Jan 16. Are the central banks going to save us this time?
–US tens dropped 6 bps yesterday to 177.5 and are down another 5 bps this morning as the surprise Swiss move reverberates through the markets. Once again near eurodollar calendar spreads have made new lows, with peak EDU15/EDU16 at just 73, down another 5 on the day. New low in red/green euro$ pack spread to just 56.25. The market has removed the Fed from the equation, even though Reuters is running a piece this morning with this opener: “Tumbling oil prices have strengthened rather than weakened the Federal Reserve’s resolve to start raising interest rates around midyear even as volatile markets and a softening U.S. inflation outlook made investors push back the timing of the “liftoff.”‘
–When Fed officials have talked about tightening previously, all they managed to effect is a flattening of the curve. Yesterday, 5/30 actually made a new recent high at 119, up 4 bps. Curve outperformance is moving forward, a direct reflection of a Fed on hold. In December, NY Fed’s Dudley made a speech that cited financial conditions. The market’s perception of financial conditions is tightening, with junk bond spreads making new highs as treasury yields tumble. The global stress occasioned by the Swiss move will now make next week’s ECB meeting the subject of intense focus. Confidence in central banks has rolled over…the price of risk assets is now beginning to reflect… RISK. As a friend of mine used to say, “I don’t want the cheese any more, just help me get my head out of this trap.”
–News today includes CPI expected -0.4 with Core +0.1. Industrial Production expected -0.1. Yesterday’s Job Claims jumped back above 300k. Though US consumers are getting the benefits of cheaper gas, the oil patch is cutting workers.
Jan 15. SNB drops EUR peg. Vote of no-confidence
–The Swiss dropped their EUR peg this morning, sending EUR/CHF from 120 to nearly 85 instantly, now 104ish. US stocks immediately spiked to yesterday’s lows but then came back, now just modestly lower from the close. It seems to me that the decision by the Swiss is essentially a vote of no-confidence in the Euro, and of course against the USD, the euro dropped to a new low below 116 but has now bounced back to just above 117. This move is likely a precursor to more instability and is likely disinflationary for the US.
–In US interest rates yesterday tens fell another 5.5 bps to 183.5. Near eurodollar calendar spreads continue to post new lows. Peak 1-yr spread is still Sept 15/16 but it fell another 4 bps yesterday to just 78. There was sizable capitulation in both futures and options on these spreads, for example, there was a seller of Short September (based on EDU6) 9825/9787ps vs buyer of front Sept put spreads. Clearly looks to be liquidation from this morning’s open interest; the net effect is to compress the spread between near contracts and deferred. Red/green (2nd to 3rd year) also made a new low of just 58 bps. The market is taking the Fed out of the equation. However, the back end of the dollar curve steepened just slightly, for example greens were +8.125 while golds (5th) were only +5.875. Bears watching. Red/green/blue pack fly settled 29.5 on Friday, and has fallen to just under 23 in just 3 sessions.
–India delivered a surprise 25 bp cut, and like every other central banker, Rajan is advising the government to make structural changes. Sensex up nearly 3%, probably the only equity market worth being involved in from the long side.
–Today’s US news includes Job Claims expected 295k but will likely be above 300. PPI -0.4 but +0.1 Core. Philly Fed expected 20 from 24.5. Retail sales were disappointing yesterday… as the price of oil weighs on energy firms I would expect data to come in softer than ‘official’ expectations.
Jan 14. Anecdotal evidence suggests slower US retail, slowing home sales and declines in China’s construction
–The European Court of Justice decided the ECB’s QE program is legal…because there’s nothing that can restore confidence and growth like buying BTPs (Italy 10s) at 1.81. Right comrades? In the meantime the World Bank cut the global growth forecast and says the world economy is too reliant on one engine, the US economy. In other words, on the US consumer. And this morning we get a sense of US Consumerism with Retail Sales, expected -0.1% but +0.6% excluding gas and autos. I would caution that this number could be weaker than expected, as credit card debt growth remains anemic, and anecdotal evidence like Tiffany’s sluggish sales raise general suspicions about the desires of buyers.
–US ten year rate declined another 2 bps yesterday to 189 despite the ten year auction. Thirty year bond auction is today, w/i yesterday closed 248. Once again near euro$ spreads made new lows, with the peak one year calendar, Sept’15/16 down 2 bps to just 82. On December 31 this spread closed at 101.5. I marked ten year treasury to inflation index note spread at a new low of just 154.4. Again, this is a loose indication of long term inflation expectations, and for the first 3 quarters of 2014 it was between 2.0-2.25%. I would say it’s becoming a little harder to view declining inflation as a transitory phenomenon, though maybe this afternoon’s Beige Book will shed some light on things.
–As mentioned previously, not only is oil sliding, but copper has taken a huge tumble as well, having held above $3 in October, now plunging to $2.50 this morning. Reports have indicated that construction in China is slowing dramatically. Additionally, copper inventories have supposedly figured heavily into China’s shadow financing, though I haven’t seen many stories about that recently. Again, a dash of anecdotal evidence: Elon Musk said Tesla’s sales in China were down in the fourth quarter. US stocks are also starting to show fissures, with lower closes yesterday on big, outside day ranges… in part spurred by slow sales in US housing, as reflected in KB Homes 16% faceplant yesterday.
–There is heavy buying in EDM5 9962/9975c spreads, yesterday bought for 6.0 against selling EDU5 9950/9962c spd for 5.5 in total of at least 60k. Open interest in EDM5 9975c is a whopping 575k, settling at 1.0 bp vs 9962.5 in EDM5, with 153 days until expiry.
Jan 13. Extra primo good
–Ten year treasury yield dropped another 6.5 bps to 191 on Monday and is lower yet this morning at 188 in front of today’s note auction (with 30 year bonds tomorrow). Tens have now pierced the intraday low yield of 188.5 from Oct 15 and Dec 6. Crude oil has again gotten slammed to a new low, currently sub $45. The press is cheering the plunge in the price of the most important commodity in the world, though the last similar move was in the midst of the financial crisis in 2008. Well, yay…I guess.
–This morning I saw a snippet that Japan’s fives have moved to a negative yield (-0.1%), with a hearty welcome from German Bobl, also at -0.1%. US 5yr yield is 135.
–All of the front eurodollar spreads made new lows again yesterday. Once again, the peak one-yr calendar, Sept’15/Sept’16 fell 4.5 bps to a new low of just 84. Dec’15 to March’16 is the peak 3-mo calendar spread at just 22 bps. So much for the idea of Fed hikes of 25 bps at every quarterly FOMC… I recall that Richard Dennis used to say, watch how the market reacts on news. Well, late yesterday SF Fed’s Williams said June would be the right time for the Fed to consider raising rates. YAWN. Every time the Fed hints at tightening, long end yields move lower.
–This is sort of interesting: Tiffany fell 14% on disappointing holiday sales. From a BN story: “The shocking thing was how slow the Americas was,” said Dorothy Lakner, an analyst at Topeka Capital Markets in NY “Given the strength in the economy, given the strength in the stock market, it was setting them up for a really good holiday season.” And, from the company, it’s “planning cautiously as we anticipate significant headwinds from the stronger U.S. dollar against all of our key currencies.”
–The stronger dollar has preemptively acted as a tightening on the US economy. Additionally the equity market doesn’t appear to have generated strong ‘wealth effect’ spending. Or maybe it’s just that people were forced to make choices on their consumption. Rolls Royce had record sales in 2014. Such a vexing decision, do I buy the jewelry or the Rolls? …The lobster or the cracked crab. What do you think? Can’t we have both? …Extra primo good, Mr Coleman.
Equity market warrants caution….
A couple of posts on Zerohedge.com point out overvalued metrics on US equities:
http://www.zerohedge.com/news/2015-01-12/us-stocks-most-overvalued-relative-rest-world-history
http://www.zerohedge.com/news/2015-01-10/permabull-throws-towel-stocks-are-massively-overvalued-key-multiples-are-post-war-re
The latter refers to Jim Paulsen of Wells… I had previously put out this note, summarizing several other metrics indicating overvaluation, noted below.
—————————————
Reasons for caution
1) Technicals
- a) Profits as % of GDP are at record highs (at a time that wages haven’t grown in real terms). This has been going on for some time, but it doesn’t seem reasonable to expect it to continue in the face of dollar strength and disinflationary pressures from Asia and Europe/ see below
- b) Margin debt is near record highs http://www.advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.php
- c) Shiller p/e ratio is at danger level 26.4 http://www.multpl.com/shiller-pe/
- d) Market cap to GDP is at level only exceeded by Nasdaq bubble (one of Warren Buffet’s favorite measures) https://research.stlouisfed.org/fred2/graph/?graph_id=164130&category_id=0
2) Considerations with respect to other domestic measures
a) The US yield curve flattened dramatically in 2014, and even further in the first few days of 2015. This is a HUGE warning sign. With a zero FF rate, the curve can’t really invert, which is a predictor of a recession, but the treasury curve is on the SAME TRAJECTORY as it was in 2004-2006, the last time the Fed was on a tightening cycle and the curve inverted. We know what happened in late 2007. (see my notes on chartpoint.com)
b) US commodities have been in a bear market. Not just oil, but grains, copper, etc. The energy sector is responsible for the a majority of job growth over the past year. That will now go into reverse. Here is a chart of CRB index to SPX…Divergence! CRB in white, SPX in red.
- c) there has been some deleveraging on the consumer side in the US. This is a positive, but not as big as people think. On the other hand, Corporate Debt is at a record level nominally. In terms of debt service, corporates’ ability to service debt is high, however, credit spreads are moving out…see below. Company buybacks have been one of the MAIN drivers of stock strength and growing corporate debt loads.
- d) Junk bond spreads in the US are moving higher and are now at levels around the surge seen in mid-October. The Fed had forced players into lower rated credits in a reach for yield, now those spreads are starting to reverse, especially given the crude oil sell off.
- e) inflation is edging lower. Why is that a problem?? Not because of lower costs for consumers, but because assets no longer throw off enough income to service debts associated with them. A negative liquidation spiral is the risk (that the central banks in the world are very aware of).
3) Global concerns
- a) EURO at risk of failing, as is well known. There is too much bad debt/assets in Eurozone banks. Well advertised
- b) Japan continues to depreciate the yen, but in a demographic nightmare the economy of Japan cannot be SAVED without massive immigration.
- c) This has led to the very real risk that China depreciates as a response to Japan “stealing” market share, which is HIGHLY disinflationary, as is strength in the $ in general. Domestic US companies face pressure from cheaper imports, and US exporters’ goods become ‘priced out’ of overseas markets.
- d) Strength in the dollar has been a disaster for emerging market economies. See EEM (emerging market ETF). Don’t forget that emerging markets have become a larger percentage of the global economy, and in 1998 the EM crisis threw stocks into a tailspin.
Conclusion, the US equity market has been the beneficiary of global capital flows due to crashing yields in Developed economies. Company buybacks have been a big driver in retiring shares outstanding, making EPS look better. Depressed sovereign yields make any dividend return seem valuable by comparison, a benefit to stocks. Are those flows likely to continue through 2015, I doubt it.
Jan 12. Lower yields on Friday. New lows in near Euro$ calendars. Watch Financial Conditions.
–First, notes about Friday’s trade. Yields continued to sink, as wage data from Friday’s employment report was weak. Even though several investment banks said that across the board wage declines suggested the data was a fluke, the trend had already been set for the day. Tens fell 4 bps to 197.5. Front end eurodollar spreads made new lows, suggesting that the market has pushed back both the timing and aggressiveness of the Fed tightening schedule. As recently as early October, the largest one-yr eurodollar calendar spread was as high as 112 bps. The current peak spread is still Sept’15 to Sept’16, but it is now only 88.5 bps, having dropped 3 bps on Friday. The big trade anticipating the rally and curve roll, a buy of 100k EDZ’16 on Thursday between 9827.5 and 9830.5 was a big winner, with that contract settling up 7 bps to 9836.5. Straddles were immediately hit after the data, but then found support. TYH 128.5^ was 2’05 early morning but settled at 1’63.
–Though the dollar weakened slightly on Friday, both oil and euro are pushing for new lows this morning. Interesting on Friday that gold had a fairly strong rally, associated with the dollar which softened only in the context of a pause.
–Last week Hilsenrath had mentioned a speech by the NY Fed’s Dudley, which is quite an interesting read (the actual speech, that is). The quote that might be of focus: “Let me be clear, there is no Fed equity market put.” Which perhaps should be lumped into the same category as “Read my lips, no new taxes.”
Here is a link: http://www.newyorkfed.org/newsevents/speeches/2014/dud141201.html
–The speech is from Dec 1, and mainly considers monetary policy in the context of financial market conditions. He spends some time praising the Taylor Rule…”First, it very explicitly focuses on the two parameters—the long-term inflation objective and the level of potential output consistent with that objective—that map directly to the Federal Reserve’s dual mandate objectives. Second, standard Taylor Rules are self-equilibrating. They respond to economic shocks and forecast errors in a way that pushes the economy back toward the central bank’s objectives. …Third, academic research shows that Taylor-type rules typically perform quite well across a wide range of economic models.” However, he then concludes that more subjective policy making is needed. Ironically he essentially said the Fed erred in its previous TWO recent policy endeavors. “First, during the 2004-07 period, the FOMC tightened monetary policy nearly continuously, raising the federal funds rate from 1 percent to 5.25 percent in 17 steps. However, during this period, 10-year Treasury note yields did not rise much, credit spreads generally narrowed and U.S. equity price indices moved higher. Moreover, the availability of mortgage credit eased, rather than tightened. As a result, financial market conditions did not tighten.” Conclusion, the Fed didn’t tighten aggressively enough in 2004-06. “Second, during the financial crisis, especially during the fall of 2008, financial market conditions tightened dramatically even as the FOMC was cutting its federal funds rate target to zero. Monetary accommodation turned out to be insufficient…”
–If the Fed never really gets it “right”, then why should we buy into the need for subjective rule making?
–This note is already a bit long, but the St Louis Fed helpfully publishes a “Financial Stress Index” that bears watching. http://research.stlouisfed.org/fred2/series/STLFSI
Here is the list of data that goes into the index:
http://www.stlouisfed.org/newsroom/financial-stress-index/key/
As a summary, despite junk bond spreads widening, etc, this index shows little signs of stress, though is has turned up in the past several months.
Jan 9. Employment day
–Curve steepened yesterday with tens closing back above 2%, up 6 bps at 201.5. Red/gold euro$ pack spread jumped 8 bps to close just above 115. The move is probably best viewed as profit taking in a long downtrend, rather than a change in fundamentals, however, the back end of the curve is still remarkably flat. The dollar index closed at another new high as euro closed below 118.
–Flows yesterday in interest rate futures were dominated by a few new positions, a buyer of 100k EDZ6 from 9827.5 to 30.5 (settled unch at 9829.5 with open interest up 52k), and selling of five year straddles, notably 10k FVG 119.75^ from 45.0 to 43.5 (settled 44 with OI up about 6k) and 10k Green March 9812.5^ from 36.5 to 35.5 (settled -1.5 at 35.5, OI up 5k in calls). Suggests no real concern about possible downside, and a steady and slow roll up the curve… in spite of day-to-day data.
–Today of course, employment data is released, with NFP expected around 240k at a rate of 5.7%.
–Sort of interesting to look at Obama’s announcement of TOO FREE YEARS of community coledge (ha, funny right?) for everyone in the context of yesterday’s consumer credit data. Consumer credit was up $14 billion (not so funny). Non-revolving was $15 billion of that, meaning, yes, that credit card debt actually declined, from $883b to $882b. Non-revolving credit is STUDENT DEBT and car loans, and the amount outstanding went from $2.400T to 2.415T!! We know that car sales are strong at a 17 million unit rate, but it’s my thought that households are simply substituting cheap student loan debt, most of which is guaranteed by the govt at high default rates, for high rate credit card debt. I am not sure of exact amount of student debt outstanding, but I know it’s greater than $1.2T. Heck, free community college may actually save the gov’t money. In a way, the $1.2T student debt may be double counting, as the federal govt, (at $13 trillion outstanding), borrows and then lends to students…so they can take classes like this one about Kanye West, http://www.huffingtonpost.com/2014/01/26/college-course-jay-z-kanye-west_n_4661573.html , while the Asian kids study refractal computational physics…or something like that.
Jan 8. Brief note; most markets have modest rebounds from recent trends, though NOT the Euro
From Fed minutes: Fed officials saw rate rise before April as unlikely. Not much market movement after minutes were released. Later, from Chicago’s Evans:
- *FED’S EVANS SAYS RAISING RATES WOULD BE A CATASTROPHE
though he also said this year’s growth could be 2.6% and he’s optimistic on the economy.
–This morning euro is at a new low under 118. Bloomberg has a piece citing ING as the most accurate FX forecaster, looking for parity.
–Yesterday the eurodollar curve steepened slightly, with reds (2nd year) modestly outperforming to the upside. Reds +2.125, Golds (5th yr) unch. Apparently, new corporate issuance was a weight on the back end of the curve. Ten year yield finished unchanged. Somewhat interesting that even as the back end of the dollar curve has dramatically flattened, the absolute tick value of blue midcurve atm straddles has moved up to parity with greens. Green straddles had been slightly greater in value as that part of the curve had been considered “in play” with respect to Fed tightening.
–Today’s news includes Jobless Claims expected 290k and tomorrow’s Payrolls expected 250k with rate of 5.7.
Jan 7. Don’t panic?
–The sense of panic is growing. Stocks are testing mid-Dec lows and in some cases taking that level out, and even trading below October lows (for example GOOG, IBM, GE is close). Junk bond spreads are testing highs from mid Oct. The curve is flattening ferociously. Red/ gold euro$ pack spread fell another 5 bps to close 105.25; on Dec 29 it was just over 127, a massive move in 5 sessions. Crude oil continues to get crushed (below $48 late yest, now 48.60). Emerging markets are under pressure. Look at something like Brazil’s oil company Petrobras (PBR), hit 20 in September, but now 6, below the oil and stock crash in 2008. 5/30 treasury spread is just 103 bps, a marginal new low. The dollar looks like it could have another big leg higher as EURUSD trades 118.50 this morning. Eurozone inflation came out this morning at -0.2, lower than expected. But that’s still warmer than it is here in Chicago: -2. Remember how the polar vortex shaved off some growth last year? Well, surprisingly enough, it’s winter and it’s cold.
–Ten year yield at open outcry close was 196, down over 7 bps on the day. Low during the day was 188.5, matching the spike panic low seen in mid-October when the SPX crashed below 1850. SPX now is 2000… Obviously, US stocks and bonds are currently the beneficiary of capital flows that are looking for safety…there might not be a yield, but the currency translation will more than make up for it.
–The result is pain for treasury option market makers. Skew is extreme. For example, yesterday TYG 129.5c vs 127.0p as a combo vs 128-22, there was a buyer for 14 to the call, open interest in both strikes up 25k. Settlements were 19 in the call and 11 in the put vs 128-115s, according to my sheet, nearly a full vol higher in the call. March 129 calsl are the leader in open interest with 95k and 129.5c have 68k open. There are forced buyers as futures trade up.
–As the EU worries about Greece, Italian unemployment hit a record high of 13.4. And that’s including drugs and hookers. http://www.businessweek.com/articles/2014-05-23/italy-mocks-europes-rules-by-counting-drugs-and-prostitution-in-gdp
–US news today includes ADP, Internat’l Trade and FOMC minutes.
Jan 6. It’s starting to become unhinged…ten year yield sub 2%
–US ten year yield is back below 2% this morning as oil continues to crash (now below $49/bbl) and stocks press lower. Both the Nikkei and Sensex (India) fell 3% today. Tens yesterday fell over 8.5 bps to 203.5. The curve is getting crushed, with every back spread at new lows. 5/30 is only 104 bps, having dropped 4 yesterday. Red/gold eurodollar pack spread is just 110 bps, fell nearly 10 bps! One year ago 5/10 treasury spread was over 140, but late yesterday was only 46 bps, on the same downward trajectory as seen in 2004 to 2006 when the Fed was tightening 25 bps at every meeting. For the curve to be this flat with a funding rate near zero is telling you something, and I would say that it’s negative for the global economy. (I’m sure the guys on tv will tell you it’s a signal to buy stocks).
–Implied vol is firming on the move to lower yields. Once again, ETF’s that might be considered canaries in the coal mine are getting hit, with EEM (emerging markets) down 1.8% yesterday and hi-yield JNK and HYG also turning over, though nowhere near mid-December lows. The spread between treasuries and hi yield is, of course, blowing out, but again, spreads are lower than levels associated with mid October and mid December, so no reason to panic…yet.
–The stark failure, in my opinion, of QE programs is on graphic display when comparing SPX with the CRB index. SInce late 2012, stocks have been in a strong rally. The CRB, associated with THINGS rather than cash flows, and perhaps a better monitor of global economic health, has gone down. (Chart attached).
–Today’s news includes Factory Orders expected -0.5% and Service ISM at 58.0 vs 59.3 last.
Chart below is CRB in white and SPX in red. Though the CRB heavily is influenced by oil, the divergence from late 2012 is probably a signal of broader issues than simply energy prices.
