Sept 15, 2014. The soft underbelly of central bank “control” is about to be exposed

–It was a fairly big day Friday as the back end of the US treasury curve slid to new lows.  US 30 year bond rose nearly 10 bps in yield to end near 335.  The five year note jumped over 3.5 bps to close at 181.5.  This was the highest close in fives in over a year; it was almost exactly a year ago at the September 2013 employment report when the 5 yr yield hit 185.   This year it has been in a range from around 145 to 180.  There was heavy buying of Blue October 9675 puts for 3.0 (settled 3.0 ref 9704.5, 18 delta).  There was also a large 100k trade synthetic long EDZ5/EDZ6 spread, selling 0EX 85/87ps to buy 2EX 73/76 ps for 1.5 debit.  Nearly all Eurodollar calendars made new highs.  EDZ15/EDZ16 has been the peak one year spread for some time, and rose 2 bps to 109.5 to a new recent high.
–This is, of course, a heavy news week with the Fed meeting and the Scottish vote for independence.  However, the bigger picture seems to be a global change in perception with respect to a low volatility environment.  Certainly the fx arena has seen some major break outs and a surge in volatility. As examples, $/yen has jumped from 102 to 107 in a month.  Aussie is making a new low as of Sunday evening, having plunged from over 93 to 89.50 this month. And now US interest rates have become somewhat unsettled in front of anticipated changes in the Fed’s posture.  Implied vol in treasuries was much firmer, with fives at 3.2, the highest since early June.  And there was even a large buyer of October VIX calls, paying up to 0.45 for over100k Oct 22 calls.  The point is that we seem to be in a period of roiling changes, like a shifting of tectonic plates.  In terms of societal structure, we’ve seen the “Arab Spring” and other revolutionary actions and military hotspots.  It almost seems to me that the Scottish vote is just another link reflecting a global sense of societal disappointment, to be shortly followed by Catalan in Spain.  Central banks had quashed volatility with ZIRP policies, but recent fx action is a sign of a leak in the dam.  If longer term interest rate markets unhinge, then certainly the cult of “nowhere else to go” pervasive in the equity markets will also crumble.  (New lows as well in crude oil this morning).
–Markets appear to be on the cusp of rejecting central bank “control”. This is a HUGE Fed meeting, one that could mark an historic shift.  We are seeing one breakout after another, following societal rejection of governments and borders across the globe.  CME stock investors seem to be banking on increased volumes and volatility as the stock surged to 8 month highs in an otherwise weak market.  ICE also jumped Friday, breaking the year’s down trend. Leave it to a (hopeful) broker to project pandemonium in global markets and then point to a micro example of futures exchange prices… But all the examples of compressed risk spreads will fade to distant memory within a year.

Sept 12. 5/10 flattening this year…run its course?

–Nearly all interest rate futures contracts settled unchanged yesterday, though in spite of a well received 30 yr auction, the bond future slid lower just after the floor close.  Weakness has been concentrated in green euro$ pack and the 5 yr note as the market anticipates “lift off”.  At the end of last year when the ten year yield had ramped up to 303, the 5 yr yield was 174.  Yesterday tens were 1/2% lower at 253, while 5s closed at 178, 4 bps higher.  Red/gold euro$ pack spread was 306 in Dec, now 204.  It has been a remarkable flattening.  When the Fed was raising rates from 2004-06 the curve also flattened and eventually inverted leading for many to call for a recession.  It was a very early call, but proved correct in a big way of course.  I think the back end of the curve has been steadfastly projecting growth at stall speed.  Perhaps an improved labor market will finally provide a spark?
–Anecdotal evidence runs both ways.  For example, Hollywood is having a terrible year, with ytd box office -5.6% and employment in the industry down significantly.  On the other hand, Ferrari revenues are +14.5% ytd.  Let them eat cake.  But they don’t seem to be driving those fancy cars.  If you look at Estimated Vehicle Miles Driven for the US it’s still down significantly from the highs in 2006, and even looks worse when adjusted for population.  http://www.advisorperspectives.com/dshort/updates/DOT-Miles-Driven.php

From a global perspective, yesterday’s IEA report noted a large down shift in global energy demand.  From FT : “In its widely followed monthly report, the west’s energy watchdog said on Thursday that global oil demand growth had slowed to below 500,000 barrels a day in the three months to June – the first time it has reached this level in two-and-a-half years. …“While much attention has been paid to the relentless growth in North American unconventional supply, demand headwinds have perhaps been less widely noticed,” the IEA said in its report. “The recent slowdown in demand growth is nothing short of remarkable.”   Maybe it’s just China and the EU.  Shanghai rebar made another new low and I believe I saw that iron ore prices are down 38% on the year.
–In terms of yesterday’s price action, crude had a huge day, first sinking to new lows for the move, then posting an outside day with a higher close, +1.57 late.  In the short term, selling pressure has been shut down in oil.
–Retail Sales today expected +0.6% and +0.4 less autos and gas.

Sept 10. Obama to outline ISIS strategy on eve of 9/11

–All near euro$ calendar spreads made new highs yesterday as the market continues to trade heavy in anticipation of rate hikes somewhat sooner than previously expected.  The peak one-year spread continues to be EDZ15/EDZ16 which rose 3 to 107. (Reminder, last year the peak 1-yr spread hit 124 as tens were around 3.0%).  Ten year yield (w/i) rose 3 bps to 2.51 in front of today’s auction.  Weakness again led by the 5 yr, up 4.3 to near 1.76, and green pack which was down 6.5.  5/30 treasury spread flattened by 4 as the long end barely moved.
–A lot of AAPL hype yesterday and this morning related to new product releases.  Price action indicates that most of the news was already built in to the stock, as an initial surge tested the recent high. and then fizzled to end slightly lower.  I would say that US treasuries have the same sort of psychology.  Though NFP was much lower than expected last week, an initial pop in tens couldn’t hold, and there has been somewhat heavy put buying ever since.  ‘Flight to quality buyers’ had already made their allocations into UST.  As Obama auspiciously gives a televised speech tonight, on the eve of 9/11, to rachet up the ISIS plan, a bid for safety may again be evident, but for now it’s all been put buying and call selling.
–Given the Fed schedule of next year, I have watched May ’15 FF which continues to test 9975 or 25 bps, and August ’15 FF which had traded just below 9950 in late July.  There are FOMC meetings on April 29 and July 29 so these are ‘clean’ months with no meetings.  However, they don’t coincide with press conferences so I suppose rate changes are somewhat less likely than at the quarterly meetings.  Yesterday FFK5 settled 9975.5 or 19.5 bps, -1.5 on the day, and FFQ5 settled 9954.5 or 45.5, down 2.0.
–One other small aside is that copper was down around 6 cents to 310.  For the past several years 300 has been a key area of support.  If it doesn’t hold this time around then it may foreshadow weaker global manufacturing.

Sept 9. Dollar is surging, yields edge higher

–Yields ticked higher yesterday with Green euro$ pack -4.0 and Blues -4.125.  Treasury curve weakness in the belly, with both 5/10 and 5/30 slightly flatter.  Another 40k new positions in EDH5 9962p, bringing total open interest to 312k on a payer of 5.5 and 6.0.  EDH5 futures settled 9964 with total open interest of 1.2 million.   Another notable put buyer, adding to positions, was in Green Oct 9787p for 6.0-6.5 (settled 8.25, OI +20k) and 9775p for 3.5 (settled 4.5, OI +14k).
–The dollar is surging.  Dollar Index was around 80 at the start of July, late yesterday was 84.30.  In July of 2013, there was a high of 84.75, prior to that DXY hasn’t been this high since 2010.  $/yen has surpassed 106, highest since 2008.
–Today’s news includes JOLTS and NFIB small business optimism index, which has been steadily climbing and is expected at 96.0.  Three year auction.
–There was a SF Fed research piece going around yesterday which suggested that the market was under appreciating the timing and magnitude of possible Fed hikes.  Some selling pressure was attributed to this story.  “The public seems to expect more accommodative policy than FOMC participants” and “…the range of the public’s forecasts is somewhat smaller than that among FOMC participants, suggesting the public may also be less uncertain about their projections.”  Duh.  Anyone who has compared the “dots” to the back end of the euro$ curve already knows this.  Additionally, the Fed’s own forecasts in the SEP have been well off the mark and are continually revised as time moves forward.  It gets down to the problems inherent with “models” that often work until there is some small kink like the housing crisis.  ‘Hmmm, our models suggest that rates should be higher and they’re not.  Must be something wrong with the MARKET.’  Reminds me of my favorite YZ story, where a group was sitting around the bar drinking and having a heated discussion about some sort of trade position.  YZ, in an effort to conclude the discussion says, “Let’s run it through the model…”  takes a quarter out of his pocket, flips it… “Tails.  Sell.”

Sept 3. Put buyers in tens

–Yields jumped yesterday on a strong ISM number of 59.0 and robust Construction Spending.  Aside from mid-2011 this is the strongest ISM since 2004.  And it comes on a string of other powerful data, including last month’s 22% rise in Durables.  Of course that was mainly due to aircraft orders (which might actually show sustained growth as there are reports this morning that 11 commercial aircraft have gone missing from Tripoli’s overthrown airport).  In any case, 10 year yield rose 7.5 bps to nearly 242, and is higher yet this morning in front of today’s releases of ADP (223k expected) and Factory Orders of +10.9 exp.  Option activity was decisively bearish.  In dollars there was heavy put spread buying vs call selling.  In tens there was new buying of at least 15k TYV 124/125 put spreads (just through the upper strike this morning) and a new buyer of TYZ 123.5/124 put strip.  I generally like to see confirmation of a move with 1) heavy volume 2) an increase in implied vol, and 3) an increase in open interest.  Surprisingly, open interest was down in 5’s, 10’s and bonds, but the market definitely trades bearishly.
–Curve was just marginally steeper.  Dollar was much stronger with $/yen climbing above 105.  Crude plunged over $3; I  marked CLV at 9284 late, down 312 though still above August low of 9250.
–Now it’s all about the hiking schedule and whether rate increases can actually be sustained.  I saw a story that since the crisis, central banks that have tried to raise rates have already been forced to reverse course, including Finland, Norway, and New Zealand, and that high levels of global debt preclude funding rates of over 2%.  With the Fed making progress toward stated goals, some think the first Fed hike comes as early as spring.   The Fed assesses the market as expecting the first move in Q3.  I would split the difference and lean towards summer, but with the preponderance of geopolitical time bombs that could yet shock the economy, rate hikes are no sure thing.

Sept 1. Labor Day. Guns and Butter

–Just a few quick notes about labor and the markets.  I saw a note where Marc Faber cited a report from the US military that 71% of the US population that is eligible for military service would fail to qualify.  That’s ALMOST HALF.  (Just kidding, but I couldn’t believe that figure and thought he was misquoting).  So I looked it up and there are several stories in the press about this report, the one I will quote from is on the WSJ site from June 27, 2014.  http://online.wsj.com/articles/recruits-ineligibility-tests-the-military-1403909945  “… the Defense Department estimates 71% of the roughly 34 million 17- to 24-year-olds in the U.S. would fail to qualify to enlist in the military if they tried, a figure that doesn’t even include those turned away for tattoos or other cosmetic issues.”  “The military deems many youngsters ineligible due to obesity, lack of a high-school diploma, felony convictions and prescription-drug use for attention-deficit hyperactivity disorder.”  “The quality of people willing to serve has been declining rapidly,” said Gen. Batschelet.
–Think about that for a second with respect to the US labor pool, and some businesses complaining about not being able to find skilled applicants.  I have tremendous respect for the US military but to say that 71% aren’t qualified is mind boggling.  Where does that 71% go?  Goldman?  What are the implications for wage growth?  Sure, skilled labor can get wage gains, but the Fed has absolutely no influence on this 71%.  Also, think about social services and the percentage of actual taxpayers that have to support those programs.
–And here’s another interesting story which points up some contrasts in the low wage service businesses.  The sentiment which is spurred on by our political leadership, is that everyone deserves a raise in these jobs, and that labor must start winning back its fair share from capital.  Perhaps there’s some truth to that.  I recall a clip from Bill Maher saying there is NO dignity in working at a fast food restaurant.  But take a look at this story:  http://www.businessinsider.com/restaurant-helps-workers-own-franchises-2014-8  Here’s a quote:  “We practice this philosophy by giving each promising cook and server a clear path to owning his or her own store. Right now, 45 former minimum-wage employees own Hwy 55 franchises. And up until very recently, we exclusively franchised with long-term employees.”  The minimum wage job isn’t supposed to be an end unto itself, any more than being a runner on the floor of the CBOT, which I personally did.  Want to see a job where you take a lot of sh-t and don’t make any money?   Run a few grain orders…and hand an order with the wrong contract month to Sheldon in the beans.  That guy took a good minute out of his day just to yell at me at the top of his lungs.
–And just for JC
https://www.youtube.com/watch?v=xR9HuRUUTbs

Alex Manzara

Aug 29. Excuse me stewardess, is there a movie on this flight?

–Once again the curve flattened with marginal new lows in 2/10 at just over 183, and 5/30 at 144, both down around 1.5 bp on the day.  Same with red/gold euro$ pack spread at 190.75, which fell 1.125.  As the back end of the treasury market presses higher in price, straddle premiums expand.  For example, with the Dec bond up 18/32’s, the Dec 140 straddle went from 414 to 422.  TYZ 125.5 straddle was 209 on Wednesday and the 126 line settled 214 yesterday.  Similarly, Blue June 9712.5 straddle went from 65.5 to 67.0.
–There has been heavy put buying in Blue Oct puts this week, yesterday +15k 3EV 9700p for 3.5 (settled 3.25 ref 9731.0), and 12k Gold Oct 9662p which settled 2.0 ref 9699.   Next week we have ECB and Employment data, either of which could steepen the curve.  The Sept FOMC is on the 17th, so perhaps the market will finally react to the bearish projections of the dots as pertaining to the back end of the curve.  Or maybe the buyer just “doesn’t have a strategy” besides hope.
–Going into a long weekend with significant tensions, one would think that treasuries will maintain a bid.  Washington Times reports increased terror chatter as another 9/11 anniversary approaches.  However, the market trades a bit long already.
–CBS News: “A man who had an ISIS flag waving from his vehicle is facing several charges after he threatened police with a bomb Wednesday morning when he was pulled over on the Southwest Side [of Chicago].  What are the odds that he trips and injures himself in jail?

Aug 28. Watch out for falling rates

–New lows in the curve.  Red/gold pack spread fell another 2.375 to just under 192.  2/10 treasury spread 184.7, also down 2 bps as the ten year yield fell 3 to 236.  The peak one-year eurodollar calendar spread is still EDZ15/EDZ16 but it’s now only 101.5, falling 1.5 yesterday.  German ten year yield is down to 90 bps this morning.  US thirty year bond yield at 310 is the lowest level since June 2013.
–There are a lot of stubborn bears in US rates; there is continuous buying of put butterflies in blue eurodollars – yesterday it was 20k Blue Nov 9712/9687/9675p fly bought for 4.5 covered 9729.5.  And MNI put out a piece with this:   “The Rates Strategy team at Goldman Sachs still holds a bearish stance on US rates and continues to expect 10Y and 5Y year yields to reach 3% and 2.25% by year-end 2014 and get to 3.5% and 2.75%, by year-end 2015, respectively.”  I’m going to be surprised if even the 30 yr bond has a three handle at year end.  In spite of Bullard’s hawkish comments on tightening, the back end of the curve just isn’t buying it.  Or, they ARE buying it, which is to say they aren’t buying the economic/labor lift-off scenario.  Back in 1994, when the 30 yr bond contract was king, I remember seeing an interview with Tom Baldwin, at that time one of the biggest floor traders, correction, one of the biggest bond traders, period.  It was when the Fed had begun tightening, and he said for the first couple of points he fought it, but when he continued to see waves of selling, he just turned around and went with the tide.  There are a lot of people fighting the good fight against this rally, but as a friend of mine advises, “you can be bearish, just don’t be short.”
–Across the headlines yesterday was news that the ECB had retained BlackRock to advise on ABS buying.  DB referred to it as private asset QE.  Is it just me or is that waving the white flag?  In 2009 there was a lot of talk about the transfer of crappy debt from the private sector to the government in order to save the banking system.  Now the ECB is jumping into that arena, just prior to the October release of banking stress tests.  I’m sure all the banks will sail through stress tests with flying colors, and within a few months there will be a colossal failure with the usual, “nobody could have seen that coming” excuse.

Aug 27. Equity market cult as yields drop and curves flatten

–Ten year yield unchanged yesterday at 239 though the 30 year bond rose 1.4 to just over 315. New low yesterday in EUR at 131.71.  New low as well in red/gold pack spread at 194.25, down 1.375 on the day.  The spread hasn’t been this low since June of last year, when it was on its way up to the ultimate high of 306 right at the end of 2013.  So from the high, it has fallen nearly 112 bps, or 36%.  The ten year yield was also just above 300 bps at year end, now 239.  Strength in the golds has been remarkable.
–There was a late buyer yesterday of 25k FVZ 118.75/119.75 call spd for 23, new position.  Somewhat interesting given today’s upcoming auction of 5 years.  There was also a large buyer of TYV 123.5/124/124.5p trees yesterday, settled flat with a small call delta.  Open interest was up 151k in October ten yr puts, mostly due to this trade.
–There’s an interesting piece on Bloomberg, noting that global equities are at a record $66 T.  From the article, “The value of equities globally has soared from $25 trillion in March 2009. Stocks were valued at $63 trillion at the 2007 peak…”  The value of US equities is about $21 T or about 32% of the total, and is approx 124% of US GDP.
–Record low yields in developed countries have spurred this gain in equities, driven by QE, and the ECB is now getting ready to jump in to the QE pool just as the US gets out to towel off for a rest.  My feeling is that the move to extremely low yields coupled with flattening curves is a sign of economic malaise going forward, but the central banks continue to look for sparks caused by the “wealth effect”.

Aug 26. Relentless flattening of US dollar curve

— New low 5/30 and 2/10 treasury spreads, at 145 and 186 respectively using w/i 2’s and 5’s.  Ten year yield fell a bit over 1 bp to 239.  In euroollars, blue /gold (4th to 5th year) pack spread is flattening like crazy, down another 1.5 to just over 31.  This spread started the year at 71.  German Schatz plunged 5 bps in yield to – 4bps.  The US treasury auctions two year notes today, closed above 53 bps yesterday.  The spread between red dec euribor ERZ5 and red dec dollars EDZ5 is a record 90 bps.  Not surprisingly, the Euro fell below 132.  ECB banking stress test results expected in October… seems as if whatever stressful scenario they are trying to model is already in its incipient stage.
–There were some large eurodollar put flies bought late in the day.  50k Blue Oct 9712/9687/9662 put fly and 25k Green Nov 9787/9762/9737 put fly, both of which settled at 4.0.  Though there continues to be positioning for Fed ‘normalization’, the rest of the world seems anything but normal.  Capital flows which strengthen the dollar aren’t likely to be stimulative over time.
–Wildcard today is Durable Goods, expected over 5% due to orders from Boeing.  (Are bombs considered ‘durables’ because they seem to be flying off the shelves these days).

• 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.