Jan 5, 2015. NEW LOWS in the curve
5/10 is on more aggressive flattening path than in 2004…WHEN THE FED WAS ACTUALLY TIGHTENING…from 1% to 5.25%, July 2004 to June 2006. Without an ACTUAL change in rates, the market is perceiving a TIGHT Fed. Current 5/10 year treasury yield spread is 46.6. Low in 2006 as Fed was in latter stages of hiking campaign was -6.6 bps.
Jan 4. Longer term thoughts health care and demographics
Some longer term thoughts on the US economy:
1) In 2013 US health care spending increased 3.6% to reach $2.9 trillion, or $9,255 per person, the fifth consecutive year of slow growth in the range of 3.6 percent and 4.1 percent. The share of the economy devoted to health spending has remained at 17.4 percent since 2009 as health spending and the Gross Domestic Product increased at similar rates for 2010 – 2013.
The White House web site says that growth in health care spending is slowing. That’s probably a very positive outcome of ObamaCare; as deductibles have gone up, a larger percent of the population is saddled by very large out of pocket costs and therefore isn’t spending as much. From the report: “The exceptionally slow growth in health care spending in recent years has spurred a lively debate among economists and others about its causes, with some arguing that the recent slow growth primarily reflects the 2007-2009 recession and its aftermath and others arguing that structural changes in the health care system are playing a leading role.” In any case, it seems that slowing growth in the medical sector will negatively impact GDP.
2) http://www.whitehouse.gov/blog/2014/12/03/historically-slow-growth-health-spending-continued-2013-and-underlying-slow-cost-gro
2) Global demographics. Japan is imploding, with more deaths than births. In the US: “And while the United States currently experiences more births than deaths, the estimated total fertility rate—the number of children a woman will have in her lifetime, on average—remains at just 1.9 births per woman. That is slightly below the replacement level of 2.1 births per woman, a rate last seen in 2007, before the recession. “
‘Mosher said European nations are experiencing economic stagnation as their working populations age: “In Germany they’re converting maternity wards to geriatric clinics because there are no women coming into the hospitals to have babies.” ‘
http://www.worldmag.com/2014/12/another_year_of_tepid_u_s_population_growth
3) A bright spot for the US economy has been auto sales, where the annual pace has surged up to a rate of 17.1 million. That’s around the level that prevailed from 2000 to 2005. Granted the population has grown, but miles driven has been falling. Can lower gas prices give this series another boost? Maybe so… There are a lot of new car leases at around $200 month, and the gas price drop has likely put $50 month into a lot of drivers’ pockets. However, to expect growth to increase much from this level seems to be a stretch.
Jan 4. Continuing new lows: EUR, Oil, Eurodollar curve
–Friday’s price action featured new lows in crude oil, euro, the US curve, German yields (where the 5 yr fell to a negative yield). On the eurodollar curve, red/gold pack spread fell 3.625 to just over 120 bps, as golds finished up almost 6 bps. Red/green euro$ pack spread fell to 67.75. New lows continuing the flattening through 2014. Implied vol in treasuries firmed slightly as futures moved to higher strikes. Ten year treasury fell 5 bps to 212.2.
–There was an article in Barron’s featuring views of Jeffrey Gundlach, who says that tens could conceivably take out the 2012 low of 1.38%, due to the disinflationay impact of a stronger dollar, weaker oil and other commodities, and slowing emerging markets. In terms of oil’s drop, he says “The boost to US consumers from lower pump prices is the first shoe to drop, but the negative secondary effects from the crude oil price collapse take longer to surface.” [Including lower capital spending and employment reversals related to the oil boom].
–This week will feature Fed minutes on Wednesday and the Employment Report on Friday.
–Der Speigel article reports that Germany thinks a Greek exit would be manageable. Greece’s Tsipras of Syriza wants a nominal write down of Greek debt. This situation makes the Jan 22 ECB meeting quite important, as it puts into question Draghi’s pledge to do “whatever it takes” to save the euro (perhaps now without the implicit backing of Germany). Greece debt to GDP is around 174%. However, the national debt of Greece peaked in 2011 and is now below the level of 2010. Consider that in relation to Italy, with GDP 10 times that of Greece. An Italy exit clearly would NOT be manageable. But Italy’s debt continues to grow every year in a stagnant economy, and the recent debt to GDP estimate is 136%.
Jan 2, 2015. Euro starting the year at a new low
–Euro at a new low this morning (120.50) as Draghi said there is increasing risk of the ECB not meeting its price mandate. Additionally, PMI data was weaker than expected in the EU, with France and Italy below 50. France was 47.5 vs expected 47.9 and Italy 48.4 vs 49.6. The FT ran a piece on Italian President Napolitano’s resignation speech, described as generally downbeat. The article notes that “recent polls have shown that most Italians have lost faith in the state and political institutions as their country struggles to emerge from a triple-dip recession.”
–The euro$ curve flattened to new lows for the end of 2014. Red/green pack spread fell over 1 bp to end the year at 69. Red/blue and red/gold both fell 1.875 (reds +1.125, both blues and golds + 3.0), with the latter at 123.75, down 180 bps on the year!! Ten year yield ended the year at 2.17, down 1.6 on the day.
–Today’s news in the US includes PMI expected 54.0 and ISM at 57.5, highlighting the divergent growth rates of the US and the Eurozone. However, it’s often noted that monetary policy actions operate with a lag of about six months. In this category I would also put outsized market moves, such as those in the USD and in crude oil in the last half of the year. The move in the USD is certainly disinflationary for the US, and is reflected in the curve currently. The drop in oil is a mixed bag, hurting the energy sector which is a major driver of employment growth, while helping both companies and consumers as a cost input declines. My guess is that the curve flattening portends somewhat slower US growth going forward, and the the Fed will tend to soften its tightening rhetoric as the year proceeds, which will result in modest steepening.
Dec 30. The yield curve indicated high hopes for the start of the year, but ended at its flattest…just like the Chicago Bears
–Some powerful trends continued into the end of the year. The dollar index made a new high yesterday as problems in Greece caused the euro to make a new low, now near 121.50 and nearing a low from late 2012. Crude oil plunged over $1 yesterday and is now nearing 53, the lowest level since 2009.
–The ten year yield fell 4 bps yesterday to 220.5. Though not quite at new lows for the year, the curve is hovering just a few bps above its flattest levels. For example 2/10 is 149.5, started the year at 260. 5/30 is 106.5, started the year at 220. And red/gold eurodollar pack spread is 127, having started at 303. The ten year swap spread is at a five month low of just 11.25 bps, though it’s been a pretty tight range and is only 5 bps lower than the year’s high just above 16. 2014 started the year with hopes of sustained higher rates, with many calling for 3.5 to 4% for tens. Perhaps pricing at the end of the year has gotten a little too pessimistic?
–Many analysts seem to think the US can “go it alone” in terms of continued growth. But the strengthening dollar is a stealth tightening of monetary policy at the same time that the oil price plunge knocks a prop out of a major driver of growth in energy. The US interest rate curve has already interpreted the ramifications, pricing in the scenario of modest Fed hikes next year followed by…nothing.
–The eurodollar pack spreads give an indication. Reds to greens (2nd to 3rd year) is just under 71 bps. Greens to blues (3rd to 4th) is half that at 35.5. And blues to golds (4th to 5th) is about half again, at 21.
Dec 24. Merry Christmas
–Yields jumped yesterday and the curve steepened, with tens rising 9.5 bps to 225.7 while the new two year note was only up 2.5 to 73. Red/gold pack rose just over 5 bps to 129. Near one-year eurodollar calendar spreads are now above 100 bps, with the peak, Sept’15 to Sept’16 at 106.5. However, more deferred one year spreads are still quite flat, for example Sept’17 to Sept’18 (green to blue) is only 31.5 bps.
–The dollar index yesterday popped above the high from 2009, and is near levels from 2006. By 2006 the Fed had ended its tightening cycle which began in 2004, taking funds from 1% to 5.25%, which underpinned the dollar. Of course, that’s when growth was pretty strong, as GDP in Q1 2004 was 4.5% and in Q2 was 3.0%. Compare that to today, with GDP AT 5 PERCENT!! In terms of unemployment, in June of 2004 the rate was 5.8. It slowly fell throughout the tightening cycle to 4.6 in June 2006. In terms of inflation, 2004 started at 1.7 to 1.9% (pretty close to where we are now), it was up to 3.3 by June 2004 and actually peaked 2 years later at 4.3 in June 2006. Obviously, when looking at the comparisons, it appears that rates should be quite a bit higher now. Yesterday August 2015 Fed Funds are only 99.65 or 35 bps, and there are 5 FOMC meetings prior to that contract’s expiration.
–Shortened holiday session today. January treasury options expire Friday. Today’s new includes Jobless Claims expected 290k, and there is a 7 year auction.
Dec 19. Sorry…it’s another post about BUYING CURVE
–Explosive stock rally yesterday, even as oil had a late plunge (Saudi’s “Naimi says global economy slowdown largely behind market problem”). Euro also continues to test new lows.
–Yields rose in the face of equity strength, with tens up 8 bps to just under 221. Implied vol in interest rate options has been crushed since the FOMC, especially in high gamma… all midcurve Jan straddles fell about 3 bps.
–Red/gold eurodollar pack spread jumped over 7 bps yesterday as reds were -3 and golds -10.125. I sent out a couple of charts yesterday noting that 5/10 spread was near critical support 52-53 bps. 5/30 is also near strong support. Everything that can cause flattening is now well known: stronger dollar, declining inflation expectations, a less accommodative Fed at the front end. The curve has flattened all year, with many calling for a continuation in the trend. There’s an incisive chart on BI this morning [ http://www.businessinsider.com/slok-10-year-rate-forecasts-2014-12 ] with DB’s Torsten Slok calling it the most important chart of the decade. It shows that professional forecasters have wrongly been calling for higher ten-yr rates for ten years. My thought is that when everyone KNOWS that the curve has got to flatten, and the pros can easily tick off compelling reasons for continuation of the trend, it might be over. As I’ve noted previously, the curve ended 2013 close to the absolute highs for the year…why can’t the closing month of 2014 mark the low? If I was a central banker (like I’ve always wanted to be) with reserves of longer dated treasuries, I could see strategically letting the market have tens at 2% to 2.25% and moving closer in on the curve (or of course, buying gold!).
–The eurodollar curve offers the same sorts of spreads as treasuries, for example reds to blues or reds to golds, which can be expressed using midcurve options. Again, these spreads have collapsed over the year, and are at important support levels. (see note on 5/10 below). Red/gold was 305.75 on Dec 31, 2013. It was at 127 Wednesday and popped to 135 yesterday.
Dec 18. Indications that curve flattening has run its course?
Below is 5/10 yield spread. Currently 54 bps.
From the low in 2000 (-37.5 bps) to the high in 2011 (144 bps), the 50% retrace is 53 bps. We’re there.
From the low in 2006 (- 5bps) to the high in 2011 (144 bps), the 61.8 retrace is 52 bps.
Upward sloping line off those two lows is currently ~47 bps.
Seems like a pretty low risk place to buy some.
Dec 18. Crude oil priced in gold
This one is just sort of interesting because it shows that oil priced in gold is much closer to the crisis low in 2009, than is currently reflected by the price in dollars. Top chart is oil priced in gold, lower chart is oil priced in dollars AM
Oil Priced in gold. 10 year chart. Low was in 2009
In: Eurodollar Options
Dec 18. Fed signals slow and steady policy of accommodation removal
–Yields rose Wednesday as the Fed signaled rate increases starting in the latter half of 2015. Belly was weakest, with 5’s up 6.6 bps to 159 and the green euro$ pack -8.375. 5/30 treasury spread notched a new low just under 115. Powerful rallies in high yield debt and small cap stocks. The idea that stocks “are the only place” to park money, an argument that I am not particularly fond of, rings true for now as the dollar rallied and as the Swiss, for example, have introduced negative rates on deposits, apparently to discourage the flood of Russian capital seeking safety. EURCHF sits right at the 120 peg and EUR yesterday weakened at the end of the day, closing below 123.50, near recent lows. Low inflation, a strong dollar and high liquidity make US stocks attractive to a world that needs a safe haven.
–The Fed appears to be taking great pains to convince the market that any rate hikes will be gradual, and the market agrees, as there is no one year euro$ calendar spread above 100 bps. The peak spread is EDU15/EDU16 which rose 5.5 bps to 99.5. The Fed continues to see the deceleration of inflation as transitory, though in the SEP, it’s interesting to note that in September, the Fed’s guess for PCE inflation for 2015 was 1.6 to 1.9, and this time they revised it down to 1.0 to 1.6. We’ve all known market makers like that right? “Hey where are you in these calls?” “2 bid/at 3” “OK now where are you? I have an order…” “Oh now I’m 1/5”. I’m not disparaging market makers, just noting that the Fed’s projections have been poor, and I guess they’re hoping to finally get something right by widening out the estimates. I should however, note that Core inflation projection only went from 1.6-1.9 in Sept to 1.5-1.8 currently.
–The point is that the Fed is on a steady path in its goal to remove accommodation, even if inflation remains low. Clearly to Fed has no control over the disintegration of the ruble and of oil, and little influence on the tenuous politics of the ECB. My contention is that the plunge in oil will tend to slow the economy going forward, that the US consumer will NOT be a counterweight, but that perhaps gov’t spending will provide a partial offsetting boost. Small rate hikes can easily be absorbed over a long period.
–Implied vol was much softer. For example, EDM5 9962^ was 17.5/18 early in the day and ended 16.0/16.5. All back month and midcurve straddles fell 1.5 to 2 bps.
–Today’s news includes Job Claims expected 295k, PMI Services 57.3, Philly Fed 25.0 and LEI at +0.6.
