March 31. Japanese year end. JGB yield bottoming? 5/30 in US bottoming?

Not sure if this chart has much value…just that both JGB’s and 5/30 in the US appear to be putting in base patterns.   5/30 especially, looks sort of like the bottom JPY made in late in 2011.  Of course, there was more than one false start for the yen, and the catalyst of central bank action is what really sealed the deal in late 2012 and vaulted JPY back to the round trip highs of 2007.  Perhaps the catalyst for 5/30 will be INACTION by the Fed.  In terms of JGB, note that there was a yield surge after Japanese year end in 2013 as well.  Just something to keep an eye on.

5/30 US treasury spd is white line (bottoming 104 to 120) and JGB ten year yield in red

 
BELOW IS LONG TERM CHART OF USDJPY

March 30. Ending the quarter with diminished tightening expectations

–Ten year treasury yield fell 6.4 bps Friday to 194.6, reversing a large part of Thursday’s jump to over 2%.  Not much change in the curve, as reds, greens, blues and golds (eurodollars) were all up between 6 and 7 bps.  EDM’15/EDU’15 (Front June/Sept) euro$ spread posted a new recent low of just 15.5 bps – the market is lessening the odds of near term rate increases.  Yellen’s speech late Friday reinforced that theme, repeatedly noting that rate increases would be gradual.  Additionally, she cited the (stark?) difference between the Fed’s relatively optimistic forward scenario with that of the market: “That said, it is sobering to note that many market participants appear to assess the risks to the outlook quite differently. For example, respondents to the Survey of Primary Dealers in late January thought there was a 20 percent probability that, after liftoff, the funds rate would fall back to zero sometime at or before late 2017.  In addition, both the remarkably low level of long-term government bond yields in advanced economies and the low prevailing level of inflation compensation suggest that financial market participants may hold more pessimistic views than FOMC participants concerning the risks to the global outlook.”
–The big mover on Friday was crude oil, which plunged $3/bbl to close below $49.  The concern of the developed economy CBs continues to be risks to the inflation outlook and oil is certainly front and center.  To my way of thinking, it’s just another way of saying that cash flows from assets might not be enough to cover debt servicing in an overleveraged global economy.  This issue is underscored by China:  (Reuters) – “China’s central bank governor Zhou Xiaochuan warned on Sunday that the country needs to be vigilant for signs of deflation and said policymakers were closely watching slowing global economic growth and declining commodity prices.” Nearly 7% growth and concerned about deflation?  No.  The worry is that waves of debt defaults will cause asset fire sales, which feed on themselves.
–Turning back to market prices in US interest rates, note that treasury prices have not only completely negated the initial bearish move from the payroll report earlier this month, but are also mostly above the closing levels of the payroll release in February.  The market is sending a clear message endorsing Yellen’s view that rate hikes are likely to be gradual.  As a final price point, consider January 2016 Fed funds (FFF6) which closed Friday at 99.53, or only 47 bps, just 1.5 bps lower than the highest settlement of the year.  At the very end of last year, this contract traded below 99.25.  So in the first quarter, more than a 1/4% of prospective tightening has been squeezed out of the market. 

March 27. Risk reduction Friday

–Ten year yield jumped 9.4 bps to 201.0.  Curve steepened with 2/10 up 7 to 139.2.  Red/gold pack spread also up just over 7 bps to 113.37 with reds -4.0 and golds -11.125.  On relatively light volume the weakness in the back end of the curve was somewhat surprising.  There was decent early selling in reds, for example a seller of 50k EDU6…appears to be new position with open interest up 38k.  Seven year auction was sloppy.  Perhaps some incipient inflation fears as well, as oil was up over $2.  However, the global story still seems to be one of subdued prices.  For example, Japan’s Core Inflation again printed zero.  And there is a story on Bloomberg saying that despite S Korea’s rate cut, inflation expectations and bond yields continue to move lower.

March 26. Mideast hostilities help oil, hurt stocks

–Saudis launch airstrikes in Yemen.  Hostilities in the Middle East.  Who could have seen that coming?
–May Crude surged over $52 and is now holding over 51, up more than $2.  US equity markets are bleeding, with Nasdaq through the mid-March low and ESM testing those lows, however, crude oil has NOT yet neared its $54 high for the month.  So it looks like more than just higher energy prices are weighing on stocks, for example… a weaker dollar.  I was going to note that yesterday’s sell off in equities had various indices either at or slightly through the March 18 FOMC lows.  But we are well below those levels now.
–Tens are up a bit this morning after having had an outside range day with a lower close yesterday.  Ten year yield ended the floor session at 191.6, up a bit over 4 bps.  Back month eurodollars were similarly down 4-5 bps in price.  From Bullards’ speech earlier this morning in Frankfurt: “Now may be a good time to begin normalizing U.S. monetary policy so that it is set appropriately for an improving economy over the next two years.”   May be…maybe not.
–As I understand it, the Saudis are getting militarily involved in Yemen to try to stifle what they perceive is the threat of Iran’s expansionism.  The US is aiding the Saudis, even though the Obama admin has been courting Iran.  In any case, this move higher in oil is helping support the bounce in the ruble.  As our previous president might have said to sum it all up… “STRATEGERY”
–Front oil contracts have, of course, outpaced deferred.  However, Dec’15 oil is still over 57.50, more than 10% higher than near contracts.  A disruption in supply might take away the near term problem of storage in a hurry.  And if back month contracts maintain current levels, inflation will be showing up in the official data later this year.  Which perhaps suggests that the back end of the eurodollar curve is too flat.

March 25. Real time pricing

http://www.pricestats.com/us-series

–A WSJ front page clip says ‘Inflation Pickup, New Home Sales point to firming economy’.  If the market has the same interpretation, then why did all eurodollar calendar spreads again make new lows, and why did the ten year note yield fall another 4.3 bps to 187.3?  I think what more appropriately captures market sentiment (even in the US) is this item from Bloomberg: ‘Prospects for an interest-rate increase in Taiwan are fading fast after consumer prices began declining this year and more than 20 central banks eased monetary policy.’
–It’s not clear that the Fed will absolutely refrain from rate hikes this year.  What the eurodollar curve is unmistakably screaming though, is that any rate hikes will be modest and gradual.  “What did the snail say who was riding on the back of a turtle?   Wheeeeee!!”  That kind of pace…  All euro$ calendar spreads compressed.  The peak one year spread is still Sept’15/Sept’16 but it’s now only 3/4% (75.5s).  Red/gold pack spread declined another 1.75 to just 103.75.  Remember, red/gold was around 300 at the start of 2014.  If market perceptions suddenly shift on prospects for the US economy and tightening, then the dollar could have a very rapid retracement.
–Having said that, I am still inclined to buy deferred eurodollar calendars, for example from the last reds back.  Though the US economy might slow, inflation comparisons are clearly going to accelerate at some point.  There were several spontaneous conversations at the desk yesterday about the retail price of gasoline, which has surged over 20% in the past couple of weeks.  But even more compelling than that is this link: http://www.pricestats.com/us-series.  It is a measure of online retail prices and it shows a big jump.  I haven’t yet researched Google’s real time pricing project, but I suspect it shows the same dynamic.
–Five year note auction today.

March 24. Curve grinds lower in a world of financial instability

–Another day, another move to new lows in eurodollar calendar spreads.  For example, red/green pack spread (2nd to 3rd year) fell 2.375 bps to a new low of just under 52.  Red/gold (2nd to 5th) was down over 2 bps to a new low of 105.5. These are both new lows for 2015.  2/10 treasury spread down 1.6 bps to 134, also a new recent low, though I had marked at 120 in the beginning of Feb. (Treasury auctions 2’s this afternoon).  As a comparison, red/green averaged around 90 bps in the month of November…nearly halved in four months.  With the flatter curve comes declining implied vol, with the June bond 164 straddle down especially hard from 6’54 to 6’32, down 0.5 vol to 12.3.  The $/val bp of the bond contract is over 3x that of the ten year future; the atm straddle is 2.7x higher in the bond.
–The dollar continues to generally weaken since the Fed, with the Euro now trading around Wednesday’s spike high of 110.  An especially violent gap (like the FOMC spike in the euro) is almost always retested, as it clearly reflects a crowded trade.  That is, everyone who wanted to be short the euro already had the position on and there were few resting sell orders to control the upside move.
–China’s PMI was lower than the expected 50.6, coming in at 49.2, suggesting additional monetary stimulus is on the way.
–Fischer’s comments yesterday suggested that a move away from the zero bound is as much about getting away from unintended distortions caused by unconventional tools and policies as it is about the actual need to raise rates as a response to economic strength.  The one comment that stood out for me, in the discussion of Fed moves after the crisis first hit in 2007/08 was, “These steps likely prevented a second Great Depression, but they were not sufficient to avoid a severe global contraction.”  It’s my belief that when there is widespread leveraged malinvestment, NOTHING can stop a contraction, central banks can only cushion the blow.  That’s why financial stability is such a hot topic; why it’s important to lean against bubble behavior in the first place.  This is probably a big stretch, but as an example I saw an item on Business Insider that suggested Slack, a tech start-up was worth $2 billion.  “The app itself is a chat room for the workplace…”

March 23. “How did you go bankrupt?” Two ways. Gradually, then suddenly.”

–Having absorbed the heavy selling in the front end Thursday, interest rate futures resumed their rally Friday.  Ten year note yield fell further below 2%, falling 4.5 bps to 193.  The peak one-year eurodollar spread, Sept’15 to Sept’16, fell 4 bps to a new low of 76.5, having settled as high as 95 on the last employment report.  Red/Green euro$ pack spread settled at a new low just barely above 1/2%, at 54.25.   2/10 treasury spread also made a new low of 134.6, down 3.5 on the day.
–Price action was a bit odd last week.  Huge rally in rate futures after the FOMC, as several shops pushed back the timing (to never) for eventual lift-off in light of Yellen’s dovish press conference.  There was a brief mad scramble to cover euro shorts, and oil had a key reversal, (new low, outside day, closed higher).  But the dominant trade Thursday was huge selling in the front end of the dollar curve rumored to be a west coast account, who apparently disagreed with a delayed lift-off schedule, leading to renewed dollar strength, a pullback in stocks, etc.  On Friday, those who had pushed back the timing of tightening, pushed back in the market, more than erasing Thursday’s sell off.  The 30 year bond contract made a new high for the month of March, and the dollar again weakened.  The eurodollar curve is reflecting a very subdued pace of tightening…
–Headline from Bloomberg over the weekend, “Tspiris warns Merkel of ‘impossible’ debt”.  That’s funny, why would foreign leaders be discussing Chicago’s finances?  Fitch downgraded the Chicago Board of Education on Friday to BBB-, triggering penalties of $228 million.  Earlier in March Moody’s downgraded the Chicago Park District, and of course in late February the city’s general obligation bonds were downgraded.  As a friend of mine likes to quote, Ernest Hemingway when asked, “How did you go bankrupt?” Two ways. Gradually, then suddenly.”
–Stanley Fischer speaks today…

March 20. “To the celestial and my soul’s idol, the most beautified Ophelia”

Which means that the people who own the pork belly contracts are saying, “Hey, we’re losing all our damn money, and Christmas is around the corner, and I ain’t gonna have no money to buy my son the G.I. Joe with the kung-fu grip! And my wife ain’t gonna f… my wife ain’t gonna make love to me if I got no money!” So they’re panicking right now, they’re screaming “SELL! SELL!” to get out before the price keeps dropping. They panickin out there right now, I can feel it.

-Billy Ray Valentine

and that’s Ophelia in the middle

Solar eclipse, supermoon, spring equinox: Friday will see three rare celestial events
http://www.independent.co.uk/news/science/solar-eclipse-supermoon-spring-equinox-friday-will-see-three-rare-celestial-events-10111592.html

–The curve flattened as heavy selling occurred in the front eurodollar contracts.  2/10 treasury spread edged to a new recent low of 136 as the two yr yield jumped 5.3 bps while tens only rose 3.2 to 197.4.  Open interest in the euro$ complex surged 231k (prelim) with almost all of that in the front 4 contracts.  June 2015 open interest was up 100k alone.  However, all of the near put open interest declined massively.  EDM puts -112k, EDU5 -87k, EDZ5 -46k.  In just looking at OI, it’s almost as if the heavy outright futures selling spurred put shorts to cover.
–New low as well in red/green (2nd to 3rd year), euro$ pack spread which slipped 0.75 bp to 55.75.  Yesterday’s market message is, “If you tighten now, you can’t tighten later.” Today’s message of course, is pre-ordained by the celestial events noted above.  And it’s quadruple witching day.
–Commodities continue to trade at or near new lows.  Sugar, orange juice, hogs, pork bellies, oil.  The plunge in sugar has been linked with that of the Brazilian real which continues apace to new lows ($/real over 3.30 this morning).   Hogs have lost about 25% since the beginning of the year.

March 19. Pointing out the obvious?

Below is a chart of 5/10 treasury yield spread (white line) with the Fed Fund target rate (orange stair-step).

As you can see, the 5/10 flattened hard during the 2004 hiking cycle, as the Fed Funds went from 1% to 5.25%.

Then of course, the curve steepened in 2007 as the Fed eased (yields in front end of curve go down harder).

The current episode of flattening since the beginning of 2014 has occurred against the backdrop of a flat-line funds rate of 1/4%…but it looks the same as a tightening cycle.

The reasons are 1) Fed’s removal of accommodation through taper and frd guidance 2) disinflationary pressure of oil and other commodity declines  3) the stronger dollar, which imparts a deflation bias.

Today the curve flattened as there was heavy selling in the front end of the curve, surprising given the dovish press conference yesterday.

However, as economic data falters, I think the flattening will come to an end…

5/10 treasury vs FF’s

March 19. The Fed cuts rates

–The Fed followed the Riksbank’s lead and eased yesterday, sending the ten year yield plunging 13 bps and the 2 yr note down 12 [2pm mark in tens was 194.2, down 11.6].  Stocks ripped higher and the euro had a five handle run, trading above 110 having started the week flirting with 105.  One year eurodollar spreads were crushed, with the peak now being EDZ15/EDZ16 at just 79 bps, down 8 on the day.  Red/Green (2nd to 3rd year) pack spread settled at a new low of just 56.5, just slightly above this year’s low of 53.0.
–Of course, the Fed didn’t actually ease, but they slashed economic projections suggesting further weakness, and all those looking for bond armageddon were sent scrambling for the exits.  I have been watching January 2016 Fed Funds to gauge the extent of perceived tightening for the rest of this year, and it jumped 9.5 bps to close exactly at 99.50 or 1/2%.  A news item this morning cited Morgan Stanley is now expecting no hike in 2015.
–Here are the economic projection changes:

Change in Real GDP went from 2.6 to 3.0 in Dec to 2.3 to 2.7 at this meeting

Unemployment rate from 5.2 to 5.3 in Dec to 5.0 to 5.2

Core PCE inflation from 1.5 to 1.8 in Dec to 1.3 to 1.4 (well below 2% target)

Dot projections:

For 2015 from 1.125% in Dec to 0.772% in March vs EDZ5 settle  99.310 or 0.69%

For 2016 from 2.537% in Dec to 2.022% in March vs EDZ6 settle 98.520 or 1.48%

For 2017 from 3.779% in Dec to 3.184 in March vs EDZ7 settle 98.000 or 2.00%

–Even though the Fed tried to narrow the gap between what the market has been pricing and their dot projections, rates set by Mr Valentine are still substantially lower than the Dots.  Though the dot plot for the end of 2016 dropped by over 50 bps to 2.02%, EDZ6 settled 98.52, consistent with a FF target of just 1.25%.
–US economic news today includes Jobless Claims expected 293k, Philly Fed at 7.0 and Leading Indicators at +0.3.

• 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.