Aug 22. Jackson Hole. Anticlimactic before it even starts.
–Yellen and Draghi speak at Jackson Hole today. There is a lot of focus on whether Yellen can be dovish enough to justify current yield levels. But the minutes this week have already acknowledged the idea that dealers are expecting a hike by Q3, and the Fed is discussing operational issues related to rate increases. Back month euro$ calendar spreads are not widening. (Highest one year spread remains EDZ15/EDZ16 at just 103). The market is telling us that rate hikes will almost certainly be limited. Even if Yellen isn’t as dovish as expected, bond bears are likely to be disappointed. And when Yellen is done, Draghi will confront the mess that is Europe. Recall that ECB stress test results are due right around the corner in October. And dollar strength along with yield differentials still support a bid in US treasuries.
–A couple of large positions taken yesterday also reflect the idea of a gradual curve roll forward without much drama. There was a seller of 30k Short Sept 9925 straddles with Green Sept 9812/9825 strangles covered 9824 in EDU6, from 20 to 18.5. Three weeks until expiration. There was also a new buyer of 40k Green Nov 9812/9837/9862 call flies for 2. The spread between EDU6 and EDZ6 is 25.5 bps. If things stay pretty much the same, the roll will put the fly right in its sweet spot between the low and middle strikes, and the decay of Sept midcurves will almost surely pay for initial outlay.
–Treasury option expiration today. Watch out above.
–One other thing to note is that the administration is preparing the public for a much bigger confrontation with ISIS. Odds of a terrorist threat increase, which means increased security measures right down to the local level. Which in turn implies at least some degree of suppression of rights. Perhaps it’s a stretch to connect something like ISIS with the idea that a fragile situation in many large US inner cities could boil over. But it’s something to perhaps keep in mind?
August 21. Fed minutes from July push yields a bit higher
—Fed minutes sparked a sell off in interest rate futures as discussion about rate normalization and “lift off” caught the market’s attention. Tens rose 2.5 bps to 242.8. On the dollar curve, greens and blues were weakest, -5.625 and -6.125 respectively. Going into the Jackson Hole conference which will emphasize labor markets, this line from the minutes could be important: “Many members noted, however, that the characterization of labor market underutilization might have to change before long, particularly if progress in the labor market continued to be faster than anticipated.” Yellen wants to see real wages increase, and may stress the underutilization theme as a push back to some on the committee.
–In the staff review: “The median dealer continued to see the third quarter of 2015 as the most likely time for the liftoff of the federal funds rate from the effective lower bound, although, relative to the June survey, the distribution of the modal expected time of liftoff became more concentrated around the third quarter of 2015.”
–Before the minutes were released, there appears to have been some large position adjustments. Exits of red and green Dec midcurve put spreads vs calls (sold puts/bot calls) and a new buyer of 80k red March midcurve 9850p for 10.5 and 11.0 (approx 32 delta and 27 bps out of the money). While these puts rose 77.5k in open interest, Green Dec 9762, 9775 and 9787p combined lost 40k in open interest. In terms of timing, it makes sense to swap into March, as Dec midcurves only have 114 days left versus 205 for March. It’s also reasonable to move a bit forward on the curve, as the back end appears to expect only limited tightening and continued low inflation. Again I would note new lows in Crude, now below $93 and down over 7.5% in a month and a half, and a slight new low in ten year treasury to tip spread, just under 218 bps.
Aug 20. Does a flight to quality bid spark a mortgage refi bid?
— US rate futures have been fairly boring for the past couple of sessions, with stocks floating higher and sellers attempting to press treasuries lower on this sign of apparent economic strength (that less astute traders must be missing). Since August 8, when stocks reversed their sell off and soared from 1905 to 1975, tens have mostly edged higher, TYU having been slightly below 126 on 8/8 and now trading slightly above at 126-04. Sellers keep trying to press, waiting for the rest of the world to wake up to the obvious signals in the US equity market. But it appears as if the rest of the world just wants to find a safe harbor, which has led to a dollar bid, and underlying support in treasuries, and of course stocks as well. Yesterday the ten year yield edged up 1.5 bps to just above 240, with TYU teasing shorts at the 126 strike going into Friday’s option expiration.
–In the bigger picture, I saw a headline scroll across Bloomberg that Poland’s tens were trading at a new low yield, 3.09. Sure enough, I checked out world bond yields and saw Poland just as advertised, with Bulgaria nipping right behind at 3.10. These are the “high yielders”! Japan’s at 49 bps and German bunds are on either side of 1% with schatz a few bps below zero. Global debt levels and the growth of CB reserves have actually served to keep yields low, with bad debts allowed to linger on. Zero rates have forced investment managers to pay up for that incremental dollar of earnings or yield.
–In terms of US rates, there was a rather interesting piece in the FT Monday, which argued for tens to reach 2%. Part of the reason has to do with the Fed’s mortgage portfolio: “…the Fed, the biggest mortgage investor on the block, has made clear it will reinvest principal repayments dollar for dollar. Normally, the widening in mortgage spreads mutes the impact of the rate decline on mortgage rates, slowing the pace of refinancing. This time, advertised mortgage rates are likely to fall more rapidly than in prior refi experiences.” The idea is that as tens approach 2.25%, a new wave of refis may hit. The Fed will just take the proceeds of called mortgages and reinvest, with no sensitivity to returns. And if the Fed’s not sensitive, doesn’t it make sense to get out in front… The home mortgage market is about $9.35T according to the last Z.1. The Fed holds about $1.7T in mortgage securities. (Total Fed gov’t debt is $12.57T). Is the Fed’s portfolio large enough to cause a rippling rally IF the refi wave hits? I don’t know. But it certainly makes me understand wingy call buyers.
August 18. Why can’t rates go lower?
–New lows set in near eurodollar calendar spreads on Friday. Red/green pack spread remains under 98 bps. Dec’14/Dec’15, covering next year’s expected tightening, fell 2 bps to a new low of 66, having been at 84 at the end of July. As colleague Todd Colvin notes, maybe the market should be thinking less in terms of 1/4% tightening increments, and consider moves of 1/8%. For example, August ’15 FF contract was recently trading at 50 bps on Fed hike prospects, but closed Friday at 3/8% (99.63). Red/gold pack spread fell just over 2.5 bps to close at 201, as the dollar curve continues to flatten. Ten year yield was down 6 bps to 234. While stocks rebounded from an early drop caused by Russia/Ukraine tensions, treasuries maintain a bid. Many people refer to both stock and bond bubbles, but going into the Jackson Hole Conference, bonds are likely to keep a firm undertone near recent new low yields. Yellen speaks about the labor market on Friday at 10:00 EST. An article on Bloomberg this morning highlights the large number of people working part-time because they can’t find full time employment. Draghi’s speech is at 2:00 EST Friday.
–In skimming the headlines this morning, there were references on several sites to declining property values, notably in China. (FT) China property prices fall…New home prices fell by 0.9% between June and July, the sharpest drop in three straight declines. The UK is also in focus. (BBG) London Home Asking Prices Plunge Most in More Than Six Years …Nationally, prices declined 2.9 percent, a record for an August. And in the US, a bumper crop in corn with the resultant plunge in prices is likely to pressure farm values. Deere & Co has already been affected, having announced Friday “it will lay off more than 600 factory employees indefinitely as part of its plan to scale back agricultural equipment production amid weaker demand.” (Market Watch).
–The point is that subdued labor markets coupled with property values that have come off the boil are factors that could keep global rates biased to the downside.
August 15. $/yen going to 120 by year end
–30 yr bond auction yesterday was bid 2 bps through pre-auction level, coming in at 3.224. Ended the day at 3.205 as demand for US assets (and some type of yield) continues unabated. USU is at the 140 strike with one week to go until Sept option expiration. USU 140^ settled 1’14, just under 8 bps. Crude oil sold off smartly with CLU down 214 at 9545 and CLV down 271 to 9403. Inflation expectations are evaporating. New low in ten year treasury to inflation index note spread at 222.4. The ten year tip is just under 18 bps; real yields hover around zero, right where the German Schatz is. At the end of July, Aug ’15 FF futures were at 9950, suggesting that by the July 2015 FOMC, rates would be at 1/2%. The market has decided the economy couldn’t possibly withstand such a punitive rate and FFQ’15 settled 9962.5 yesterday. Going into the Fed’s Jackson Hole conference, there will likely be presentations on how the Fed can more appropriately support the economy…
–The highest one year euro$ spread is still Dec’15/16, now the only spread over 100 at 101.5. At the end of last year the high was 124, a drop of about 20%. Ten year yield was 305, now 240, down 21%.
–Japan tens are 50 bps, as the idea of building an ice wall around Fukushima (remember that? I think we’re going to be hearing a LOT more about it) has been scrapped. Of all the astounding signs of complacency, perhaps the sideways range of JPY between 101.60 and 102.60 for the past three months takes the cake.
–Today’s news includes PPI expected +0.1 with +0.2 Core. Empire Carpets 20.0. Industrial Production +0.3.
Aug 14. Bund yield on either side of 1%; San Diego discovered by the Germans
–Yields fell yesterday as Carney dialed back the prospect of tightening, tying policy to wage growth. Then US retail sales disappointed, coming in at 0 vs expectations of +0.2. Tens fell 3 bps to 242.5. Near eurodollar calendar spreads made new lows. The peak one year spread, Dec’15/Dec’16 fell 2 bps to end at 102 (now the only one-year spread above 100). This morning weak GDP data in Germany and France caused bunds to dip below 100 bps. Korea cut rates to 2.25% (expected).
–It seems to be an endless cycle of tepid growth and contained wage pressure which combine to snuff out tightening expectations and encourage share buybacks funded with debt. Other markets are also telegraphing reduced price pressures, with Nov Soybeans at a new low this morning after yesterday’s crop report. Corn is hovering at the low. Crude oil is down slightly today, and copper, which had been holding up quite well, fell 3.75 yesterday and is a bit softer currently. (HGU 310.75, averaged around 324 in July).
–Interesting item in this morning’s WSJ that San Diego County Employee Retirement fund is levering up with the use of derivatives in an effort to increase returns to cover pension shortfalls. http://online.wsj.com/articles/san-diego-pension-dials-up-the-risk-to-combat-a-shortfall-1407974779
As a footnote, in 1994 Orange County went tits up due to its reach for yield using sophisticated financial instruments. From NYT, “The investments had been made by a county desperate to get additional profits on its investments to pay for government services. But the fund, with about $8 billion invested in it — and with borrowings of about $12 billion — now faces a loss of at least $1.5 billion.” Recall that 1993 was a year of low rates, with FF pegged at the THEN low rate of 3% for the impossibly long period of of 14 months. There followed a “reach for yield”. Aggressive tightening in 1994 caused many financial dislocations, contributing to the Mexican Peso crisis as well. Stay classy, San Diego… Ron Burgundy: Discovered by the Germans in 1904, they named it San Diego, which of course in German means a whale’s vagina.
August 13. Slight steepening bias to yesterday’s curve
–Fairly quiet in interest rates yesterday, however there were some large trades late in the session, apparently spurred by a Reuters article with this summary: ‘Yellen resolved to avoid raising rates too soon, fearing downturn.’ Large buying out to EDH16 which closed +2.5; last two reds were the strongest part of the curve with the most increase in open interest (EDH16 OI +38.6k with total ED open int +84k). There was also a late buyer of 40k Blue Dec 9712/9687/9662/9637 p condor for 6.0. Net effect was a slight steepening of the curve, with reds +2.25 and golds -1.25. A few near spreads made new lows. For example EDU14/EDU15 fell 1.5 to 50.5. Mind that the sometime in the beginning of next year is when tightening is expected to begin, yet the market prices the one year spread at only 50 bps… EDZ14 9975 straddle settled at just 4.5, with 125 days until expiration.
–A Telegraph article by Ambrose about the glut of oil has the following line: The IEA said in its monthly report that the oil market seemed “eerily calm in the face of mounting geopolitical risks spanning an unusually large swathe of the oil-producing world”. It’s not just the oil market, it’s every market. CLU is lower this morning at 97.23, the geopolitical gains of late June which saw prices nearing 107/bbl have been thoroughly erased.
–Elsewhere in the world Japan’s GDP plunged by 6.8% in the aftermath of the consumption tax. From this morning’s FT: “Chinese lending slumps amid property downturn…Credit grows at slowest pace since 2008”. Stocks are, of course, higher across the board, with even the Nikkei and Shanghai Comp posting slight gains.
–Today’s news includes Retail Sales expected +0.2. Fed’s Dudley speaks about wholesale funding risks…did you see the EDZ straddle Bill? Ten year notes are auctioned in the afternoon.
Aug 11. Peace dividend?
–Stocks posted an outside reversal higher Friday, after trading heavy volume at new lows during european hours. Treasuries held up fairly well despite the rebound in stocks, but still closed near lows of the day. Not much change in the curve. Red/green euro$ pack spread closed exactly at 100; peak one year spread is still EDZ5/Z6 at 104.5.
–Implied vol firms as treasuries rally. Last Tuesday I marked atm TYV 124.5^ at 1’41 or 4.4. With stocks pressured later in the week, straddles went bid. TYV 125^ settled 1’50 on Friday, 5.0 vol. Even with the bounce in SP’s premium in fixed income held up.
–This week brings auctions of 3, 10 and 30 yr treasuries. Retail Sales on Wednesday is probably the biggest economic report.
–So far, bombing raids in Iraq don’t seem to be having much of a market impact. But doesn’t US military capability seem stretched a bit thin? There’s Iraq/Syria, Russia/Ukraine, and unrest in the China Sea. If there was a defense “peace dividend’, it has surely vanished. Even at the local level, the State of Illinois has agreed to assign State Troopers to help the Chicago Police Dept handle increased crime. With attempts to redraw borders across the world, the US becomes a safe haven for capital flows, but it’s probably an error to mistake these flows for underlying confidence in economic fundamentals. Risk has increased globally, the US is likely just the last place for it to really show.
August 8. The dam could collapse
–The market has reacted negatively to Obama’s announcement of humanitarian air drops in Iraq. Ironic, because Russian troops massing along the Ukraine border are also on a humanitarian mission.
–New lows in bond and ten year yields. I last saw tens at 236, fully 11 bps below Wednesday close Stocks are under pressure. SPX was through its 100 day MA as of Thursday close, and Nasdaq is under the 50 day. Both are lower as of this writing. Japan’s Nikkei down 3% today.
–I had a beer with a friend yesterday who thought that from these yield levels, there probably wasn’t much a play left in treasuries, even with a disaster in stocks. But the fact is that vol has gone bid on the rally. The disbelievers in the case for lower yields are still out there, but someone’s willing to pay a bit more for low yield insurance, just in case something like, well, global conflict breaks out. Or a global pandemic. And you’d probably prefer US Fives above 150 than German ten year bunds at 1%.
–A Fed survey uncovered the stunning result that some 40% of families are financially stretched. “Overall, the survey found that as of September 2013 many households were faring well, but that sizable fractions of the population were at the same time displaying signs of financial stress.” Next time, just send the fresh faced Chicago Fed summer intern out on the Green Line el and have him get off at Cicero and walk around a bit and (maybe) report back. Signs of financial stress, you say?
Aug 7. Stocks stabilize but treasuries suggest more trouble ahead
–Yields continue to press slightly lower in the US with tens closing down 1 bp at 247 yesterday, trading 246 today. German schatz (2y) trades 0% and briefly dipped negative in front of the ECB this morning. German bund is 108. Aussie at a two month low against the dollar as unemployment hit a 12 yr high. A reflection of China slowdown?
–Not much change in dollars as green, blue and gold packs all closed +1.5. There was heavy activity in EDM5 puts yesterday, a buyer of 20k 9912/9887p 1×2 for 0.5 and a buyer of 50k 9900/9875 p spread for 1.5 and 1.75. Heaviest open interest in June puts is 9950p with 284k open, futures settled at 9945. There continues to be a buyer of Dec FV year calls. A few days ago paid 7 for 30k FVZ 120c and yesterday bought the 120.5 strike for the same price, 6 to 7, in the same quantity. Both new positions. Roughly 20 bps per futures point, so 120.5 strike is around 40 away, and current 5yr yield is 165. But 1.25 yield doesn’t seem like that much of a stretch given bund sub 110. Though stocks rebounded from early lows yesterday morning, there is still substantial skittishness. Themes I continue to see are 1) stretched valuations in corporate bonds, even with the recent pullback, and 2) reduced liquidity as the financial infrastructure has been regulated away.
–Crude oil testing lows from early May at 9667. I read this morning that Brent futures curve has gone contango today as near contracts have been heavily liquidated after the July run up on geopolitical tensions. WTI curve still backwardated. BBG chart of the day. Dollar strength, spec liquidation and the outlook for a slower global economy all at work.
