Oct 12. Friday summary. Hi yield portends lower stocks.

–In spite of continued weakness in equity markets, interest rate futures were little changed.  Five year yield fell 1 bp to 156.  Tens were essentially unchanged at 230.  In terms of the eurodollar curve, calendar spreads edged a bit lower.  The near one-year calendars that had made new highs in early October (associated with the huge long liquidation in reds), collapsed to new lows Friday.  As an example, the peak one year spread which is now EDU15/EDU16, made a new high of 113 on Oct 3.  Just one week later it fell to 102.5, down 1 bp on the day.  The other spread worth noting is high yield to treasury, which tacked on about 4-5 bps on Friday to a new recent high.  (See charts on www.chartpoint.com ).  In eurodollars there is constant accumulation of long dated straddles, and there are some buys of wings in treasuries, for example +10k TYZ 135c for 1/64th.  At approximately 12.5 bps per 1 point in the futures, the 135 strike is over 100 bps away.
–In terms of stocks, Nasdaq fell 2.3%, Russell -1.4 and SPX 1.15.  A colleague noted that SPX broke its 200 day moving average, and said that the last time that happened was a brief spike late in 2012, which was followed by a strong non-stop rally (this one).   I thought that fact was worth taking a closer look at…  In late 2012 SPX was around 1400, versus 1900 now, so the market is 35% higher.  At the end of Q3 2012, market cap to GDP was 90% compared to around 120% now.  The ten year yield was around 1.75% versus 2.3% now.  The spread of high yield to treasuries was about 100 bps lower.  GDP was 16.4T versus 17.0 now, a change of around 4%.  Does it really make sense to expect another rally from this “pull back” when valuations are obviously so much richer?  Are there not headwinds to earnings growth, such as a slowing global economy and increased funding rates?  The guys on CNBC aren’t wavering from the “stocks for the long haul/buy the dip” pitch.  But I’m not sure that the central bankers of the world can pull a rabbit out of this hat.

Oct 12. High yield breakout

Top chart is a spread of hi yield index, (Barclay’s US Corp Hi Yld to Worst), vs 5 year treasury yield.  This chart broke a long term trendline in the middle of the year and has been rallying ever since.  Bottom chart shorts Hi Yield ETF, JNK, which made a new low today (Friday) on heavy volume.

While Corp debt has grown at a rate of 8.2% in Q1 and 6.2% in Q2 to a record $7.37T, a Bloomberg article on Oct 2 noted that S&P 500 companies have “… the lowest net debt to earnings ratio in at least 24 years”.  However, with rates rising on high yield debt, balance sheets may begin to suffer under the weight of record debt levels.

The middle chart shows $/yen which looks very similar to the break out of high yield spread.  $/yen quickly retraced 50% of its multi year decline.  If hi yield does the same, it would suggest a move of another 150 bps.

Alex Manzara 

http://federalreserve.gov/releases/z1/Current/z1r-2.pdf

http://www.bloomberg.com/news/2014-10-02/corporate-u-s-healthiest-in-decades-under-obama-with-lower-debt.html

Oct 10. “Everybody has a plan until they get punched in the mouth.” Mike Tyson

–Going into the Columbus Day weekend, equity market turmoil is becoming the dominant theme.  Russell 2000 and German DAX have traced similar patterns, with small caps in the US leading the downside, and DAX having decisively cracked through several old lows around 9000 (now at 8825) to define a top.  While HYG did not make a new low, JNK did, suggesting further weakness in high yield credit markets.  Oil is off more than 20% from Russia/Ukraine inspired highs in July; down over $2 yesterday and this morning is below $85.  The complete reversal of the stock market rally after Wednesday’s minutes presages further volatility.  This thing’s shaking like the old Tacoma Narrows Bridge…http://on.aol.com/video/the-original-tacoma-narrows-bridge-collapse-of-1940-119995718
–October midcurve options expire today, though open interest is relatively small in calls just at or above the market.  Short Oct (red) 9912c have the most at 37k, yesterday’s high in EDZ5 was 9914.0.
–Somewhat surprisingly, the eurodollar curve from reds back flattened, with red/green at a new low of just over 90 bps.  Red/gold pack spread closed down 2.25 at 172.
–Floor closed for interest rates on Monday.  I will be in for a few hours Monday morning.

Oct 9. The Fed put. Preserve the “wealth effect” at all costs

–FOMC minutes sparked a huge burst of buy orders, without apparent concern for product code, as interest rate futures, stocks, gold and currencies surged.  Green eurodollar pack was the star performer, up nearly 12 bps.  5 yr treasury yield fell about 9 bps to 155, and tens were down a couple as the curve steepened from 5’s back.  Minutes cited dollar strength as a risk to inflation goals, with possible “adverse effects on the US external sector.”  The market digested the 26 pages of minutes with two words:  No tightening.
–By the end of the day most near eurodollar calendar spreads had sunk to new lows.  The peak one-yr spread is EDU5/EDU6 which fell 3 to 103.  The near one-year calendar spreads that should be pricing in twelve months of potential Fed tightening are EDZ14/EDZ15, which settled 68, (down 8 bps! on the day), and EDH15/EDH16 which settled 89, down 6 on the day.  Perhaps as clear as anything reflecting market perceptions of Fed actions is FFQ’5, August 15 Fed Fund contract.  There are 5 meetings in 2015 prior to this contract, which had spent the middle of September near 9950…an indication the market expected a FF rate of 50 bps by the July 29 meeting.  Yesterday this contract settled 9971.5, +7.5, much closer to 25 bps than 50.
–Is this really good for stocks?  Colleague John Brady thinks it’s a clear signal that the Greenspan/ Bernanke/ Yellen put is alive and well.  I am not so sure, but there is no arguing with an outside day with a huge range that closed near the high.  Reversal signal, pure and simple.
–It’s hard for the Fed to jawbone against dollar strength, when the EU and Japan have made weaker currencies a centerpiece of their policies to stoke inflation and grow exports.  No question that those policies are disinflationary for the US, but a reversal of dollar strength may mean that other parts of the world have a much more difficult task of escaping the quagmire.  Is crude oil, the one thing that couldn’t rebound after a relentless sell off, an indication of dwindling global demand and prospects?
–Out with the puts, in with the calls.  Prior to the minutes there was a buyer of 80k EDZ5 92/95c 1×2 for 2.5 and 30k EDU5 92/95 c 1×2 for 4.5, both long term plays for a Fed on hold and a grinding roll up the curve.  Green and blue Dec midcurve puts were sold.  After the minutes 40k Short red June 9825/9800 put spreads were sold at 6, another exit.

Oct 8. I don’t want the cheese anymore, just help me get my head out of this trap

–Stocks tried to hold up but then broke down into the end of the day with major indices -1.5 to 1.7%. New low for the year in Russell 2000.  Nov Crude fell 1.75 to 88.58, the lowest settle for the first position contract on the year (and it’s now down another $1, below 88).  There was a tremendous amount of eurodollar option liquidation…  turning the ship around in terms of Fed tightening expectations and in terms of near term growth prospects.  Even with ten year auction today and 30 yr bonds tomorrow, yields broke to new lows.  Tens were down  to 234 by the end of the day, a plunge of 8 bps.  Five yr yield fell to near 162, down 6 bps on the day.  There is probably substantial support at these yield levels, but a blow-up in the equity market means all bets are off.  New high 5 yr swap spread to 19.25 bps…highest since August of 2013 and up from 12.5 in mid-Sept.  Spot vix jumped 1.7 to 17.2.

–Spreads: 2/10 treasury, 184.  New low (since Aug).  Red/green pack spread 92.5. New low.  EDZ5/EDZ6 104.5.  New low.  The peak one year eurodollar spread is now EDU15/EDU16, which is currently 106, down 5 bps on the day.

–Bid for the upside in treasury options.  On Tuesday, TYZ 125.5^ settled 1’40.  Yesterday, the new atm straddle, 126 line, settled 144.  Call open interest is rising on the move to lower yields.  The market is demonstrating a strong concern about a further drop in yields, and it could easily turn ugly.  “They panickin’.  I can feel it.”  http://www.youtube.com/watch?v=uI4fVgVVpiw

–FOMC minutes this afternoon, might have some bearish undertones.  But even though the meeting was only three weeks ago, the prospective road map forward has changed.  Want to see a parabolic chart? (no, not $/yen).  Take a look at Google trends for ebola.  It’s been a fairly short time frame, but is already beginning to change behavior.  https://www.google.com/trends/explore#q=ebola%20virus

Oct 7. Long liquidation in red eurodollars over?

–Yields eased yesterday with US tens down 2 bps to 242.  Red/green eurodollar pack spread made a new low of 93.25, also down 2 bps on the day.  While some commentators continue to look for aggressive tightening, one-yr calendar spreads below 100 bps suggest differently.  Interesting piece from JPM on ZH saying QE has made “made private non-bank investors very overweight credit.”  The implication is that the forced move into higher yields could result in a nasty unwind.  We’ve just seen a small example of potential carnage in HYG and JNK.  Sell to who?
http://www.zerohedge.com/news/2014-10-06/chart-day-why-every-corporate-bond-manager-freaking-out
–Not much change in open interest in red euro$’s yesterday, indicating that relentless long liquidation has abated.  There was a large short cover buyer of 50k EDH5 9975c for 1.75 and also a new early buyer of 40k Green Dec 9800/9825 call spreads for 6.0.
–Overnight weakness in equities as German data continues to disappoint.  Weak Factory orders Monday were followed by today’s release of the worst Industrial Production in 4 years, -4.0%.  Ebola fears are spreading.
–On a more anecdotal note, Samsung profits plunged due to weak smartphone sales (WSJ).  GT Tech fell 90% yesterday as AAPL didn’t use the company’s sapphire screen technology.  Has the smartphone business crested?  AAPL has, for the last month, stayed in a tight range completely within the high and low set on April 9 when the company rolled out the iPhone 6 and iWatch.  The low of that day is just above 96.  A break of that level could have broader equity market ramifications.

Oct 5. Financial and physical transactions under a cloud

–Somewhat stronger non-farm payrolls than expected on Friday, with a rate of 5.9%, caused some selling pressure in shorter maturities.  Peak one year eurodollar calendar shifted from EDZ15/Z16 to EDU15/U16, so one might conclude that the market is pushing the timing of rate hikes slightly forward.  EDU15/16 closed at 113, a new high, +3.5 on the day.  However, the back end of the curve flattened to new lows.  Red/gold pack spread (2nd to 5th year) narrowed by 2.5 to a new low of just over 169.  In May of 2013 when Bernanke first hinted at the taper, this spread was just under 150.  By the end of 2013 it was above 300, and now it’s close to where it started.  I would say that inflation expectations have been squeezed out of the market, and indeed the CRB and RBOB gasoline breaking down to new lows (lowest since 2010 in gas) corroborates that viewpoint. Also consider a spread like EDZ16 to EDZ18.  It too, is down to a new low of just 95 bps…over TWO years.  EDZ16 is at a price of 97.82 or 2.18%.  That price is consistent with a funds rate of 1.75 to 2%.  Consider that against the most recent Fed dots.  For the end of 2016, there were 3 dots below 2% and 4 over 3.75%.  Toss those out and average the remaining 10 and the forecast is 2.68%, nearly 100 bps higher than the market.  I guess the Fed models don’t adjust for geopolitical strife…
–In terms of specifics in the futures market, open interest continues to drop in the reds due to long liquidation.  EDZ5 -25687 contracts and EDH6 -32106.  EDZ5 OI is down to 1.277 million from over 1.55m pre Gross departure from Pimco.  That’s down over 17%, still leaving it with the most open in any contract, which is not too surprising given that tightens are expected to start next year and the Fed dots favor end of year contracts. The huge new trade Friday was EDM5 9962c vs 9925p, sold puts at 0.5 and 0.0 vs bought calls.  Open interest there was +84k call and +92k puts to a whopping 584k in that put strike.  Recall there had been large buying of EDM5 9950/9925p 1×2, so there was already a large short in the 9925’s.  This trade on its own suggests that there will be no tightening by June, therefore EDM5 will naturally roll up through the 9962.5 strike.
–Interesting piece on Reuters suggests that the move to higher spreads between high yield and treasury is negative for stocks.  http://www.reuters.com/article/2014/10/04/us-markets-stocks-usa-weekahead-idUSKCN0HS20Z20141004
“The spread has since widened by more than 100 basis points, according to Bank of America-Merrill Lynch data. Previous spikes of this magnitude have preceded pullbacks in the S&P 500, and the greater the selloff in high-yield debt, the worse the outcome was for stocks.”
–Fairly quiet next week with 3, 10 and 30 year auctions.  FOMC minutes Wednesday.
–Physical transactions and financial transactions.  JPM says it was hacked, as were other institutions.  Financial transactions are almost all electronic, could these be impeded?  Could the spread of ebola impede physical transactions.  Are we on the verge of large changes in consumer behavior?

Oct 2. Of gods and central banks

–“And just like Hercules confronting the Hydra, it sometimes seems as though just as we defeat one challenge, such as the sovereign debt crisis, two new challenges spring up, such as low inflation and a weak recovery,” [Draghi] said.  ECB meeting this morning, and I think Draghi could have cited a few more heads on the hydra, including ebola, geopolitical tensions, weakness in the banking system, and the slowdown in China.  The market is going to clamor for full scale QE, but it won’t yet be delivered.
–This morning Crude is at a new low, sub 90, down $1.  Volatility has come back with a vengeance in some markets, and it is starting to develop the feel of forced action.  Fairly well controlled so far, but we might be nearing the point where regulators (and the equity investing public) scratch their heads and wonder where the liquidity went, not that they have anything to do with it… I marked the yield spread between high yield etfs and US fives as 408 bps, up 25bps yesterday.
–It was a huge volume day coupled with large ranges in interest rate futures.  Ten year yield plunged 10 bps to 240.   Red/gold pack spread down 5.5 to a new low of 171.  USZ (30 yr bond) had a range of 2 points.  Open interest in red eurodollars continues to plummet.  Even with yesterday’s rally: EDZ5 -40k, H6 -92k, M6 -24k and U6 -22k.  Total loss of OI in dollars was 184k, most of which of course, was in reds.  Short Dec puts were down 76k in open interest as long put holders exited.  Same in Short March puts, -71k. Massive volume in EDZ5 of over 750k and in EDZ6 over 525k, as traders who have keyed on these contracts with respect to the Fed “dots” were compelled to adjust their outlook.   There was heavy buying of 9962.5 calls in EDM5 and EDU5 representing new bets for the Fed to stay on hold through next year.  Pretty obvious now that the Fed dots and Fed models are irrelevant to the market.  By pulling back the curtain and opting for full transparency, the market has seen that the Great Oz is (or was) projecting power that it sadly doesn’t possess.  It’s like the scene in The Man Who Would be King, when Sean Connery sheds drops of blood and the conquered tribes realize he’s not a god.  Or the scene from Ghostbusters.   Winston Zeddemore: Ray, when someone asks you if you’re a god, you say “YES”!

Oct 1. Start of Q4. Feeling confident and secure?

 

–In eurodollars, long liquidation related to Pimco continues.  Associated with large sell orders yesterday, open interest in EDZ5 fell 63k, H6 -27k, H7 -32k.  Total open interest in dollars was -124k.  Because of this outright selling, some of the near one-yr calendar spreads made new highs, for example EDH5/EDH6 rose 2.5 to 105.  Ordinarily one would interpret the higher spreads as an indication of faster and more aggressive Fed tightening.  However, in this case, it simply appears to be forced selling.  EDH16 is 1.385 yield.  Think we’re going to have 1.25 o/n rate by then?  I don’t, but will let the selling run its course.
–Other markets are projecting slack demand and global stress.  The gold/silver ratio has pushed above 70.  Dollar index continues on a tear higher, with $/yen breaching 110 earlier today.  Copper is testing $3.  Crude oil plunged over $3/bbl yesterday.  The Russell 2000 fell 16 points or 1.4% yesterday to 1102.  Another performance like that and it will be at a new low for the year (low this year just above 1080). Large caps are remarkably resilient, but warning flags abound.  News of the first ebola case in the US sent stocks on a leg lower right after the 4 pm close.   Is it any wonder that ebola is here?  The southern border is like a sieve and an intruder was able to waltz into the front door of the White House and find the Nixon tapes.  If we’re not careful swarms of Canadians are going to start leaping the fence.

Sept 30. And that’s when I kicked his ass…

—Curve continues to bull flatten as near eurodollar contracts like EDZ15 see long liquidation, perhaps related to Pimco.  Red pack to everything behind it made a new low.  For example, red/gold pack spread dropped 4.5 bps to 176.  Red/green pack spread fell almost 2 to close 97.5.  Ten year yield fell over 4 bps to close at 249.  5/30 spread made a new low of 141 bps.  Flatter curve might ordinarily be interpreted as a sign that central bank policy is getting tight.  But don’t worry…Chicago Fed’s Evans said QE could be restarted if the economy falters. :- l
–There are overt signs of social stress, most obviously in Hong Kong, with tomorrow’s national holiday and start of Golden Week a possible flash point.  In the markets, the Emerging Market etf EEM continues to slide, falling 2% and closing below the 200 day MA.  New lows yesterday in the Russian Ruble, Brazilian Real, and ZAR is getting close.  Eurozone CPI was just +0.3 yoy.  Ford sharply cut its earning outlook, in part based on EU weakness. Hi yield etf’s tacked on another couple of bps and spread to 5yr treasury widened by 5.
–Friday’s premium buying was somewhat reversed yesterday.  For example, USZ 138 straddle closed 3’30 on Thurs, 3’38 Friday and 3’28 yesterday.  There were some large option spread trades in dollars yesterday, but right at the end of the session there was a seller of over 25k Short Dec 9900c at 5.5.  Looks to be a new position, and again related to heavy long liquidation of EDZ15.  Maybe the trader tasked with reducing exposure in that part of the curve can’t bring himself to sell outright at 1.10% yield with a spread of 27.5 bps to EDU, and just launched calls instead, knowing that Gross will come in Monday morning with the intention of scooping that stuff right back up.
–If it’s slow here’s a good read of pure Americana:  “His fondness of spaghetti Westerns was only surpassed by his love of bacon, beer and butter pecan ice cream. He fondly reminisced about good friends, good drinks and good times at the Tri-Valley Sportsmens Club in Burgettstown. He was a long-time member of the Elks Club in McKees Rocks where he frequently bartended and generously donated his tips to charity. Quite a teller of tales, Big Al’s elaborate stories often were punctuated with the phrase, “And that’s when I kicked his ass.” He enjoyed outlaw country music: Waylon, Willie, Hank, Johnny. He was also on a first-name basis with the Four Horsemen of liquor: Jack, Jim, Johnnie and Jose. – See more at: http://www.legacy.com/obituaries/postgazette/obituary.aspx?n=raymond-alan-brownley-big-al&pid=172561140&fhid=9852#sthash.tkiRVD42.dpuf

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.

  The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.