Indications of inflation are slipping away as the Fed nears the end of the taper

“In the next few meetings, we could take a step down in our pace of purchase,” Bernanke said in a question-and-answer session with the Joint Economic Committee….on May 22, 2013.

On the charts below, May 22, 2013 is circled.  Just comparing the level on that day with current levels, as tapering nears its end.  The ten year yield is indeed higher at 2.48% vs 2.04 when tapering was first hinted.  However, inflation indicators are all lower.  Red/gold pack spread was 182, now 176.  The German bund yield has collapsed…UST vs Bund has gone from 61 to 152.  Gold from 1370 to 1217.  Copper from 334 to 305.  CRB from 288 to 282 and Ten year treasury to the inflation index note from 230 bps to 195…right at the low from June 2013.  Not pictured, but EEM etf was 42.96, now 41.61.   I guess the point is that one of the Fed’s goals is to engender inflation to make the debt load a bit easier to bear.  As we near the end of tapering and a possible hike in short term rates, inflation indicators are faltering.

These are levels from May 22, 2013 and today

Ten yr yield                         204         Current 248

Red/gold pack spread    182         Current 176

US ten yr/bund spd        61           Current 152

Gold                                      1370       Current 1217

Copper                                 334         Current 305

CRB                                        288         Current 282

Ten yr treasury/tip spd    230          Current 195

Dollar Index                       84,35       Current  85.60

 

 

 

 

 

 

Sept 29. Things are getting shaky as we move into the fall

–Friday features were straddle buying and weakness in the red pack eurodollars, which closed -5.875 (hardest hit on the curve).  The theme was either position adjustment by Pimco, or others trying to front run expected changes as Bill Gross exited the firm.  New highs were made in the near one-year eurodollar calendars, again due to weakness in reds, for example EDZ14/EDZ15 was up 6 bps to a new high 84.5 and EDH15/EDH16 was up 5.5 to close 102.5.  Ten year yield rose 2.4 bps to 253.3.  Red/gold pack spread fell almost 4.5 bps to a new low of 180.5.
–Strength in near calendar spreads reflects the idea of hikes beginning a bit earlier.  Or… that Pimco didn’t like the risk of being long the reds…open interest changes indicate heavy long liquidation.  Here are OI changes in reds: EDZ5 -61k, H6 -7k, M6 -50k, U6 -24k.   But green OI was up on the day: Z6 +6k, H7 +20k, M7 -5k and U7 +23k.  All ED contracts -35.7k.   On the treasury side, open interest in fives was nearly unch’d, (the part of the curve where Gross favors the roll up), and tens were down 28k as October options expired.
–What is clear is that there was straddle buying across the board, notably Green Dec 98.875 for 31-31.5 and 98.75^ for 33-33.5 and Blue March 9700^ for 50.5 and 51.0.  I marked 5 yr vol 3.1 (adjusting for weekend) vs a close Thursday of just over 2.8.  Hi yield ETF’s HYG and JNK both closed lower on the day, though well off early lows.  I marked the yields on these two at 5.63 and 5.59 respectively at the floor close (3pm EST).  Five year treasury ended just over 1.80, so the spread to fives is around 3.80.  I will start marking this spread daily.
–Big week ahead with ISM Wednesday and Employment on Friday, with the ECB sandwiched in between on Thursday, hoping to instill market confidence with ABS buying.  But it’s not only confidence in central banks that has been shaken, it’s also been stirred in political systems globally.  In France, Le Pen’s National Front picked up two senate seats for the first time and in Hong Kong protests are gaining steam, with Hang Seng -1.9% today and down over 8% from the high set earlier this month.  From the FT:  “A ‘poisonous combination’ of record debt and slowing growth suggest the global economy could be heading for another crisis, a hard hitting report will warn on Monday”…the Geneva Report suggests rates will have to stay low for a very long time… http://www.ft.com/intl/cms/s/0/4df99d28-4590-11e4-ab10-00144feabdc0.html#axzz3EboufQjJ

Sept 26. Credit conditions tightening

–Stocks continue to trade heavy, with SPX -1.6%, Nasdaq -1.9% and EEM, the emerging market ETF, down 2.2%.  Treasuries were bid, as auctions wrapped up with the 7yr; tens fell 6 bps to 251.  New low in the red/gold euro$ pack spread to 185, -3.5 on the day.  In the beginning of 2013, red/gold was hanging around 150.  Before the talk of taper.  When tens traded with a 1 handle.  Now down to 185.
–Credit spreads surged.  Hi yield ETFs JNK and HYG both made new low closes for the year.  I haven’t charted the spreads but HYG (iShares iBoxx $ High Yield Corporate Bond ETF) closed at 5.6% yield, so 3.1% over the ten year.  Companies had been using cheap funding to buy back their own shares. That window might be closing with the autumn chill.  As we close out September, it’s worth remembering that ECB stress results are supposed to be announced next month, and the Fed is expected to end this round of bond buying.  In a world dominated by the value, no, that’s the wrong word, by the PRICE of financial assets, liquidity is an absolute necessity.  Changes at the margin can have outsized effects.
–GDP revision today expected 4.6%.  Does a higher revision cheer the stock market, or serve as a reminder that Fed sentiment has shifted towards tighter credit?

Sept 24. Curve continues to flatten

–The curve continues to flatten after last week’s Fed meeting.  Red/gold pack spread closed -2.25 bps to near 185.  This is the lowest red/gold has been since June of 2013, when it was in its incipient climb to over 300 as Bernanke first hinted at the taper in May 2013.  Once again, there was some fairly heavy put selling, for example 30k EDU5 9925/9900ps sold and 60k EDZ5 9875/9850ps sold (9.5 and 6.5, rolling up short strikes).  Straddles came in by 0.5 to 1.0.
–Stocks continue to trade heavy, led by Russell 2000, which closed down nearly 1%, and lower on the year.  While the major indices are holding, weakness seems to be moving from the periphery to core.  For example, EEM, the emerging market ETF had a gap open lower on Monday and closed at its low yesterday, down about 7% from its high set earlier this month.  I would note that one of the factors that caused the Fed to pause on its tapering plan last September was turmoil in emerging markets.  While EEM is nowhere close to lows made last summer, several currencies are testing new lows, and new recent lows in industrial commodities like copper and iron ore suggest a global slowdown.
–Five year auction today.

Sept 23. The market’s fine here, trust me…

–Ten year yield dropped 2 bps to 256.5.  Red/gold pack spread fell 2.5 to a new low just under 188.  Implied vol was under pressure as futures prices rose and long put positions were exited.  For example, there had been accumulation over the past month of at least 80k EDZ5 9900/9850/9800 put flies, yesterday about 20k were sold at 9.5.  Dollar index (DXY) made a new high.  New recent lows in Brazilian Real, Turkish Lira and SA Rand, underscoring vulnerability in EM.  Copper nearing support level of 3.00.  HYG (hi yield ETF) had an outside day and closed lower, with yield of 5.55.  Watch for continued signs of credit stress.
–This morning Eurozone PMI Composite came in at a disappointing 52.5 and German Mfg PMI was only 50.3, below forecasts.  US auctions 2 yr notes today; w/i at the close of the floor was 59.5/59.0.  There are a few Fed speakers on tap, Bullard at 9 EST, preceded by Powell and George.
–Small cap stocks are leading the market lower in the wake of last week’s Alibaba IPO, which incidentally made Jack Ma the richest guy in China.  From a Business Insider article ‘…what really stood out during the interview was his use of the word “trust.”  “Trust. Trust us, trust the market, and trust the young people. Trust the new technology…”
–You know what I’ve learned about people that are always saying “trust me”?  That’s right, you can’t trust them.  All the central banks are also begging for trust, and for gov’ts to institute structural improvements, but of course they don’t really trust the market to seek its own level.  But eventually it does.  Like water.

Sept 22. Selling pressure in treasuries reverses as commodities plunge

–Friday was a huge day in terms of market action.  Early in the morning yields pushed to new highs and tested resistance, only to reject those levels and end the day significantly lower.  For example, early Friday morning the 5 yr note traded 187.5, just surpassing the high of 2013 (185) and then collapsed below 182.  Ten yr made a high of 265, a big resistance level as there were highs in early June of 264.5 and 265.5, but sank to 258.5 by the end of the day, -4.0 bps.  Five, ten and bond treasury futures made new lows early, had outside days and closed higher, a strong signal that selling pressure has been shut down. 30 yr bond contract made both its low and high for the week on Friday, and closed at the top of the range.  EDZ15/EDZ16, the peak one-year euro$ calendar spread, made an early high of 115.5 but closed unchanged at 113.5 as new selling came in; both contracts saw open interest rise about 17k.  Red/gold euro$ pack spread closed at a new low just under 190 bps.
–Commodities were crushed.  Corn, wheat and beans made new multi-year lows as the dollar firmed.  Silver plunged, with the ETF down 4% to a four year low.  Gold/silver ratio broke out to a new high of 68 (using December contracts), a level not seen since 2010.  EEM (the Emerging Market ETF) closed at 43.46, poised to test three month lows and key support at 43.  The divergence between large caps and small caps is growing (see chart comparing DJIA and Russell on www.chartpoint.com from Friday).  Nasdaq had an outside day and closed lower.  Smaller cap stocks have terrible price action.  In spite of that fact, total equity market cap to GDP remains near record highs.  And from the last week’s flow of funds report (citing from prudentbear.com) “Household Net Worth increased $7.679 TN over the past year to a record $81.493 TN (551% of GDP!). For reference, Household Net Worth ended 2007 at a then record $67.832 TN. Amazingly, Household Net Worth has now inflated $24.295 TN, or 42.5%, since the end of 2008.”
–The G20 is warning that risks to the global economy have increased in recent months.  From the communique:   “We are mindful of the potential for a build-up of excessive risk in financial markets, particularly in an environment of low interest rates and low asset price volatility,” …“We welcome the stronger economic conditions in some key economies, although growth in the global economy is uneven.”
–In the US, as monetary policy has blown up financial asset prices and business borrowing has been growing smartly (though mostly for stock buybacks), the Fed is trying to hand the torch of credit and economic growth back to the private sector.  But there’s a lot of concern about Financial Stability as the transition occurs, and some market indicators are are flashing warning lights.

Sept 19. On the Ali BABA IPO….

…Gold/silver ratio is breaking out to the upside at 67.7.  Next target 70.  At the height of the crisis in late 2008, gold/silver ratio hit 84.  Silver is being whacked, now below 2013 low.

Crude oil has turned down.  The spread between Brent Dec14 and Dec15 contracts is at a new low of 1.80 (near contract has sold off much harder than deferred indicating a large drop in demand.  Copper has given up the gains of the PBoC injection news from a couple of days ago.  The five year swap spread is testing this year’s high, it is now 17 bps.  While HYG and JNK (hi yield ETF’s) had a spirited bounce in August, they have turned down thus far in September.  Some EM currencies have been weakening rapidly.  For example USD/BRL (Brazil) hit a high of 2.45 in late Jan and is now 2.375, as high as it has been since Feb.  Same story with SA Rand (ZAR).  Turkish Lira is at a six month low.  The ETF representing Emerging Markets (EEM) is testing an important level and appears poised to cascade lower.

In the US, as Alibaba IPOs, there has been a growing divergence between large cap stocks and small caps, especially over the past month.  One chart is ratio between DJIA (INDU on Bloomberg) and the Russell 2000 (RTY).

There appear to be many markets that are indicative of increased risk.  Could Alibaba mark the top?

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Gold Silver ratio over past 5 years

Below is ten year chart of Silver

This is the calendar spread between Dec ’14 Brent and Dec’15. Curve has gone contango as nearby demand has cratered

The emerging market ETF…..

Below is ratio between DowJones Industrials and Russell 2000….

 

 

 

 

Sept 18. Fed dots hawkish; Scotland vote today

—The slope of the dots in the Fed’s SEP steepened, so all near euro$ calendar spreads made new highs.   EDZ15/EDZ16 is still the peak, and it rose 2.5 to 111.5, just under the 112.5 strike of the put spread spreads done a week or so ago. (Sold OEX 85/87ps and bought 2EX 73/76ps).  The green pack (EDZ16-EDU17) was the weakest part of the curve, closed -6.0.   However, EDM19 was unchanged and contracts behind it were all up on the day.  Gold pack closed nearly UNCH.  5/30 treasury spread closed 156, -2.  Five year yield was 182 late in the day, still hasn’t quite taken out the high from last September of 185.  The dollar exploded higher (JPY now 108.70) and implied vol in fixed income was hit, for example about 30k Green Oct 9775p were sold at 6.5 covered 9780.  The 9775 straddle settled 18.5 vs 21.5 for the 9787^ on Tuesday.
–Inflation data was lower than expected 1.7 yoy.  With the Fed being perceived as more hawkish, the curve should flatten further.  The late sell off in the bond contract was surprising, but it is slightly higher this morning.
–Scotland vote today.  Also ECB’s TLTRO results will be posted this morning.  EUR remains below 129 this morning after plunging in response to yesterday’s FOMC.  US news includes Housing Starts at 1.038m, Jobless Claims at 305k and Philly Fed, expected to drop back to 23 from the surge to 28 last month.

Sept 17. FOMC… Going to be a considerably long day

–FOMC today. My thought is that “considerable period” remains in the statement, as global deflationary forces continue. The fact that China is injecting $81B into its banking system is evidence of a slowdown. The immediate result was a rally in Aussie, and in copper, etc. But the initial moves may not hold. The fact that every central bank feels the need to just do ‘just a little bit more’ to keep the plates spinning is a sign that organic growth is tepid at best. Even if the Fed does change the language, eventual rate hikes in the US are likely to be cautiously spread out.

–Curve steepened as red euro$ pack was the outperformer +2.875. Red/gold pack spread gained just over 2 bps to close near 196. 2/10 treasury spread edged to a new recent high at 205.6. The peak one year calendar spread on the dollar curve remains EDZ15/EDZ16 which is 109. There has been very heavy long positioning in this spread through options…selling midcurve put spreads on EDZ15 and buying put spreads on EDZ16.

–The difference between the Fed dots and market pricing may begin to narrow a bit. I would think that longer term dots continue to edge down from 3.75%, and perhaps reds to golds steepen from here. However, geopolitical events may intervene and keep the back end of the US curve well bid. There was a notable buyer of 10k TYZ 127c yesterday…these are about 35 bps out of the money, somewhere around 2.25% on the current ten year note. If Scotland breaks up with the UK and France is downgraded (Citi warning of the possibility), then US safe haven status will keep treasuries firm.

Sept 16 FUBAR is the US translation

–US interest rate futures had a modest bounce Monday, with most eurodollar contracts up 2 -2.5 bps.  The action yesterday was in Nasdaq as the index fell around 1%.  Tesla sank 9%, a loss of about $3 billion in market cap.  While some of the selling is likely making room for the Alibaba IPO, which is expected to raise about $22b, valuation levels in general are becoming more of a concern (TSLA).
–The OECD cut growth forecasts and urged aggressive measures from the ECB to ward off deflation.  China’s economy is also slowing, evidenced by falling commodity prices.  Since the July FOMC crude oil is off about 10%, though for the time being is finding responsive buyers around 91.   Aussie continues to fall, testing new lows this morning near 89.25.   PPI this morning expected 0.0.
–Fed doves will likely win out at tomorrow’s FOMC, but military hawks are gaining more influence as the US bombed ISIS positions near Baghdad, stepping up the heat in a clear offensive move.  The US is back in an Iraq war, whether admitting it or not.  In other obvious news, French Prime minister Valls is now privately admitting “in three to six months, if the situation isn’t reversed, we’ll be foutu”, according to Le Monde.

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

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