Dec 17. FOMC announcement and press conference today
–Once again yields fell in the US with tens ending -4.5 bps to 207, and the 30 yr bond down just over 4 bps to 270. Extraordinary volatility in several markets as the ruble plunged and crude oil continued lower. However, treasury implied vol marked the high of the day early in the morning and eased throughout the rest of the session. As noted yesterday, at the height of panic on Oct 15, the atm straddle with 37 days until expiration traded as high as 2’49. Yesterday the TYG 128^ with 38 days traded 2’11 early and closed 2’01. Obviously the panic isn’t at the same level, as Oct 15 lows in major US stock indexes are still far below current levels (though EM stocks are well through Oct lows).
–The big event for today of course, is the FOMC announcement and press conference. In the morning CPI is released, expected -0.1 with +0.1 Core. I think the Fed will remove “considerable time” and take pains in the press conference to note that there is not a specific timetable for the first hike. Yesterday, there was heavy buying of red midcurve Jan and March 9875 puts covered against EDZ5 futures 9918. Though straddles have become slightly elevated in red mids, this part of the curve could still see choppy and volatile trade. About a week and a half ago 0EH (short red March) 9900^ was trading 30.5, yesterday settled 34.5. If the Fed does not take out “considerable time” and highlights the drop in inflation due to energy, then reds and greens should lead the curve higher.
–On a related note, I saw a couple of pieces of research yesterday noting that Texas has created 40% of all new jobs, and that, since the onset of the crisis, total US job growth without the energy boom states of Texas and N Dakota would be negative. Going forward, the decline in the energy patch is going to cast a negative cloud on US economic growth.
Dec 16. Russia hikes rates by 6.5%. US might, just might, go 0.25% next year
–It’s sort of amazing that US traders are wringing their hands over whether or not the Fed removes “considerable time” from its statement tomorrow, leading to a possible 1/4% rate hike SOMETIME NEXT YEAR, while Russia raised its rate from 10.5 to 17.0 late yesterday to stop the ruble’s decline. (It didn’t). Indonesia intervened to halt the slide in the rupiah. Brazil real is making a new low. China HSBC PMI was lower than expected 49.5 vs 49.8 expected.
–US curve flattened further with front end pressure as positioning for US rate hikes continued. New low in 5/30 to 116.5 bps. Red/gold euro$ pack spread (new, using March contracts) fell over 3 bps to a new low of just 127 as reds fell nearly 6 bps. This line is from the Oct 29 FOMC statement, just one and a half months ago: “Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.” Think there might be some modification on that projection?? Let’s see, oil is down 30% just from the end of October. Copper’s down 5%. Emerging market currencies are pretty much in free fall, and China continues to decelerate. The long end of the US market is still a safe haven, and is dismissing all concerns about inflation (for the time being). Isn’t it a little suspect for the Fed to deem levels of inflation below 2% as transitory when the US Ten yr treasury can barely hold its yield above 2% (2.11 at end of the day yesterday).
–It’s pretty clear that Fischer wants a higher fund rate, in order to normalize policy (in a very un-normal world). But what if he is overruled by the doves? If “considerable time” stays in, there will likely be an immediate short cover rally in reds and greens. My preferred way to play for a continued dovish Fed is to buy deferred one year euro$ calendar spreads, for example March17/March 18 at just 47.5 bps.
Dec 14, 2014. Sliding into year end
What a mess this town’s in tatters I’ve been shattered
My brain’s been battered, splattered all over Manhattan
Uh-huh, this town’s full of money grabbers — Rolling Stones
The theme now has become higher quality credits vs lower quality, and uneasiness with the latter is becoming pervasive. One look at the treasury market reflects demand for the highest quality, but there are numerous other indications of stress, including the surge in high yield spreads, under performance of small cap stocks this year, the collapse of inflation premia, the downgrade of France to AA by Fitch on Friday. Remember when we were constantly reminded that the subprime mortgage sector was a mile wide but only inches deep? That it just wasn’t large enough to really shatter the larger market? I don’t know how it compares to the current environment, but a DB report says energy companies are 16% of the HY market, and that oil below $60 would push this sector into tatters. If it’s all about oil, one might think that perhaps the US might stop the slide by announcing major purchases for the strategic oil reserve. But the benefits of lower prices for US consumers and the prospect of further damaging Russia’s economy are a much bigger (short term and short sighted) incentive. It is the US energy sector that has been providing jobs; that engine has now stalled. Energy production also requires capital investment, plans for which have been scaled back.
–In terms of Friday’s price action, the ten year yield fell another 7.7 bps to end below 210. 5/30 treasury spread continued its collapse, now at 122.4, down 0.5 on the day. Ten year treasury to tip now below 165 bps, down 7. I rolled my curves forward as EDZ4 has expired, but the red/gold pack spread, though +2.25 on the day, is only 130 bps when using March contracts as first red and gold.
–Implied vol is expanding. I marked FVH vol at 3.8 and USH at 9.0 (having adjusted for the weekend). Earlier in the week, USH atm straddle had settled 4’00, vs Friday’s 4’32. Measuring against the Oct 15 spike, I had FV at a high of 4.5 on that day, and US at 12.5, followed by 4.0 and 10.3 on the next day (Oct 16). 2 vols are worth one full point currently in USH, so at 11% rather than 9%, USH straddle would be 5’32 vs 4’32. VIX closed at 21.08 Friday, 10 points lower than Oct 15 spike high.
–Another little red flag is waving: Russell 2000 small cap index. While all the other indexes made new highs throughout the year, this one has gone sideways, having made its high for the year in July. Since the end of November, Russell has mapped out a perfect head and shoulders top, having closed just below the neckline on Friday. Closed 1152, H&S objective around 1110.
–One last note, Congress passed a bill that continues to provide a gov’t backstop for bank derivatives, tossing out a key Dodd Frank provision. Almost as if to tell the banking sector, “We know that the oil drop is causing financial dislocations…we got your back.”
Dec 12. It’s all about oil…
–Robust retail sales data caused an early pullback in interest rate futures, but the continued sell off in oil erased those losses in the long end of the curve, with weakness concentrated in the belly. Green eurodollar pack was the underperformer, closing -5.0 bps on the day, while the 30 year bond yield was actually slightly lower by the close. The curve posted new lows, with 5/30 down 3.5 bps to just under 123. New low in red/gold pack spread at 147.6. Demand for the bond auction was surprisingly strong, with a yield of 284.8, well through the 287.5 yield just prior to the sale. Shortly after the auction, Jan Crude oil broke through $60/bbl and a new round of buying came into treasuries, concurrent with selling of equities.
–Implied vol is firming directionally with prices. For example, USH atm straddle settled at 4’20 yesterday vs 4’00 two days ago. Eurodollar straddles were also MUCH better bid. For example, a buyer of 5k EDZ16 9800p for 45 took the 9800 straddle up 1.5 bps to 103.5. My guess is that the surge in junk bond spreads to new highs is being reflected by juiced up premiums for greens. Manic back and forth price action in equity index futures is also supportive of vol measures, with the VIX closing above 20, pretty much the high for the year except for October’s spike to 30.
–As of this writing, crude is weaker again, closing in on $59, and stocks are at new lows for the month. If the entire edifice of global finance is starting to teeter on the back of plunging oil prices, it would make sense that some type of official response to stop the decline might be floated. But at this point structural cracks are becoming more obvious, and geopolitical considerations of the major players are a dominant theme. Even though some trends might reverse if oil were to bounce from here, the sense of increased risk remains.
Dec 11. US rates and curve probe lower as oil plunges
–ECB’s LTRO today, with Reuters expecting a take up of about €130 billion. It just doesn’t seem like that much as compared the last QE program by the Fed, which was $80b per month. EUR is pretty much unchanged from late yesterday, but might be trying to put in a bottom as the ECB appears somewhat tight in policy (or hamstrung), while rates in the US probe lower. US news today includes Retail Sales, expected +0.4 and Jobless Claims 295k. Russia raised rates today from 9.5 to 10.5% to arrest the dive in the ruble.
–Oil continued to plunge yesterday. Hi yield debt spreads are at or very near the highs of mid-October, up about 10 bps yesterday according to my calculations. In spite of the treasury auction, the yield on the ten year dropped 5 bps to just above 217. 2/10 treasury spread made another new low of 159.5. As I have mentioned before, last year in December the curve was pressing to the highs of the year, peaking right at the end of the month. This year it’s the opposite, at the nadir with no bottom in sight. (Does that make sense? Probably not… but as Yogi Berra said, “If you don’t know where you are going you might wind up someplace else”). In euro$’s red/gold pack spread flattened to new low of 149.75, and red/green fell 2.375 bps to just 81.25. The peak one year spread is just 97 bps, Sept’15 to Sept’16. As the BOE’s Carney said yesterday, hikes will be gradual and to a “more limited extent.” The eurodollar curve agrees.
–December midcurves expire tomorrow.
Dec 10. Long liquidation of front euro$ contracts; curve flatter in front of ten year auction
–US treasury auctions 10’s today and 30 yr bonds tomorrow, yet yields continue to press lower and the back end of the curve flattens. Ten year w/i fell 4 bps to 222.5. Red to green dollar pack spread closed at a new low just under 84 bps. There was huge selling volume in EDH5 early yesterday, though the contract only fell 0.5 bp to 9971.5. Later in the day there was another round of large clips of sales, which appeared to be long liquidation. Open interest fell 129k in March’15, 30k in June and 28k in Sept. All told euro$ open interest fell by 130.7k, around 1% of total OI. It appears that 2014 was the year that low volatility and large (and increasing) regulatory and exchange costs conspired to shutter many trading funds. I don’t know if yesterday’s large sales in dollars were associated with the end of any particular fund, but the trend has been evident.
–Stocks took a tumble early yesterday, only to bounce right back, as usual. DB notes in a research piece that something’s got to give between the plunging price of oil and its rippling negative effects (for example on high yield debt, and yes, I know there are positive effects as well), and large cap stocks which dance merrily higher. In my opinion, deterioration at the margin, in emerging market stocks and currencies, in high yield debt, and in europe, will eventually work its way inward and cause a hard pull back in US stocks. In 2007 Bear Stearns was forced to inject capital into its failing mortgage funds. It was mid-June and another crystal clear alarm bell. Actually, crude oil at that time was on an upside tear, and the Fed tightening cycle which had started in 2004 had inverted the US curve by 2007. In any event, after June the market had a sharp pullback, much like the one we just experienced in October. Then stocks made a new high into October 2007. By 2008 the market was falling, bounced in the spring and then accelerated lower. Perhaps the comparison isn’t valid because the US consumer at the time was beset by both higher energy prices and a mortgage refi spigot which had closed. Now the consumer is blessed by falling energy prices and relatively easy financing…but the rest of the world is getting shaky, and the asset values on which our economy depends are a bit more vulnerable. And, the flattening curve is giving a clear warning signal.
From DB: “These observations form the base underneath our view that something has to give here. Either the market is too negative on Energy, or it is not diligent enough in thinking about broader implications. The only argument that stands against this view is that the rest of the economy is supposed to benefit from lower oil, which as we have shown earlier, has its own limitations.”
Dec 7. Curve has flattened all year, will it change by Dec 31?
–Friday’s strong employment report sent the two year note yield to the highest level of the year at 64 bps, the highest since early 2011. While 2’s and 5’s both jumped about 10 bps, the 30 year bond was up only one bp to 296.5 and tens only 5 bps to 230.2. The curve flattened to new lows on the year. Red/gold eurodollar pack spread tumbled 11 bps to just under 158. The ten year note yield has been in a clear downward sloping channel all year, having started just above 3%, now defined by about 20 bps either side of Friday’s close, i.e. just under 250 to about 210.
–As we approach the end of 2014, it’s interesting to note that the highs of the year in the curve were set right at the end of 2013. For example, red/gold was around 305 bps and is now nearing half that (158). 2/10 was 263, now 166. 5/10 was 128, now only 62 bps. And 5/30 was 220 now just 128. Ten year tip to note spread began 2013 at 225, and is now around 50 bps lower at 176.5. The dollar index has rallied by 10% in 2014. Going into year end it’s difficult to see what can change the trend of curve flattening, especially given the disinflationary impact of oil prices and the strengthening dollar. The German schatz to UST 2-year is 66 bps, as twos in Germany trade slightly negative. The stronger dollar is also cutting the air supply to emerging markets.
–The Fed is likely to remove the “considerable period” language in next week’s FOMC meeting, another incremental step in a steady and slow path to remove accommodation, with the first actual rate hike expected in the middle of next year. It’s worth noting that August’15 Fed funds closed down 7 bps Friday, and are now 23 bps below January’15 (FFF is 9988.5 and FFQ 9965.5).
–A modest rise in Fed funds or IOER probably won’t have much of an impact on the US economy; the market is now pricing it in. Mortgage rates aren’t budging much, the 30 year mortgage rate is near the low for the year and about 50 bps lower than it started 2014. Perhaps the rise in the rate that discounts the future stream of earnings will negatively impact stocks, which may or may not cause an economic transmission via the (reverse) wealth effect. For now, catalysts for a big change in trend just don’t seem to be evident. However, at the end of 2013, many were forecasting new highs in ten year yields and a steady rise in Fed funds…sometimes the turn of the year turns the tide.
5-10 spread started 2014 at 128, now 62
5-30 started 2014 at 220, now 128
2-1o started 2014 at 263, now 166
Dec 5. Unemployment report; curve edges to new low in front
–Employment report today with NFP expected around 225k with rate of 5.8%. Crude oil is lower this morning by 40 cents (66.39) and is nearing the lowest settlement of the move down, which was just above 66.00.
–The curve flattened to new recent lows going into the close, with 5/30 edging to 137 and red/gold pack spread under 169. There has been consistent buying in TYH 129 calls, another 10k yesterday with open interest now at 66k. That strike is about 30 bps away from yesterday’s close. Solid bid in USH yesterday, though total open interest fell 9500 contracts (USZ and USH combined).
–The bond market has been unwavering in its dismissal of Fed forecasts, most notably by ignoring the Fed’s dots for the path of future policy. In my opinion, this week has been another small example, with Fischer and Dudley hinting at rate hikes on Monday, yet tens and bonds won’t seem to stay down.
–Last month’s payroll data featured a large jump of 683k in the household survey, but the reaction was a quick drop followed by a rally to close at the high of the day. Once again the wage component will be important, though inflation concerns have receded into the far corners.
–ECB disappointed on QE yesterday, but the euro was able to close higher on an outside day, a signal that selling pressure is abating. Bundesbank cut Germany’s growth forecast to just 1% for next year (FT).
Dec 4. ECB today
–Ten year yield was unchanged yesterday, 30 yr bond fell 2 bps to just under 3%, 2.982.
–As Dudley and Fischer hint at normalization, perceptions have once again shifted forward somewhat for the idea of rates hikes beginning earlier in 2015. There was quite a bit of put buying in June15 euro$ puts, for example, EDM5 9962/9937p 1×2 bought for 4.5 in size of about 25k. But it’s kind of like the tube of toothpaste theory; squeeze on the front of the tube and the back end expands. If the market expects higher rates sooner, then that means lower rates later. For example, red/gold euro$ pack spread fell over 4.5 bps on the day, to a new low of 169.25, as reds -4.125 and golds +0.5. The blue pack (4th year) settled -1.375, gold (fifth) +0.5. In treasuries, 5/30 fell to a new low below 138 bps, -3.8 on the day. The market has no fear of inflation, and a tighter leaning Fed simply reinforces that sentiment.
–The thought of higher US rates also underpins the dollar. Dollar index went to a new high yesterday, though it’s now nearing a 38% retrace level from the high of 2001 to the low of 2008. EUR, having weakened to a new low yesterday just above 123, is getting close to the 50% retracement of the same move, low of 82.30 in 2001 and high of 160.38 in 2008. So there should be profit taking in the dollar near these levels, but the fundamental backdrop supports the strong dollar trend. ECB meeting this morning, with high expectations for a QE program. There’s no toothpaste left in that tube.
–Today’s US news includes Jobless Claims expected 295k after yesterday’s slightly weaker than forecast ADP. Emerging markets (and EEM) still weak. Brazil raised rates to 11.75%.
EUR nearing 50% retrace from 2001 to 2008
Dec 3. Junk Bond etf vs front month Crude Oil future
Red line is front month Crude Oil contract. White bar chart is JNK…junk bond ETF. Looks as if lower oil prices are associated with deterioration in bonds… as Goldman noted the other day, “The Energy sector accounts for roughly one-third of S&P 500 capex and nearly 25% of combined capex and R&D spending,”. I don’t know what the percentage is, but I would imagine a decent amount of hi yield issuance has been related to energy names.
Red line is Crude Oil, White bar chart is JNK, junk bond etf
