June 7. Weekly summation
WEEKLY COMMENT
Themes:
- Employment/wage data improving, supporting the idea of somewhat higher inflation going forward. Lift off priced for September.
- Global bond yields breaking out to the upside; UST, bunds, jgb
- Change in stance from Fed and ECB on bouts of volatility
- Dollar strength v EM
- Greece
- Market panic in short rates?
Week to week changes on selected prices:
| 5/29/2015 | 6/5/2015 | chg | |
| UST 2Y | 60.7 | 71.7 | 11.0 |
| UST 5Y | 148.6 | 173.7 | 25.1 |
| UST 10Y | 218.0 | 240.0 | 22.0 |
| UST 30Y | 288.2 | 311.1 | 22.9 |
| GERM 2Y | -22.5 | -17.8 | 4.7 |
| GERM 10Y | 48.7 | 84.4 | 35.7 |
| EURO$ Z5/Z6 * | 79.5 | 90.5 | 11.0 |
| EURO$ Z6/Z7 | 56.5 | 68.0 | 11.5 |
| *peak one-yr spd | |||
| EUR | 109.86 | 111.14 | 1.28 |
| CRUDE (1st cont) | 60.30 | 58.94 | -1.36 |
The employment report was stronger than expected with NFP +280k at a rate of 5.5%. From DB’s Torsten Slok: “…over the past 12 months the Employment Cost Index has been trending higher and we are now also seeing avg hourly earnings growing at the fastest rate in five years.” Avg hourly earnings were +0.3%, with yoy +2.3, but in the past three months an annualized rate of 2.9%.
As can be seen from the above table, yields surged this week, with the 5yr up ¼% to 173.7 (9.6 of that rise was Friday). The belly of the curve led the way to higher yields. 2/10 treasury spread rose an impressive 11 bps on the week to 168.3, though it fell a couple of bps Friday as the market priced more certainty into a September lift off. October Fed Funds settled 99.725 which is 14.5 bps higher than the front FFM5 contract settle of 99.87. So the FF contract indicates approximately 60% odds of a hike in September, as does EDM5/EDU5 spread at a settle of 15.0; EDM5 99.71 and EDU5 99.56. Given Friday’s data and Thursday’s Productivity of -3.1% with Unit Labor Costs +6.7%, I would put the odds of a September hike higher, though perhaps the IMF’s plea for the Fed to hold off until 2016, and EM currency weakness (more on that below) is giving the market pause.
It’s not just the US that is seeing stronger inflation data. On Tuesday the Bund yield jumped 17 bps to 71 as EZ CPI was released at +0.3% vs +0.2 expected with yoy Core +0.9% vs 0.7 expected. Other EU bond yields also jumped, for example Italy rose 15 on Tuesday to 212. The surge in German yields has been breathtaking with a close Friday of 84 bps (having neared 100 bps on Thursday), from a low of 7.5 in April. JGB’s have also broken out of a long term trend, closing near 50 bps from a low around 20 at the beginning of the year.
US companies are clearly increasing debt issuance to take advantage of low rates before the window closes. In the first five months of 2015 the monthly average issuance of IG debt was $118.3b, versus $102.3 in the first five months of 2014, an increase of 16%. On the HY side the gain was 5.4% from a monthly rate of 29.5 in 2014 to 31.1 in 2015. (Data from SIFMA). This is another factor weighing on rates. On a related note both HYG and JNK (hi-yield ETFs) had downside breakouts this week, with both closing at lows last seen in February and March when concerns about energy companies had hit their peaks as crude oil was at its lows, sub $50.
Adding to the sense of trend change in global bond yields is a perhaps subtle shift in central bank communication. Draghi, (not so subtly) said “Markets must get used to periods of higher volatility.” In his speech on June 1, Stanley Fischer said, “…it is not clear that there are sufficiently strong macroprudential tools to deal with all financial instability problems, and it would make sense not to rule out the possible use of the interest rate for this purpose, particularly when other tools appear to be lacking.” FRBNY William Dudley said in a speech on Friday, “…lift-off may not go so smoothly in terms of the impact on financial asset prices. After all, lift-off will represent a regime shift after more than six years at the lower bound.” He goes on to say “…there must be considerable uncertainty about the path for short term interest rates. After all, the economic outlook is uncertain.” The message seems to be that central banks are willing to accept more turbulence in financial markets going forward. If true, and it’s a BIG if, then it’s clearly a game changer in terms of psychology.
Given the increasing odds for the Fed to hike rates this year, perhaps it’s not too surprising that emerging currencies are seeing renewed weakness against the dollar. For example, the Mexican Peso made a new low, as did the SA Rand, and Indonesian Rupiah. Even the yen made a new recent low, with JPY 125.6. However, the euro ended higher on the week versus the dollar, in spite of Greece upping the ante by deferring a June 5 payment to the IMF. Note that in 1998 there was also severe weakness in emerging market currencies and a 50% drop in the price of oil, and in late summer of 1998 the SPX fell 20%. http://www.traderplanet.com/commentaries/view/168117-warning-similarities-between-1998-and-2015/ Both Brainard and Dudley mentioned dollar strength and its restraint on inflation in speeches this past week.
A client on Friday asked for odds on that there could be a mini-panic in red and green Eurodollars (2nd and 3rd years). I would note that the five year treasury faces extremely strong resistance around the 180-185 yield level, which is only 7-12 bps from here. (There have been several highs between 180 and 185 since September 2013.
FIVE YR RESISTANCE 180-185
Additionally, from the perspective of possible rate hikes at Fed meetings, I would note that the peak one year spread (EDZ15/EDZ16) is below 100 bps at 90.5, indicating less than 4 hikes of 25 bps per year. Second, if the Fed were to hike in September and December and every quarter going forward, then by September of 2016, there would have been 5 rate hikes, perhaps up to 1.25-1.50%. EDU6 is 9869 or 131 bps, a level consistent with a FF target of around 1%. That leaves downside room of course, but not a tremendous amount. The other clue concerning limited downside comes from the underperformance of otm puts. For example, consider 0EZ 9850/9800 put 1×2. On Thursday, this structure settled 7.0 (20.5/6.25) with 10 delta against a futures price of 98.55. On Friday, with futures down 9 bps to 98.46, it settled 9.25 (and was better bid interday). In other words, with a 10 delta it should have moved about 0.9 tic, but was actually up 2.25, showing underperformance of otm (98.00) puts. Similar in FV. For these reasons, downside in the first 2 ½ years or so should be limited, or at least that’s what the market is saying. Note as well that 2016 is an election year, so if the Fed is sensitive to political pressures, then the actual pace of tightening might well be slower than otherwise. Additionally, Janet Yellen is skipping the August 25-27 Jackson Hole symposium sponsored by the Kansas City Fed.
On a technical note, the thirty year bond closed just above halfway back (in yield) of the move from the high in 2014 of 397 to the low in 2015 of 222. 50% is 310, and the close was 311. The 61.8 retrace is 330. In tens, the halfway back point is 233.5, and 61.8 is 250. Friday’s close was 240.
June 4, 2015. Greenspan put RIP
–Rates continued their march higher, with tens up another 10 bps to 236 (239 this morning). Moves from Friday’s close have been eye-popping: US Tens up nearly 1/4% from 212 to 236. Bunds up a whopping 39 bps from 49 to 88 (and 99 this morning!). Same story in back month euro$’s, for example EDU8 closed at 97.78 Friday and 97.485 yesterday, 29.5 bps. Even what had been relatively tame calendar spreads had large moves. Dec’16/Dec’17 euro$ spread has seen notable volume. On Friday it was 56.5, but closed 69 yesterday. Adding fuel to the fire Draghi said “Markets must get used to periods of higher volatility.”
–Though the Fed has been continually emphasizing the idea that rate hikes will be gradual, there seems to be a subtle shift in central bank communication, (perhaps not so subtly by Draghi, but more so by Fischer), that markets may again become the vehicle for price discovery, that the change may be messy at times, and that central banks shouldn’t be expected to step in at every sign of stress. That’s a huge change. Can we extrapolate to say that perhaps the Greenspan/Bernanke “put” is no longer in place?
–With the employment report looming Friday, and bonds already having seen huge declines, the psychology becomes interesting. “How can I sell now? It’s already WAY overdone and if jobs data are weak we’ll have a complete turn around.” Note: It’s NOT that the Fed moved up its tightening schedule. January 2016 Fed Funds were unchanged at 99.60, indicating one hike by the end of the year. This is driven by the long end, and the authorities may have lost control. I’m sure the TV commentators will say the ‘safe’ things…that this bond rout will provide a buying opportunity in stocks. That German yields had become too low and this is all driven by Greece and is a normal correction…has very little to do with the US. But Japan’s yields are pushing higher as well, to 49 bps, the highest level of the year and through a downward sloping trend line in place since 2013. The mentality of capturing a few straggling bps of extra yield has just been crushed. Everyone that needed to buy bonds (except the ECB) has already done it.
–The dollar index declined yesterday as the EUR surged to 112.70 (and 113.50 this morning).
–Today’s news includes Nonfarm Productivity expected -3.0% and Unit Labor Costs for Q1 expected 6.1. Jobless Claims expected 278k.
June 3. Beware the bond bear
–Bond markets were hammered yesterday as eurozone inflation increased more than expected with yoy Core CPI +0.9. US ten year yield jumped another 7.4 bps to 226.4. Curve was again steeper on the dollar curve, with red/gold euro$ pack spread up 7.375 to just under 145 bps. Heavy buying in EDZ6/EDZ7 one year spread, which closed up 4 bps on the day at 64.0. Nice roll on this trade as the one-yr spread in front, Sept16/17 is 72.
–The market appears to be shifting towards a GLOBAL bond bear. Even JGB’s are 43 bps, up 8 bps on the month, and through a long term trendline. Implied vol remains somewhat subdued however. I marked Sept TY vol unchanged at 5.8. The premium sellers have been programmed to fade every bounce. That strategy is long in the tooth. Almost every day there are articles bemoaning lack of liquidity. Lack of liquidity in a bear market equals higher vol and wider spreads.
–Interesting article on Business Insider noting heavy bond issuance driven by share buybacks and M&A>
http://wolfstreet.com/2015/06/02/last-two-times-this-happened-stocks-crashed-record-m-a-boom-share-buyback-boom/#ixzz3bzUa3T8j
“Bond issuance has totaled over $100 billion per month in the US for the past four months, the longest such streak ever, according to Bank of America Merrill Lynch. And that record issuance doesn’t account for the booming “reverse Yankee issuance,” where US corporations take advantage of the negative-yield absurdity Draghi has concocted in Europe and issue euro-denominated bonds…”
“In April, S&P 500 companies announced an all-time record of $133 billion in buybacks. It’s attracting the ire of the largest money managers in the world.”
June 2. Paper claims…wealth, until a spark starts a fire
–Rate futures came under heavy selling pressure Monday though volume was light. Active corporate issuance schedule combined with better than expected ISM was the main factor. Though Core PCE deflator was just +1.2% yoy, ISM prices were 49.5 vs expected 43. In addition Fischer’s speech about lessons learned in financial crises had this snippet, “…it is not clear that there are sufficiently strong macroprudential tools to deal with all financial instability problems, and it would make sense not to rule out the possible use of the interest rate for this purpose, particularly when other tools appear to be lacking.” I.e. sometimes rates need to be increased to wring out financial excess. Anyone see a chart of margin debt recently? http://www.businessinsider.com/stock-market-margin-debt-2015-5
–Ten year yield rose 9.5 bps to 219. In euro$’s greens, blues and golds all fell more than 10 bps (-10, -10.875, -11.375). The curve steepened with red/gold pack spread +5.125 to just under 137.5.
–In terms of corporate issuance, note that corporate debt is already at a record level of $7.6T as of the end of last year, at a growth rate of 7.5% in Q4 2014. In all likelihood those numbers have accelerated. Makes sense for companies to borrow at these low rates, but balance sheets on the whole become more vulnerable, something that Fischer seems to be concerned about. As Doug Noland said in his last missive, “Never have such enormous quantities of global securities and financial instruments been perceived as safe or low-risk (“money-like”)”… further noting that these paper claims constitute much of the ‘wealth’ of the modern world. Though there’s still demand for long dated assets (Petrobras issued 100 year paper at 8.45%), the rate structure in much of the developed world doesn’t appear to compensate for risk. There’s an interesting post on ZeroHedge citing Citi about the downgrade feedback loop:
And they’re talking about Chicago and its new status as junk. When it starts to go bad, it happens all at once.
–But it’s not just in the financial world where an unexpected explosion can occur…”Continuing a recent pattern of military exercises conducted with Pacific allies, the United States began major anti-submarine drills with South Korea on Monday. The largest of its kind, the exercises are meant to counter a perceived threat from North Korea.” What could go wrong?
June 1. Black sea, black swan
–Friday’s revision of GDP to -0.7 wasn’t much of a surprise, and was actually slightly better than expected. However, Chicago PMI of just 46.2 was much lower than expected. Could it be that Illinois/Chicago fiscal troubles are beginning to take their toll? From BBG: “Chicago won a partial reprieve from its pension burden Sunday, as the Illinois General Assembly cut by more than $200 million the city’s required 2016 payment into underfunded police and fire retirement systems.” It’s not clear that the governor of Illinois will go along with this plan to kick the can further down the road. Illinois spreads are widening.
–Oil was up over $2.50 bbl Friday in part due to fires in Alberta that are impacting oilsands production. Oil sands extraction directly accounts for 2% of GDP, but total energy extraction and support activities account for 6% of GDP, BAML says. Expect it to shave 0.1 to 0.3 off GDP, with an even more deleterious effect if the fires continue. http://business.financialpost.com/news/economy/the-alberta-wildfires-that-are-shutting-down-the-oilsands-could-wallop-canadas-gdp According to BMO consensus estimates for Canada GDP in 2015 have fallen from about 2.5 to below 2% recently, with BMO’s est at about 1.5%. The Canadian $ is weaker this morning against USD, as are all currencies, with EUR back near 109. EM currencies remain under pressure, (for example the Mexican Peso has been weakening all year with USD/MXN closing in on the year’s high of 15.67.
–What do you call a black swan that anyone that scans the news can see as clear as day? Tensions between the US/China and US/Russia continue to escalate. From ZH: Russian military aircraft were scrambled to head off a US warship acting “aggressively” in the Black Sea. China continues to build islands as military installations in the South Sea in disputed territory. It would seem that US military assets are spread a bit thin. China official PMI today was 50.1, just barely showing growth. Are military exercises a good distraction for underlying economic malaise?
–US data includes Mfg ISM expected 51.8. Friday’s market action featured weak stocks and a flatter curve. Ten year yield fell 3.5 bps to 209.5. Red/green euro$ pack spread made a new low of 61 bps, down 1.375 on the day. The range this year has been around 51 to 72, so right about in the middle. Euro$ one-yr calendar spreads remain low and stable, suggesting very gradual rate hikes. The Fed’s last “dot plot” in March showed an expected FF rate of around 3.2% in 2017. The 2017 euro$ pack averages to a price of 98.27, a rate of 1.73, more consistent with FF target of around 1.25 to 1.5%, around 175 bps lower than Fed dots. The market has become more comfortable with a terminal rate of around 2%. By the way, the Fed’s estimate in March for 2015 GDP was 2.3 to 2.7%, which itself was a downgrade from December’s guess of 2.6 to 3.0. With H1 looking like zero growth, how much lower will the Fed project Q1 GDP?
BIG DIVERGENCE BETWEEN TRANSPORTS AND SPX
Some people are suggesting that today’s softness in stocks is a result of month end rebalancing. Transports seem to suggest something more.
As one of my smart clients said “When one index related is going sideways, and the other is showing a clear direction, the one showing the clear direction is the true signal”
TRANSPORTS VS SPX
May 29. Sugar and oil
–Revision to Q1 GDP will be released this morning, expected -0.8 to -1.0. The latest Atlanta Fed GDP Now estimate for Q2 is +0.8. Looks like we’re running just about flat.
–Japan unemployment is just 3.3%, a new pre-crisis low. Ten year JGB is 38 bps. How does that fit with the text books?
–Trade in US rate futures remains quiet. Ten year yield fell from 213.7 to 213. The eurodollar curve steepened, with greens (3rd year; strongest part of the curve) +4.5 but golds (5th yr) up only 1 bp. Peak one-yr euro$ spread is still EDZ15/EDZ16 at just 80 bps, down 2.5 on the day.
–Crude oil started the day making new recent lows, but rebounded as inventories continue to be drawn down (maybe only to be stored on tankers?). In any case, crude is starting this morning up around 70 cents at 58.40. For those that think the oil market has yet to retest the lows, take heart from the overlaid chart of sugar and oil below. Sugar also had a tentative bounce in April…only to make new lows at the end of May. I’m sure the fundamentals of the two markets are quite different, but sugar is used for ethanol production. Brazil is the largest producer of sugar, likely not a good sign for the Bovespa.
Sugar and Crude Oil
May 25. We’re at the point of absurdity
–Interesting quote from Lawrence Lindsey at last week’s Peterson Econ Conference: “We’re at the point of absurdity. Maybe it made sense [ZIRP] when you had a crisis. It does not make sense now. At some point what is going to happen – and this gets to my eight or nine cataclysmic number [on a scale of 1 to 10] – is that we’re going to get a series of bad numbers – a little higher inflation, higher average hourly earnings or whatever – and the market is suddenly going to say, “Oh my God, they are so far behind the curve that they will never catch up.” And the market is going to force an adjustment on the Fed that will be wrenching. That’s the cataclysmic outcome.”
–I don’t know what the timing of such a cataclysmic event might be. However, the reaction to Friday’s Core CPI data at +0.3 seems significant (short end selling; see below). Given improvement in employment data, inflation is the final piece of the puzzle to move rates off the zero bound. Another interesting nugget in Friday’s inflation number is the rise in “sticky prices”. From the Cleveland Fed: “The sticky-price CPI includes many service-based categories, including medical services, education, and personal care services, as well as most of the housing categories which, by construction, change only infrequently.” Some economists believe changes in sticky prices give a better sense of trend with regard to inflation. Friday: ANNUALIZED STICKY-PRICE CPI ROSE 3.5%. Yoy it was up 2.1%, and has been above 2% since last August.
–Yellen, in her comments Friday noted that “…output and job growth over the next few years could prove to be stronger, and inflation higher than I expect, correspondingly, employment could grow more slowly and inflation could remain undesirably low.” There’s another scenario…lower growth and higher inflation. That’s probably the combination to really worry about.
–Inflation is now becoming the market’s main focus. The curve flattened Friday as higher than expected Core CPI of +0.3 sparked a significant reaction in short end contracts. Green eurodollars (3rd year) were the weakest part of the curve, falling 7.5 bps on the day. The two year note rose 4.6 bps, fives 6.4 bps, but tens rose only 3bps and thirty year bonds just 1.
–There were a couple of large option trades which expressed renewed hawkishness on the front end. A buyer of 20k July 9950/9937p spreads for 1.0 and a buyer of 20k EDZ5 9950/9925p 1×2 for 5.0 bps (settled 5.0 ref 9940). This week features auctions of 2’s, 5’s and 7’s. Durable today expected -0.6 with ex-transport +0.4.
————
SOURCES:
https://www.frbatlanta.org/research/inflationproject/stickyprice.aspx
https://www.clevelandfed.org/Newsroom%20and%20Events/Publications/Economic%20Commentary/2010/2010-02%20Are%20Some%20Prices%20in%20the%20CPI%20More%20Forward%20Looking%20than%20Others%20We%20Think%20So
http://research.stlouisfed.org/fred2/series/STICKCPIM159SFRBATL
May 22. I need more cowbell
–Ten year yield dropped 6.3 bps to 218.5 yesterday. Heavy new call buying with another 12k added to open interest in TYU 129c, now up to 70k (biggest strike). New buyer of 6k TYU 128.5/130.5 call spread and 20k TY5K (next Friday) 127.5/128.5 cs for 8. In dollars there was a new buyer of 80k 2EZ 9900c for 2.5 (8 delta, EDZ7 settled 9801.5).
–The curve flattened with red/gold euro$ pack spread falling 3.375 to 140.5. 2/10 treasury spread closed 161.3, down 5.5 on the day.
–Today’s news includes CPI expected +0.1, and Yellen at 1:00 pm EST on the economic outlook. Yesterday both Fischer and Draghi said they needed more cowbell… Fischer, “Eurozone needs growth to survive long term” and Draghi, “…growth is too low everywhere.”
–In terms of a reflation trade, crude oil was up 167 late to 60.69. However, many other commodities remain weak. For example, July Soybeans made a new low settle for this year yesterday. In terms of the agricultural economy, the Kansas City Fed mfg index was horrendous at -13. From BBG: “New orders this month are deeply negative, at minus 19, as are backlog orders at minus 21. These readings, reflecting contraction for export orders and trouble in the energy sector, point to significant trouble for the region’s manufacturing activity in the months ahead.” In looking through data on the KC Fed website, many statistics are right at the lows of the crisis. In Q1, the annual change of farmland prices (irrigated), showed an outright decline. Farm incomes are in a steady decline. “As farm incomes fell, cropland values moderated and more producers depended on financing to cover operating expenses.” Fortunately, the rest of the country relies more on the financial industry than more mundane things like food and energy. Right?
May 15. Mirror image
Nothing earth-shattering here, but chart below is Consumer Sentiment in white vs Crude Oil in red. Mirror image. So all the prognostications about how consumer sentiment levels relate to future consumption should probably be taken with a grain of salt. It’s all about how much it costs to fill up the Ford F-150.
