
| UST 5Y | 173.3 | 157.4 | -15.9 |
| UST 10Y | 238.5 | 226.5 | -12.0 |
| UST 30Y | 309.5 | 305.7 | -3.8 |
| GERM 2Y | -18.4 | -20.4 | -2.0 |
| GERM 10Y | 83.4 | 75.2 | -8.2 |
| EURO$ Z5/Z6 * | 89.0 | 81.0 | -8.0 |
| EURO$ Z6/Z7 | 64.5 | 63.5 | -1.0 |
| *peak one-yr spd | |||
| EUR | 112.57 | 113.52 | 0.95 |
| CRUDE (1st cont) | 59.96 | 59.61 | -0.35 |
| SPX | 2094.11 | 2109.99 | 15.88 |
| VIX | 13.80 | 13.96 | 0.16 |
On Seinfeld, one of George Costanza’s employers was Mr Kruger, the apathetic head of Kruger Industrial Smoothing. That’s the mantra for the Central Banks of the world: Industrial smoothing. But, as with Kruger (and George), it doesn’t always go according to plan. “Watkins, you’re having a t-bone too? Then we should call you ‘T-Bone’.
In the US of course, the big deal was last week’s FOMC, and Yellen’s tepid stance in terms of raising rates. We saw the dots move lower. We knew that 2015’s growth forecast had to be trimmed given weakness in Q1. (Although in his speech on Friday, SF Fed’s Williams dismissed Q1’s result with the magic of re-seasonal adjustment and “…something called GDP Plus, a new measure that…strips out the extraneous noise.”) As Mr Kruger would say, “I’m not too worried about it George.”
We saw a large decline in yields with tens falling 12 bps to 226.5. The market is taking the Fed at its word that the pace of tightening will be gradual. The peak one-year Eurodollar calendar spread fell 8 bps on the week, from 89 to 81, from closer to 4 hikes in a year to more like 3. Unsurprisingly, the dollar fell in the aftermath of the Fed. Yellen repeated she is more worried about the trajectory of rate hikes than the timing of the onset. Williams in his speech on Friday mentioned the trajectory of inflation (concerned that it might not hit and sustain the 2% target), but also said he would favor two hikes this year. “My own forecast would be having us raise rates two times this year,” he said. “But that would depend on the data.” NOTE: On Monday the NY Fed will release its new Economy Snapshot. http://www.newyorkfed.org/newsevents/mediaadvisory/2015/0619_2015.html
Though some now call for the timing of the first hike to be deferred until December (Hatzius), RBC’s Cloherty made this point: “Launching a tightening cycle a week before Christmas when everyone is terrified about liquidity seems like an awful idea. If the Fed skips Sept, we will move all the way out to 2016 rather than assuming that the Fed will start tightening in an illiquid market at an illiquid time of year.” It’s hard to argue against that point. However, with EDU5 at 9962 and October Fed Funds at 9978.5 (just 8 bps below July), the market is pricing less than 50/50 for a September move.
The other factor driving down yields on Friday is lack of movement on Greece. According to several reports, capital controls are likely to be instituted after Monday. Certainly there is a flight to quality trade, as implied vol in treasuries is again favoring higher strikes. On a week to week basis, the 5/30 treasury spread rose 12 bps. The long bond was very weak after Yellen’s press conference, which probably gives more of a pure signal on the curve than Friday’s trade, which was driven by the Eurozone situation. Five year was the star performer, down nearly 16 bps on the week to 157.4.
Another reflection of stress in Europe is noted on a zerohedge post, “Europe’s VIX has never been higher relative to the US VIX… ever.” http://www.zerohedge.com/news/2015-06-19/europe-has-never-been-riskier While US VIX is around 14, Europe is close to 30. The gold/silver ratio is also quite firm at 74.5. It posted a high of 85 in Q4 2008, a low of around 32 in Q2 of 2011, and has been grinding higher ever since. (In 2015 it’s been in a relatively narrow range of 70-75). On Friday US stocks reversed some of the relief trade associated with an easy Fed, as SPX closed down 11.0, though still up nearly 16 on the week. It’s worth noting that the Shanghai Comp fell 13% on the week. A continued reversal in China along with the crystallization of the EU’s dilemma – if capital controls and depositor losses are imposed on Greece – will surely spill over into the US, and put risk aversion back into the driver’s seat globally.
One other quick topic regarding the Fed: technology, and monetary policy. BusinessInsider ran a feature on Bond Street, a start-up firm that lends to small businesses. http://www.businessinsider.com/bond-street-raises-110-million-2015-6 This company has harnessed new technology to make loans to small business in a fraction of the time that an ordinary bank would take. “He might have paid 2% more with us, but it was a no-brainer for him to be able to open his store and work with people he likes and have that process feel very transparent.” The article notes Jamie Dimon’s warning that Silicon Valley is coming and will shake up the financial world. Peer to peer lending has already become a huge force. In the Dow Jones US Mortgage Finance Sector, Lending Club (LC) at a $6.4b market cap (went public in 2014 at $870 million), is now larger than the next four companies in the index: Nationstar NSM, Ladder Capital LADR, Ocwen OCN, and Lending Tree TREE. [thanks JD]. How does this rapid technology and transparency affect monetary policy? Obviously, it’s not always the RATE that matters, it’s access and availability of credit, and those factors have likely improved by a huge order of magnitude. Should we really be wringing our hands over a 25 bp move?
June 18. Fed aftermath
–It was fairly uneventful going into the Fed meeting, though the long end of the treasury curve traded on the weak side. As it turned out the Fed was relatively dovish. Both TYU and USU had outside days, but the tens closed higher on the day and bonds lower. According to the marks at floor settlement, 5/30 rose over 6 bps to 144.8. Ten year cash yield was essentially unchanged at 231.1. Thirty year bonds were up 2.5 bps to 307.5. Stocks were essentially unchanged and searching for direction, ESU had a range of 2078.75 to 2098.75 and settled right in between at 2089.25.
–As expected, the dot plot average shifted lower. Though most of the press looks to the median, the actual 17 dot averages went from 77.2 to 56.6 for the end of 2015, and 202.2 to 175 for 2016, a drop of over 25 bps. EDZ5 closed 9941.5, about 30 bps below the just expired June contract, essentially forecasting just one hike prior to year end. Jan 2016 Fed funds settled 9961.5, versus FFN (July) at 9986.5, a difference of exact 1/4%. The 2016 dot average of 175 compares to EDZ6 settlement of 9856.0 or 144 bps. So while the Fed moved its forecast lower, the market still figures the end of year 2016 to have a FF rate of just 1.00-1.25%. We might finally be getting to the point where the mountain comes to Mohammed, i.e. that the market (from 2016 on) will begin to sell off slightly to align with the prognostications of the Fed seers. The reticence of the Fed chair to speak hawkishly should, at some point, create angst for the long end, though Greek exit fears may yet keep a bid in US fixed income from tens in. Not this morning though, as all interest rate futures are higher and the dollar is going lower.
–Summary: dots lowered, dollar gets hit, curve steepens, Greek problems and Fed doves support the belly.
June 17. FOMC meeting and a few notes on start-up tech companies
–Fed meeting this afternoon with its Summary of Economic Projections. Almost certainly the dots will move slightly lower and the 2015 economic growth forecast will be trimmed as well. Yields yesterday drifted lower, with tens down another 4.5 bps to 231.3. 2/10 flattened by 3.2 to 162.8.
–At the last SEP, the difference between the dot average for the end of 2015 and the end of 2016 was around 125 bps. If one simply looks at the core cluster of about 10 dots, ignoring the high and low outliers, then the difference narrows to about 100 bps. But the market still has the EDZ15/EDZ16 spread at just 86.5 bps.
–Interesting article on Business Insider yesterday about VC’s and start-up tech firms. http://www.businessinsider.com/whats-a-dry-bubble-from-bill-gurleys-tweet-2015-6
The gist of the post is that the gap between unrealized valuations and ‘cash-out’ to limited partners is at a historic high. Firms are being valued at sky high levels, but until there are buyouts or IPOs, the “value” remains unlocked. From the article, “So for now at least — it’s a roach motel. All this money is going in at higher, all time higher, valuations — but very little is coming back out.” If you go to the link, embedded in the post is a power point from Andreesen Horowitz outlining several aspects of funding for tech start-ups, and it shows mostly moderate levels of funding, i.e. scant evidence of froth. However, there are a couple of rather interesting panels: “As IPOs are delayed, returns move from public to private investors. Thus, traditional public market investors and buyout funds, who would not typically invest in companies at this stage, have moved into the private markets.” And…”The collapse in the cost of creating tech companies in the last two decades means many more are being created. With each needing less money to get started there are a lot more small [funding] rounds.”
–It seems to me that if the cost to get in has collapsed, i.e. barriers to entry are low, and “new” investors are jumping in, then many of the pre-IPO valuations are probably too high. Which could have negative implications for listed firms as well.
June 16. Heavy put selling (liquidation) in US tens
–Yields declined and stocks fell as the situation in Greece doesn’t appear any closer to resolution. Additionally, economic data released Monday was soft, with Industrial Production -0.2 vs expected +0.2 and Empire State survey at -2 vs expected +6. The ten year yield dropped 2.7 bps to 235.8. Green and blue eurodollar packs closed +3.5 on the day. 5/30 treasury spread steepened by 2.8 to 139, as the 30 year bond underperformed on the rally (yield down only 0.7 bp).
–There was heavy liquidation selling on the day in TYQ and TYU 123.5 puts. Open interest fell in both, down 31k in August and down 19k in September. Because of this selling, implied vol was down across the treasury complex. For example, TYU 125.5 straddle was 2’36 Friday but settled 2’30 yesterday, down 0.1 to 5.8. Risk off, with wider peripheral spreads in Europe: Italy +14, Spain +16 and Portugal +21 to 236, 240 and 321. Yields this morning are up another 9, with Spain at 249, right where the US ten year yield traded last week.
–Stocks are under pressure, testing last week’s lows.
–Last week, a Colt .45 revolver owned by General Patton, sold for $75,000 at auction. http://www.foxnews.com/science/2015/06/12/colt-45-revolver-owned-by-patton-fetches-75000-at-auction/
Yet, the iconic gun maker declared bankruptcy yesterday, “…in large part because of more than a decade of dubious financial engineering and accumulating debt.” According to the Bloomberg article below, the private equity firm that controlled the firm saddled the company with too much debt.
Even in a low interest environment, high debt levels can be deadly, but the situation is exacerbated, of course, when rates begin to rise.
June 14. Marking time to the FOMC
Themes
- US Treasuries hit important levels and hold
- Continued improvement in labor
- Flow of funds Z.1 report; strong corporate debt growth
- FOMC projections and dots
—————————————-
Week to week changes on selected prices:
| 6/5/2015 | 6/12/2015 | chg | |
| UST 2Y | 71.7 | 72.2 | 0.5 |
| UST 5Y | 173.7 | 173.3 | -0.4 |
| UST 10Y | 240.0 | 238.5 | -1.5 |
| UST 30Y | 311.1 | 309.5 | -1.6 |
| GERM 2Y | -17.8 | -18.4 | -0.6 |
| GERM 10Y | 84.4 | 83.4 | -1.0 |
| EURO$ Z5/Z6 * | 90.5 | 89.0 | -1.5 |
| EURO$ Z6/Z7 | 68.0 | 64.5 | -3.5 |
| *peak one-yr spd | |||
| EUR | 111.14 | 112.57 | 1.43 |
| CRUDE (1st cont) | 59.13 | 59.96 | 0.83 |
| VIX | 14.20 | 13.80 | -0.40 |
Overall, not much net change on the week in terms of bond yields. Last week we mentioned yields were approaching important levels, for example 250 in tens, the 0.618 retrace from the high of 2014 to low of 2015 (303 to 164). On Thursday morning after a somewhat stronger than expected retail sales report, that level was achieved and held, spurring a short cover rally. Friday’s close was 238.5 (at futures settlement; TYU5 125-100s). The thirty year bond yield has been hovering around the 50% retrace of its 2014 high yield of 397, to 2015 low of 222, which is 309.5, the exact closing mark on Friday. (The 0.618 retrace is 330). German bunds also continued a push to higher yields, hitting 105.6 Wednesday morning. However, by Friday the bund yield came back down to 83.4, actually down 1 bp on the week. But peripheral yields jumped as the situation with Greece failed to improve: JUNCKER TOLD TSIPRAS THIS IS FINAL ATTEMPT FOR DEAL. On Friday morning Italy tens surged to 230, having been near 1% in March. Interestingly, EUR closed higher on the week at 112.57 from 111.14 last Friday.
In terms of US economic data, labor market indicators continue to improve. For example JOLTS released Tuesday showed job openings of 5.376 million, a new high, having doubled in the past five years. A Bloomberg article Friday, “Here’s one labor market indicator that’s soaring”, highlighted a 20% jump in Q4 earnings of Korn/Ferry, the world’s biggest headhunting firm. “Last night, the company reported that activity levels picked up — especially in North American executive search, up 10 percent year-over-year.” The Atlanta Fed’s GDP Now projection, which in late May was 0.7% for Q2, surged to 1.9% on June 11, as data strengthened. The nowcast for Q2 real consumer spending growth jumped from 2.1% to 2.9% following vehicle sales data and the retail sales report. Friday’s PPI headline release of 0.5 is another factor that should support higher yields, though the Core yoy growth was only 0.6.
Also released last week was the Fed’s Flow of Funds report Z.1. Most of the press looks to this report for information on changes in net worth. But there are a couple of interesting notes regarding domestic debt levels and growth. First, in terms of levels, there are three sectors of nearly equal size: Household (Mortgage and Consumer), Business (Total and Corporate), and Government (Local and Federal). The debt levels at the end of Q1 are $13.6T, $12.2T and $16T (of which Federal is $13). The interesting notes are 1) In terms of household growth, the total is only 2.2% annualized, down from 2.9 in all of 2014. Mortgage growth was actually negative, -0.3. (Can the world really depend on the US consumer?) The strongest domestic debt growth rate was Corporate, +7.2, from 6.5% for all of 2014. And while the Federal debt change was also negative, falling by $53.8 billion, state and local gov’ts more than made up for it, growing by $140.2B.
It’s now well known that that has been significant corporate debt issuance in order to fund share repurchases, and Goldman noted last week that this dynamic is beginning to draw political scrutiny: “Some lawmakers have linked share repurchases with stagnant wages and a lack of business investment and have recently begun to call for regulatory changes to constrain repurchase activity.”
A change in the propensity of corporates to continue propping up shares with buybacks could take away a very important support factor for the market in general.
From the Daily Shot, “Corporate loan balances on banks’ balance sheets are growing at some 12% per year.” St Louis Fed’s FRED:
Commercial and Industrial Loans
Now let’s move to this week’s FOMC. Consider the tables below:
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The last FOMC with a Summary of Economic Projections was March, when the Fed slashed its economic growth forecast, from a range of 2.6 to 3.0 in December to 2.3 to 2.7 in March for 2015, and its 2015 inflation forecast from 1.0 to 1.6 down to 0.6 to 0.8. The dot projections also showed huge declines (Lower table). For example, the end of year 2016 fed fund projection went from 250 bps to 200 bps. Eurodollar contracts, of course, rallied. EDZ16 went from 98.325 on the Friday prior to the Fed to 98.520 on the FOMC 3/18 settlement (98.455 Friday). EDZ17 went from 97.760 to 98.000 (97.810 Friday). You can see from Friday’s settlements that we’re not far away from March 18 end of day levels. Almost certainly the dot averages will have to come down again this week, given the Fed’s repeated guidance of gradual rate increases. However, net changes from March to June are likely to be much smaller than they were from December to March. The March projection of 2.022 would be consistent with a price in EDZ16 of around 97.60 to 99.70. The settlement on Friday was 98.455, consistent with a funds target of 1.25%. The market believes Fed pronouncements that rate hikes will be gradual, the FOMC members are just coming around to that concept…
June 11. Red/gold euro$ pack spread points to a steeper curve
Above is red/gold euro$ pack spread, which closed at a new recent high of 159. (reds -3.25, golds -8.375). As you can see, the high in the beginning of 2014 was 305.75 (when the ten year treasury yield hit 303), and the low this year was 103.75, (low in ten year treasury yield was 164). Essentially a 200 bp range from 300 to 100. the 38% retracement is 181, currently about 20 bps away and a reasonable target.
–Wednesday yields continued on their upside march, hitting important technical levels early in the day and holding those levels, though without any sort of enthusiastic bounce, even after the ten year auction was successfully concluded. In fact tens slipped back down near new lows late in the day. 30 year bond auction today.
–Almost all euro$ calendar spreads made new highs. Peak one-yr is still EDZ5/EDZ6 which rose 2.0 to 92.5. Using the new ten year note, 2/10 hit a new high of 175 bps.
–Retail sales for May expected +1.2 from 0.0, ex-autos +0.8, but given the surge in revolving credit I think there’s a chance of a stronger than expected number. Jobless claims 275k.
–Both New Zealand and South Korea cut rates.
June 10. Yield reflation
–Tens again closed lower on the day, at a new high of 241.7, up 3.5 on the day, and pushed as high as 243 shortly after the close of the floor. This morning the sell off has continued as bunds traded above 1% and US tens (247 as of this writing) are flirting with the 61.8 retracement of the 2014 high 303 to 2015 low of 164, which is 250. Above that there’s resistance at 260-262, the high from mid-September. Treasury auctions tens today and thirties Thursday. Stocks were relatively quiet, though the Dow Jones Composite closed at a new low for the year.
–Not much in the way of trade in interest rate options. There was a large new buyer of August 2 yr 109 puts for 7.5 to 8.5 which equates to around 6 bps of premium. At a close of 109-05.25 in TUU5 the puts are about 7.4 bps out of the money. Two year cash treasuries went out at 70.9, so the strike equates to just above 78 bps; breakeven would be around 84 bps. There was a late buyer of 7k Blue July 9750 straddle for 26.5 (settlement price) …note that June midcurves expire Friday and a huge amount of open interest that was built up in expectation of a June rate increase will simply vanish.
–For whatever reason, bonds are in a bear market. Yesterday’s JOLTS data of 5.376 open jobs continues to show labor market improvement, and the Atlanta Fed’s Wage Growth Measure (released Friday) was getting some play yesterday; it showed an increase of 3.3 yoy in April.
–Crude oil surged yesterday after an unexpected inventory draw down. Now trading 61.50, the contract is up around $3.50 since Monday’s close
June 8. Strong Consumer Credit report Friday afternoon
–Consumer credit was up another $20.6 billion in April (data released Friday), but the interesting part is the surge in revolving credit which had been sluggish…it was up at a rate of 11.6%. (Doesn’t really square with the weak retails sales report that came out in April, but perhaps Thursday’s report will be a blockbuster). The only real deleveraging since the onset of the crisis occurred in the household sector, could it now be changing? The Financial Obligation Ratio for households [Household debt service payments and financial obligations as a percentage of disposable personal income] at the end of 2014 was 15.27%, close to its lowest level in the past 35 years. Low has been 15.04 and high 18.09. The story is different with corporate debt, which is at record levels and growing.
–Friday’s employment report solidified expectations of a rate hike this fall. Some of the near one-year calendar spreads were able to close at new highs. For example EDZ5/EDZ6 closed +5.0 to 90.5, though last month’s range has been pretty tight at just 79.5 to 90.5. EDZ5/6/7 fly closed at 22.5 with EDZ6/EDZ7 at 68, up 2. There is a large long position in EDZ6/7 from the low 60s. Ten year note yield closed at 240, up 9.3 bps, through the 50% retracement level (233.5) of the 2014 high of 303 to the 2015 low of 164. The 61.8 retrace is 250, which should provide strong resistance over the short term.
–Turkish lira at a new low on surprise election results, but new lows as well in the ringgit and rupiah. China exports fell just 2.5%, better than expected, but imports plunged 17.6%. Echoes of the 1997/98 Asian crisis...
