Nov 14. Oil plunges. Yields edge lower in spite of firm equities.
–Yields eased yesterday as oil plunged $2/bbl. Certainly the dropping price of energy is good for the consumer, but DB notes a more insidious aspect on junk bond default rates if oil price weakness persists. However, junk spreads are quite stable since the October scare.
–Ten year yield fell nearly 2 bps to 234.5 as auctions concluded with the 30 year. $/yen back above 116. France and Germany GDP both positive, but Italy had another negative outing, with GDP losses in 11 out of the last 13 quarters. Must be coached by Trestman.
–An Economic Outlook piece by Pimco’s Clarida points out that neutral policy rates are likely to be much lower than they were prior to the financial crisis, and that the total stock of debt, both public and private, is higher as a percentage of GDP now than in 2007. The vast overhang of debt is a smothering influence on the global economy.
–Though stocks continue to press higher, early strength yesterday didn’t hold, with small cap Russell actually closing lower on the day. If Dec Russell were to close below 1168.50 it would be a caution signal for the broader market. The other commodity that had a big price plunge yesterday was cotton. They’re blaming it on high inventories, but I can’t help thinking it has something to do with the substitution of yoga pants for jeans. Cotton is at the same price it was back in 1996.
–Retail Sales today expected +0.2 but +0.5 less autos and gas. November midcurves expire.
Nov 12. Markets are circling central banks like a pack of hyenas
–Slow day Tuesday as it was a US bank holiday. Yields edged slightly higher…eurodollars were down 1-1.5 bps across the strip. Most notable was early weakness in yen as $/yen surpassed 116 early. However, the dollar weakened as the day went on. EUR/JPY closed over 144, a new high.
–This morning however, we are seeing equity market weakness, with some pointing to new fines $3.4b) on banks for forex market improprieties. Both EUR and Crude Oil are also weaker this morning. In addition, as advertised, Abe postponed implementation of new sales taxes. According to Bloomberg, the JGB yield is up 6 bps to 51 bps. On a chart I sent out yesterday I had it marked at 48.7 (chart below). In any event, it is now close to breaking out of its downtrend in yield terms. If there is no change in trajectory of gov’t revenue (i.e. no new taxes), the market is ready to test the BoJ through higher bond yields. And Japan’s gov’t budget can’t withstand higher rates. This may be the biggest story in the financial markets going into the end of the year. The BIGGEST Jerry! And it’s not just Japan, markets also want to test the SNB’s euro peg. And the ECB has internal issues with QE. What does that do for US bonds? Likely drives a fresh safe haven bid, and a desire to own gamma.
–From yesterday’s FT: “We see a slowdown in emerging markets, partly driven by a lower need for raw materials from China. Europe – it’s very slow growth, if any, at the moment, and there’s no reason to expect a big change here,” said Nils Andersen, Maersk’s chief executive. Maersk is the world’s largest container shipping line.
–News today includes Fed speakers Plosser (pre-US open) and Kocherlakota in the afternoon. Basically cancel each other out. Ten year auction as well.
Abe postpones sales tax; JGB yield poised to jump
Below is chart of $/yen (orange line) and JGB yield (white). Also included is NKY (Nikkei in green) although it trades very closely with the currency. Today it was announced Abe is considering delaying implementation of the sales tax, causing $/yen to trade above 116.
In late 2012, the yen started to depreciate in earnest due to QE, and the move just accelerated to new highs based on the massive increase in QE announced Oct 31. Though JGB’s had a yield spike higher in Q2 2013, the yield is now only 49 bps, as the BoJ will essentially buy ALL of the new issuance. However, given the trend in the currency it might be worth considering what the market currently deems implausible, that is, shorting JGB’s… the widowmaker!
Halfway back between June 2013 high and the recent low in the yield is 68 bps.
Nov 11. Another October 15 day possible going into year-end? YES
–New high in $/yen this morning over 116.00 as Abe might delay implementation of a sales tax increase. Early yesterday it was trading 114.30 and the dollar appeared to have finally run out of steam. However, dollar strength has reasserted itself, with the euro now pressing near 124. Crude oil was up $1 yesterday morning, but plunged over $2.50 from the early high, closing at 77.40 and is slightly lower again this morning. A huge move. EUR/CHF is knocking at 1.20, apparently ready to test the SNB’s resolve to hold the floor. US stocks are at new highs.
–The point is that there is still heightened volatility across markets, and October 15 might not have been an anomaly. There was a WSJ article the other day about the plunge in yields that day, noting that some automated trading systems are simply switched off in particularly volatile periods. From the article, “Regulators and other experts are examining deep-seated shifts in trading since the financial crisis, which could help explain the unusual size of the move in a market many investors rely on for its relative stability.” The fact that regulators are delving into the day’s trade must make many algo shops that much more inclined to reduce risk (and liquidity) on wild days, as the cost of possible regulatory ‘fixes’ has to be weighed against potential profit.
–In US rates yesterday, trade pattern was similar, though less dramatic than oil. Ten year futures added to Friday’s gains early in the morning, and then slid lower through the session. Both 5’s and tens tacked on about 5 bps in yield, with the latter at 2.37/2.365 (w/i) going into tomorrow’s auction. Green Dec euro$ (EDZ6) range from Friday’s employment low to yesterday’s high was 19 bps, 9806.5 to 9825.5. In EDZ7 it was 20.5 bps from 9736.5 to 9757.0. Volume was light yesterday, with some attributing the sell-off to sparse flows and today’s holiday. Well, we are now in the seasonal period of somewhat lessened liquidity. There are 24 trading days between now and the Dec 12 settlement of Dec midcurves. The Green Dec straddle settled 21.5 and Blue Dec at 22.0. The idea is to own and scalp gamma. There are plenty of catalysts that can get the ball rolling in either direction…
–I will be in for the early part of the day, and we can source market makers to tighten screen markets.
Nov 10. Friday’s payroll data stopped the move toward higher rates
–Friday’s disappointing wage growth and lower than expected non-farm payroll data caused a trend reversal in treasuries, as all futures contracts had an outside day and settled on the high, having been under moderate selling pressure for the past few weeks. Gold also arrested its drop with a new low, outside day, and higher close.
–Ten year yield fell over 6.5 bps to 231. 2/10 treasury spread edged to a slight new low at 181, but there is a ten year auction on Wednesday, followed by 30’s on Thursday, so a move to further flattening may not occur until very late in the week.
–Immediately after the data, implied vol was crushed with the Short (red) Nov euro$ straddle trading at 6.0, from 9.0 settle Thursday. Green Dec straddle went from 24.0 Friday to 21.5 right after data, though it settled 22.5.
–Consumer credit was also released at the end of Friday, showing a robust gain of $15.9B. However, the growth continues to be primarily in student loans. At an annual rate (flow), revolving debt has increased at $17.3 billion. Non-revolving grew ten times higher, at 173.8 B. In fact, outstanding revolving debt is lower now than in 2009. Same with mortgage debt (more on this in another post). However student loan debt has soared and is now $1.3T. In 2009 non-revolve debt was 1.64T, now 2.39T (also includes auto loans).
–Oil is up $1.00 this morning. Another China/Russia gas deal was sealed making China Russia’s largest gas buyer.
Nov 7. Ruble plunges. US awaits Payroll report
–Today brings the employment report, with NFP estimated 235-250k at 5.9%. Yields continued to grind higher across the curve, with tens up 2.5 to 237.7. Treasuries trade weak going into the data, at the low end of the recent range, indicating the chance of a stronger than expected release, with some estimates of 300k. However, implied vol was pressed during yesterday’s session, with TY vol back below 5.0, so there isn’t a big fear factor associated with higher yields. Today’s (week 1) TY straddle settled at 36/64’s against 126-02, breakeven of 125-12 and 126-18. I would think that ten year yields would be capped at 2.50% over the medium term.
–What does NOT trade weak is the dollar, with EUR slipping to 124 after Draghi’s comments yesterday, and the Ruble continuing to collapse, down 10% this week. It has taken the EUR fully six months to achieve the same sort of drop, 140 to 124, a decline of 11.5%. While the ruble’s fall is breath taking, it’s got plenty of company in terms of new lows against the dollar, as examples, the Brazil real and Korean won. I saw a chart yesterday of Crude Oil overlaid with the ruble, showing high correlation on the recent move. I have recreated it below and included the Brazilian real as well.
–Stocks are hitting records, haven shaken off the mid-October scare. SPX, Dow Industrials and Transports all make new highs; Utilities made a new high Wednesday but reversed yesterday, being more sensitive to the prospect of higher rates.
–Interesting article by Ambrose Evans Pritchard yesterday on Draghi’s choices as political infighting continues at the ECB regarding QE. Here is the link, http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/11211973/Mario-Draghis-efforts-to-save-EMU-have-hit-the-Berlin-Wall.html#article The article concludes with these lines:
There is another job waiting for him [Draghi] in Rome as Italian president, should he wish to take it. The offer must be tempting, if only for sweet revenge.
His departure would shatter market confidence in the euro overnight. He could then lead his country to recovery, with a correctly-valued lira, and inflict a massive trade shock on his tormentors in the North for good measure.
RUBLE OIL and REAL
Nov 4. Election day and instability
–Yields in the US edged slightly higher yesterday as ISM was stronger than expected at 59.0. Tens were up 1.4 bps to 234.5. Curve was slightly flatter with 5/30 at 143.7. Red/gold euro$ pack spread fell 1.875 to 180.5 as the gold pack settled unchanged on the day.
–The big story of course, is not the US election, though we’ll get a small taste of ‘regime change’ here. (Remember two years ago when Obama told Putin, “After my election, I have more flexibility…”? Things can change pretty quickly). The big story is oil, which had tested $80 several times in October and now has decisively crashed through that level to around $76. While in the US, the price drop is sometimes thought to be beneficial to consumers as a ‘tax cut’, it raises the prospect of disinflation, especially in conjunction with a stronger USD. Capital intensive projects that were economical above $90/bbl can be shelved at prices below $80. Deflationary fears are most acute in europe, where the EU has just cut both growth and inflation projections. From BBG: “Gross domestic product in the 18-nation region will rise by 0.8 percent this year and 1.1 percent in 2015, down from projections for 1.2 and 1.7 percent in May…” and inflation is projected at only 0.8 as opposed to the ECB guess of 1.1.
–While Japan has stoked its financial asset prices with its latest round of depreciation, or rather, QE, pressure is now on other countries to respond to pressure on export markets. Especially China, as signs of a slowdown continue to mount, the latest being a record 23% drop in Macau casino revenues. Maybe it has to do with a drop in conspicuous consumption, maybe with fears of ebola, but 23% is a BIG number.
–Implied vol levels in US rates have shaken off the surge from mid-October, and some measures of risk have stabilized. Most obvious of course is the run to new highs in major US stock indexes, and tightening of junk bond spreads following October’s jump. However, we are seeing one example after another of destabilization being blithely dismissed by stock analysts. The yield crash in October was the start, followed by Japan’s QE bombshell and now the plunge in oil. There are going to be serious reverberations that could easily see US tens revisit 2%. How can US yields at the long end drop in a growing economy with an improved labor picture? Because growth is now heavily dependent on the value of equities. A project that might look good when portfolios are robustly growing, could easily get put into the “maybe” category in case stocks swoon again. I didn’t know that HLF really stood for ‘half’, as in the value of Herbalife being cut…
Oct 31. BoJ gives dollar bulls a surprise treat
–The BoJ gave dollar bulls a treat with massive expansion of QE, sending dollar/yen above 111 (from 108 yesterday) and lifting the Nikkei nearly 5%. Japan’s gov’t pension fund has also decided to increase its allocation into stocks. Gold is down another $25, oil down $0.60 and S&Ps have soared to a new high above 2010. Interestingly tens are only down 4/32’s to the 126.5 strike, and green eurodollars only -1.5. Though Kuroda’s move overwhelms all else, German Retail Sales were reported -3.2% for Sept, as the EU continues to face its own deflationary pressures.
–While positive wealth effects from the stock rally should be negative for US fixed income, the BoJ’s actions probably pressure other Asian exporters to cut prices and/or depreciate currencies. It likely adds to deflationary pressure in the EU and US. EUR edged to a slight new low from yesterday, touching 125.5, before bouncing back slightly.
–Today’s US news includes Personal Income and Spending expected +0.3 and +0.1. Chicago PMI expected 60.5, unchanged from last time.
Oct 30. Aftermath of FOMC hawkish tilt. Stronger dollar. Lower stocks?
–Back in the old days of telephones and trading floors there were some amusing stories regarding trading errors. The floors were pretty loud back then, and international phone connections sometimes weren’t that clear. In any case, a clerk in the S&P’s gets a call from his Chinese customer in a busy, rallying market and gets this order: “buy all you want”, so of course the clerk says, “I didn’t catch your order…what?” Again, this time in a scream, “buy all you want!!”. So the clerk buys a ten lot and says I bought you ten so far… Response from Hong Kong: “WHAT?! ONE…I told you to buy one. BUY ONLY ONE.”
–It just seems to me that the Fed has told the market, regarding the dollar, BUY ALL YOU WANT. An upgrade in labor market conditions, disregard of disinflation indicators, and an end to QE. The euro started to sell off a couple of minutes before the actual announcement and picked up steam afterwards. The dollar is stronger against, well, pretty much everything, including gold, which is off around $20 since pre-FOMC. Crude oil too, sold off on the announcement, though it’s still above 81.50. What isn’t selling off is Soybean meal, which has leapt by a third in the month of October, from 300 to over 400. Apparently the crush has gone crazy.
–On the eurodollar curve, greens led the way down, with a drop of 12 bps. August 2015 Fed Funds were down 4 bps, but still settled at 9974, or just 26 bps. Five FOMC meetings in 2015 before that contract, the last being at the end of July, and it’s only at 1/4%, so it doesn’t appear as if the market is pricing rapid rate increases. But the curve is still saying that Fed tightening will cause lower inflation and slower growth. Hard flattening: 5/30 treasury spread was down 11 bps to 144, with the 30 yr bond actually lower in yield by 1.5 bps to 3.045, while 5’s jumped 9 to 160, with a sloppy auction foreshadowing the FOMC. 2/10 was down 6 to 183.5. December 2020 ED contract was unchanged, with following contracts closing marginally higher.
–It’s likely to become a more challenging environment for emerging markets. Brazil raised rates to 11.25. Unsurprisingly, the ruble is at a new low.
Oct 29. Of QE and burn rates
–FOMC announcement this afternoon. First, a couple of notes about yesterday’s action. Back end of the dollar curve was relatively weak, with red/gold pack spread posting a new recent high of just under 188 bps, +2.375 on the day. Ten year yield rose 3 bps to 228.5. For the three months prior to October, tens felt comfortable trading a range from 240 to 260, but now it seems as if something like 210 to 235 might be more appropriate, even as the Fed is expected to end [this round of] QE.
–Implied vol was crushed as stocks soared higher and high yield spreads tightened a few more bps. On Friday, USZ 142 straddle settled at 2’60, yesterday at 2’28. TYZ straddle has gone from 1’40 to 1’23. FV straddle was trading over 1 point, now 51.5. Blue Dec closed 30.5 from 32.0 on Monday; during the mid-Oct panic atm blue Dec settled as high as 37.5.
–Ruble makes a new low every day… destabilizing.
–Now just a couple of quick thoughts on broader issues this morning, tied together with acronyms: FB and QE. Starting with FB, which gave forward guidance of massive increased spending related to recent start-ups. From a BBG article: Whatsapp…”The messaging service, which reached 400 million active users in December, generated less than 3 cents in revenue for each one last year. By comparison, Facebook paid $55 per user when it acquired the company. WhatsApp’s net loss was $138.1 million for 2013.” In the middle of September there were several articles about stratospheric tech company “burn rates”, with a notable warning by Bill Gurley. http://online.wsj.com/articles/venture-capitalist-sounds-alarm-on-silicon-valley-risk-1410740054 What is sort of ironic is that FB, is now doing it to themselves. They made acquisitions with the funny money of their own stock that threatens to burn them. But perhaps it’s temporary, and one company, though it is down 10% after the announcement, is perhaps not symptomatic of the stock market as a whole. But I think the whole idea of QE is analogous to a “burn rate”. Money keeps getting pumped in, but the returns aren’t showing up. So now it’s being ended. In the capitalist model, the company has to sink or swim. We’ll see. It will be interesting to see how the Fed responds to diminishing inflation, and whether the statement will still note “significant underutilization of labor resources.”
–In terms of inflation/deflation, central banks note the huge risks of the latter, now brought into focus by the large decline in energy prices. But to worry about disinflation due to energy is ridiculous, it’s a tax cut to consumers. Certainly a decline in energy prices won’t make consumers put off purchases today (though it might halt some capital expenditures). The real risk is when financial assets no longer generate a stream of income to cover debt service payments. That’s the harrowing ‘deflation’ scenario that leads to an asset liquidation spiral. That’s what the ECB stress tests are supposed to calm us about. But DB just announced a loss and replaced their CFO, and the bank is beset by a regulatory spiderweb. What seems more tangible? DB’s actions or ECB’s words?
–QE by its very design is supposed to force money into riskier assets with less cushion. It succeeded. But the question is whether those assets have the income streams to cover debt service, even at extremely low rates. Has QE thus far ended the ‘burn rate’?
