Feb 16. Bonds ‘smarter’ than stocks?
–Yields edged higher Friday, with the ten year note closing over 2% at 2.017, up 3.7 bps on the day. Large trades on the day were a seller of about 70k EDM5/EDU5 calendar spreads from 19.5 to 18.5 (settled 19) and a buyer of 60k 0EM 9862/9837p 1×2 for 1.0 bp, (settled 0.75). The former trade appears to be a roll into a new long position in EDU5, and the latter is also a new position, with EDM6 at 9871.5 or 9 bps away from the upper strike.
–Stocks are making new all time highs. It’s interesting to note that crude oil made its low (at least for now) in late January. The same is true for the Euro. However, the Dow Jones oil and gas producers index made its low in mid December. JNK, a junk bond etf, similarly made its low in mid December, as did EEM, the Emerging Markets index. Major stock indexes also tested and held the December low as oil crashed into late Jan; the point is that even the sectors that should have been the MOST vulnerable bottomed before the end of the year. So stocks were already apparently looking past possible economic damage due to lack of global demand as reflected in the price of crude oil. Typically, people refer to the bond market as being “smarter” than the stock market. But now, as stocks shrug off signs of economic malaise, eurodollar calendar spreads are quietly edging to new recent highs. For example, the red/green euro$ pack spread (2nd to 3rd year) was up 1 bp to a new recent high just above 62. Red to blue (2nd to 4th) also notched a new high at just under 97 bps. Previously, as Fed officials parroted the company line that rate hikes were likely this year, the curve would flatten, as if ANY rate hike would be more than the economy could withstand. Now there has been a minor change in tone and back end contracts are reflecting the idea that perhaps rate hikes might be a bit more aggressive than thought. Once again, it appears to have been initially signaled by the stock market…
–Note that CME electronic markets close at noon CST due to the holiday with Greek negotiations looming as the major event.
Feb 10. China’s debt and deflation and the US bond contract
–Interest rate futures continue to trade under pressure in follow through from Friday’s jobs data. Today we get NFIB (small business optimism, which has been steadily rising), expected 101 from 100.4. Also JOLTS data which could show more strength in the labor markets.
–Implied vol was generally bid as futures moved lower. Large buyer of 2EH 9875p for 4.0. (Settled 3.75 vs 9892.0, open int up 24k).
–I switched to June contracts in treasuries to track implied vol. The most significant change is, of course, in the 30 year bond contract. Due to the much longer duration of this contract given the cheapest-to-deliver, $/val bp is $246.50 compared to around $169 for the USH (march) contract, or about 1.45 larger. (The CME is using 3 to 2 for the roll). One futures point in USM will be worth only a little more than 4 bps. I marked implied vol from Friday in USH at 10.4…an equivalent value for USM would be > 15% just carrying through the math, but the USM straddle at a whopping 9’04 is only 13.1 (late screen quote was 8’55/9’10). If USM vol were at 15%, then the straddle would be around 10’24. Makes it look as if paying over 9 points for the bond straddle is a good bet. Giddy-up.
–New high in near one-year calendar spreads in dollars. March15/16 rose 0.5 to 80 and June15/June16 rose 2 to 87.5, now the peak one-year spread, equaling Sept15/16 which is also 87.5.
–In skimming the news this morning I saw about five or six references to China’s debt and inflation. What if the story isn’t about Greece and the EU, but really about China? From BI, “China’s debts as a proportion of GDP climbed from 144% in 2007 to 245% in 2014.”
From ZH: “For the 34th month in a row, Chinese Producer Prices (PPI) fell YoY (dropping 4.3%, missing expectations of a 3.8% deflation).” CPI is also at a five year low, though positive. What have other countries done to combat lower inflation? Depreciated their currency. Which leads to a stronger dollar and decreased inflation in the US. No wonder the curve flattens every time it seems more probable that the Fed is close to hiking…
Feb 9. “Hey, are you guys playing cards?”
–Unambiguously strong employment data caused yields to jump Friday, with tens up 12.6 bps to 194. Belly was weakest with fives up 16.8 bps to 146.5 and the green euro$ pack down over 21 bps. The peak one-year euro$ calendar moved forward to June’15/June’16 at 85.5 bps, up 14 bps on the day. Still well under 100…
–Given that three month libor has been setting around 25 bps, the June’15 eurodollar contract at 9957 indicates about 70% odds of a 25 bp hike at the June FOMC. Near Fed Fund contracts have been around 9988 (or 12 bps) so July FF at 9975 indicate a bit better than 50/50 for a hike in June.
–With stronger data, (consumer credit Friday also showed a nice bounce in revolving debt), it’s easy to make a case for the Fed to lift rates from zero. Many are still marveling at the difference between where the market is pricing forward rates and the substantially more aggressive path the Fed is communicating about forward policy, even over the relatively short term. But while the Fed takes note of problems in the rest of the world, and always reassures that they can handle any fallout IF something bad happens, investors have to actually price risks in the rest of the world…including the hardened stance between Greece and the EU (both all-in), an escalation of military activity in Ukraine, deterioration in China’s numbers, the oil price plunge and associated deflationary pressures. There are at least four big poker games going on. The Fed is watching on tv from the relative safety of the living room sofa. But Yellen will have the chance to play her cards at the scheduled Humphrey Hawkins testimony on Feb 24-25.
–This week features treasury auctions of 3, 10 and 30 year, starting with 3’s tomorrow.
–In terms of pricing of eurodollar options, it’s somewhat interesting to note that while greens had the biggest price move (reds -18.625, greens -21.25, blues -19.25 and golds -9.75), blue midcurve straddles are higher than greens in terms of absolute ticks. For example, 2EH7 9825^ settled 27.5, while 4EH9 9762^ settled 29.0. All blue straddles are 1-2 bps higher than greens. There was a trade on Friday that’s an apparent play for a shift in volatility to nearer contracts: Bought 8k 0EJ6 (April expiration on EDM’16 underlying) 9875 straddle 28.5s vs Sold 3EH8 (March expiry on EDH’18) 9787.5 straddle 29.0s, for 0.5 to 1.0 credit. The long straddle has an extra month of time value, and is arguably in the part of the curve that should have much more “play”. This trade also circles back to the idea that while the Fed may exert influence on the near term path of rates, the longer dates are much more market driven, and the market doesn’t hold the same terminal rate view as the Fed does.
January 31. New lows in yields but implied vol tame.
–Friday featured new lows in yields, with tens down 8.2 bps to 167.3, having tested the low yield level from 2013, at 163. 30 year bond also hit a record low yield just below 225. Many yield curve spreads made new lows, for example 2/10 closed 120.4 (vs 128.5 the previous Friday). The peak one-yr euro$ spread, Sept’15-Sept’16, closed at a new low of 69.5, down 6.5 on the day. Last week I had suggested that the red/green/blue pack butterfly might decline to the upper teens…Friday to Friday move was 27.25 to 21.5.
–Of some interest is the plunge in the ten year inflation indexed note yield, from 20.7 bps to just 2.1 in the space of a week, down over 10 bps on Friday alone. At the end of 2014 the yield was over 50 bps. There hasn’t been a negative real rate on tens since the middle of 2013; the low was -91.7 at the end of 2012. As a point of comparison, the yield on the 5yr tip is -32 bps. The low set in 2013 was -177 bps. But 5’s also ended the year of 2014 in positive territory at nearly +50 bps. So, while oil (CLH5) soared $3.71 on the day, over 8% to 48.24, market based indicators of inflation seem decidedly soft.
–Previously as yields fell, implied vol was bid up. On Friday, there was a new seller of TYH5 132c and 132.5c. Open interest in both calls was higher according to prelim figures, with 132c +16k and 132.5c +12k. The 132 strike is about 13.5 to 14 bps away from Friday’s settle of 130-28, while the 132.5c is 20 bps away, approx yield levels of 153.5 and 147.5 on the current ten year. So, this week we have seen vol generally contained even as yields moved lower and equities traded on the soft side. I marked the atm TYJ (April) straddle at 6.4 one week ago vs 6.1 Friday. It appears that the upside in rate futures might be contained due to this option activity, unless equities take an unscheduled swan dive.
Ten Yr TIP yield just 2 bps
Jan 29. FOMC aftermath. Oil price drop may be “transitory” but strength in the dollar isn’t
–Yields plunged after yesterday’s FOMC announcement with tens down over 10 bps to 172.2. 2/10 treasury spread made a new low of 122, down over 6 bps. Red/green euro$ pack spread fell 4 to just 55.75, another new low. The peak one-yr euro$ calendar spread is still EDU15/EDU16, but it has fallen to 75.5, down 6 yesterday, though holding just above the recent low of 73. The 30 year bond yield plunged to a new low of just 229.
–Although interest rate futures made new highs, implied vol was subdued. For example, early in the day the March Ten Year (TYH) 129.5 straddle was trading 141, and then settled in at 138/140 in the morning. Just after FOMC when TYH was trading 130-04, there was a seller of the 130 straddle at 134. As we closed futures at 130-15, the 130.5^ settled at 140. Similarly, TYM 129^ traded 324 at the open; TYM 130^ settled 320. Previously, moves to successively higher at-the-money strikes were associated with higher absolute straddle levels…skew is fading.
–Crude oil made a new low yesterday, closing at 44.45, down 178. This morning the Aussie $ is making a significant new low, with the dollar generally firmer against everything, as Asian nations take steps to weaken their currencies. The Fed still insists that lower oil prices are transitory, and I suppose in looking at the crude oil futures curve they have a point: while the March contract is 44.50, September is over $6 higher around 50.70. However, the NOT transitory part of the equation is the strength in the dollar, which works to import deflation to the shores of the US. Continued thoughts of a mid-year “lift-off” in the fed funds rate combined with overtly deflationary tactics of exporters appears to be a longer term dynamic.
–News today includes Jobless Claims expected 300k. Treasury auctions 5 and 7 year notes.
Jan 27. “…survey-based measures of longer-term inflation expectations have remained stable”?
–Shorter maturities led US interest rate futures marginally lower yesterday. Ten year note yield was up 1.3 to 182.3, red eurodollar pack was -2.625. 2 and 5 year note auctions were re-scheduled to Wednesday and Thursday. Market action suggests sporadic profit taking; bonds trade a bit long as the Greek election passed and associated price spikes quickly dissipated. The “news” has mostly been absorbed…for example, the late downgrade of Russian debt to junk barely caused a ripple with TYH just ticking to 129-24, well off the overnight high 130-06 associated with Syriza’s victory. Other indicators also suggest a bout of profit taking (though not a change in trend). Open interest was down in all treasury futures, with TY the leader at -85k. Implied vol was hit, with TYH 129.5 straddle trading 1’51 early and settling at 1’46. USH 150^ settled 3’38 on Friday and closed 3’22. Unwinding of hedges and insurance. As a friend says, “you can be bearish. Just don’t be short.”
–Attention now turns to the Fed. From the last statement: “Inflation has continued to run below the Committee’s longer-run objective, partly reflecting declines in energy prices. Market-based measures of inflation compensation have declined somewhat further; survey-based measures of longer-term inflation expectations have remained stable.”
I track ten year notes vs inflation indexed tips…the spread is now around 161, as opposed to 165 – 170 at the time of the last Fed meeting, and an average of 190 in the month of November. Inflation, (or the lack thereof) appears to be the critical factor, with dollar strength a contributing factor that the Fed can’t ignore.
Jan 26. Deflation pressure only intensifying
–After initial spikes related to Syriza’s victory in the Greek elections, markets have pretty much reverted to previous levels. Euro went as low as 111.02 now 112.50. ESH to 2025, now 2038. TYH to 130-06 and now 129-24. However, in what is perhaps a more significant move, the Chinese yuan is weakening, now 6.2556, nearing the lows of last summer, another shot over the bow in the currency wars that threatens further deflationary pressure in the US.
–This week the US treasury auctions 2, 5 and 7 year notes, which will perhaps lead to new lows in 2/10 and 5/30 treasury spreads. 5/30 to move under 100? FOMC announcement is this Wednesday. It probably becomes more difficult to adhere to the party line that factors pushing inflation lower are temporary, as crude oil has fallen another $12 since the last FOMC, and the dollar has also strengthened significantly, similarly moving 12 big figures in the Euro, which went from 124 to 112. I would suspect that red/green/blue butterflies in euro$ will decline as the market comes to grip with the idea that the Fed is on hold. Red/green/blue pack fly currently just over 27…I would think it could be in the upper teens by week’s end.
–“Being patient is a risk that we just don’t want to take. We need growth in Europe. With entrenched unemployment, people are being forced out of the labour market, and we are seeing the whole foundation of the European project being weakened. This cannot last for too long,” he [Benoit Coeure] said. [as the Greek election demonstrated…]
http://www.telegraph.co.uk/finance/mark-carney/11367570/Mark-Carney-warns-of-liquidity-storm-as-global-currency-system-turns-upside-down.html
–Interesting notes regarding American corporate icons: I saw a story that IBM is getting ready to cut 1/4 of its workforce… http://www.itworld.com/article/2875112/ibm-is-about-to-get-hit-with-a-massive-reorg-and-layoffs.html (saw it on the internet, it MUST be true?). And from last month, McDonald’s sales are cratering, US same store sales down nearly 5%.
–Another interesting story, which is probably a bigger macro factor in prices (and in the leveling of social opportunity globally) than people give it credit for is this growing dynamic: “Zach Sims, a college dropout, founded Codecademy, a website which enables users to learn six popular programming languages, via a simple interface, for free. Codecademy is three-years-old now and Sims has 26 million students.”… “Its crazy that two kids could start something in a one-bedroom apartment in California, and educate more people in a weekend than a formal institution could in years,” he says.
> Read more at http://globaleconomicanalysis.blogspot.com/2015/01/education-moment-man-with-26-million.html#U2JKoFvf1VkIO5w8.99
–In sum: Energy costs lower. Imports cheaper with stronger dollar. Obamacare a factor in pushing health care costs lower…fewer visits given huge deductibles. Higher education under pressure from internet competitors.
Jan 23. FX adjustments continue; look for DXY 95.86
–The big move yesterday related to the ECB meeting was, of course, in the currency, where the euro fell from 116 to a low of 113.16 vs USD, and this morning at 112.40, while EURJPY was down 240 to 134.56, just barely holding the spike low from Oct 16 at 134.14…and this morning well through at 133. Canada also continued its decline vs USD, late at 123.92 and above 124 this morning, as the market continues to adjust to Canada’s rate cut.
–The dollar index made another new high yesterday, at 94.50…last July it was 80 and has traded higher ever since, a rally of 18% in six months. US goods are becoming more expensive on world markets, which makes it tough on US exporters. Conversely of course, the US benefits from cheaper imports, which adds to deflation fears. The strength of the USD causes huge foreign demand for longer dated US assets, whether stocks or bonds…an 18% move in the currency is a comforting cushion against possible price losses in underlying assets. At this point, the boat might be close to tipping, the risk of the “crowded trade”, but I would think the dollar index will at least test 95.86, the 50% retracement of DXY from the high of 121.00 in 2001 to the low of 70.70 in 2008.
–In US interest rates, tens gained 4.4 bps yesterday to 189.5, and the curve was slightly steeper, for example red/gold eurodollar pack spread was up 2.25bps to 119.5. Implied vol was hit throughout the day, with TYH straddle starting the session at 1’58 and closing at 1’50. February treasury options expire today, and this expiration is more exciting than most, with the TY Feb 129 straddle having closed at 26/64’s vs 129-04s, and futures last trading 129-23, or 46/64’s intrinsic. It hasn’t been a particularly fun ride for the guys that are consistent premium sellers, as one market after another is roiled by huge discontinuous moves.
–Today’s news includes PMI expected 54.0, Existing Home Sales 5.05m and Leading Indicators at +0.4.
Jan 21. The IBM financial model for Central Banks….
Note: changes referenced are Friday to Tuesday close. Curve flattened as the ten year yield edged down 1 bp to 180, and 30 yr bond fell 4.4 bps to 239.3. 2/10 treasury spread made a new low just below 132 bps. 5/30 fell 5 bps to 110.5 (down to 109 after floor close) but is still holding above the recent low of 103. Shorter maturities were under pressure, as the Fed continues to stubbornly insist (through Hilsenrath) that rate hikes will still occur this year, even as the dollar soars to new highs and essentially does the heavy lifting of tighter policy. The only one who’s going to look foolish is Hilsenrath, but I guess that’s the price of central bank “access”. The same access is afforded to news anchors who lunched with the President prior to the SOTU. And if you weren’t already convinced that the state of modern journalism is deplorable, the SUN ended PAGE 3! It’s no wonder the world’s going to hell in a bucket.
–As futures floated around during Tuesday’s session, there was consistent premium selling. Late Friday straddles were strongly bid. For example, FVH 120.75 straddle settled 1’17 Friday, was sold early at 1’14 (open interest increased, so appears to be new positions) and settled at 1’12. TYH 130^ went from 2’11 Friday to 2’01 yesterday. In contrast I would say that green and blue March midcurves held up very well, with Blue March 9800^ only losing 0.5 bp to close 37.0 yesterday. Lower option prices are somewhat surprising given increased tensions in Ukraine and elsewhere, along with uncertainty in front of the ECB meeting tomorrow. Additionally, liquidity across markets appears to have lessened, providing scalping opportunities.
–One quick note on Crude Oil. The one year spread between CLH’15 and CLH’16 appears to have bottomed, having gotten to -869 early in the month and now around -773. The discount appears to have been fairly extreme given an underlying price around $47. I don’t know what the storage costs for oil are, but a discount of 15-17% for front month oil in a world of negative yields seems pretty compelling and perhaps the stabilization of the spreads suggests that downside is limited in near contracts.
–One last thought. About a year ago Stanley Druckenmiller cited IBM as the poster child of financial engineering due to share buybacks and increased debt to make earnings look good. IBM reported results yesterday and Q4 revenues were down 12% yoy. however, EPS only fell 4% yoy. it appears as if the lack of organic growth combined with increased debt (even though buybacks have diminished), have caught up with the company, as the stock has fallen from 195 in October to 155 now (-20%). I suppose that it’s simply company specific, but I can’t help but think of the comparison with Central Banks, who encourage debt and increased balance sheets with QE, trying to hold up the appearance of a vibrant underlying economy. The BoJ appears to have overshot the runway, yet the ECB is desperately trying to grab the baton…
Jan 18. Strong bid in UST implied vol. Japan’s free ride is coming to an end.
–The new year’s bond rally finally sputtered, with the ten year note yield rising 3.6 bps to just over 181. In TYH, 13 of the past 14 sessions prior to Friday had a higher close (since late December), making a pullback overdue. In spite of the price correction, implied vol in treasuries remains extremely well bid going into this week’s ECB meeting. As an example, one week ago Friday I marked TYH 128.5 straddle at 1’63 with six weeks until expiry. On Friday the 130 straddle settled 2’11, even though a week of time value vanished. In the five year note, the bid is even more pronounced. One week ago FVH 120^ settled 1’08, and on Friday the 120.75^ settled 1’17. In Blue March euro$ midcurve, the 9775^ was 35, the 9800^ on Friday settled 37.5. Volatility across all markets has increased, and of course the ECB meeting looms on Thursday with the Greek election following.
–There has been a good size seller of TYH 128.5/131.5 strangles last week, with open interest in both strikes up over 15k on Friday, strangle settled at 1’00. The upper strike is 1’20.5 away from Friday’s settle, or approx 20 bps away, while the put is 1’11.5 away, or 17 bps. Roughly yields at the strikes of 1.98 to 1.61.
–Since last October, EUR/JPY has done a round trip, starting at around 135, rallying to 149.50 in December, and now back to 136. Of course, in late 2012 it was only 100. The success of Japan’s depreciation has helped it gain export share and of course boosted the Nikkei. However, with the ECB intent on using the same technique to weaken the euro, coupled with the shaken faith in Central Banks after the Swiss decision, the free ride for Japan is coming to an end. No matter whether the ECB’s QE is large or small, it will be hard for the euro to rally. For me, the only conclusion is to sell the Nikkei on any type of a bounce. THIS IS NOT A RECOMMENDATION for you… just something that I am going to do. There’s a double top around 18000, and just above 18000 is the old high from 2007. It closed last week at 16864. Remember, trading has RISKS, unless you have an inside line to the SNB or ECB. I wouldn’t want to remain short if Nikkei closed above 18,000.
