July 17. Possible rate hikes, but back end of the curve says “limited”
–The message from the curve is that the economy will have a hard time digesting even relatively small near term rate hikes. While there has been selling pressure out to greens in anticipation of funds “normalization”, tens remain anchored to 2.5% (yield fell 1 yesterday to 253.6). Near euro$ calendar spreads edged to new highs. For example, EDH5/EDM5 rose 1 bp to 20. EDZ14/EDZ15 rose 2 to a new recent high of 79. However, more deferred one-year calendar spreads actually made new lows. For example, EDU16/EDU17 slipped 0.5 to 80.5. Red/gold euro$ pack spread dipped 1.375 bps to just under 207. The back end of the curve suggests a sluggish economy and lack of inflationary pressure. Peak one year calendar has been and still is EDZ15/16, at just 105.5.
–Treasury volume was light but there was huge trade in various euro$ option structures, mostly put trees and condors. These trades echo the theme from the curve in general; sell offs are likely to be targeted, without follow through. When Carney said near term hikes might be in the offing, short sterling plunged 30 bps, but the new put strike was heavily sold. Same sentiment in dollars, get to a level then stop.
–Green August 9812.5 ^ went from 20 settle on Tuesday to 18 yesterday. USU 137 straddle was 236 two days ago and settled 2’20 yesterday. TYQ 125^ which expires one week from Friday closed just over half a point, at 35/64’s.
–The euro sold off, and appears ready to test 135.00 which has been a recent support area. However, new sanctions on Russia by Obama have spurred a risk-off trade this morning. Stocks pulling back, dollar/yen a bit lower.
–Today’s news includes Housing Starts expected 1020k, Jobless Claims 310k and Philly Fed at 16.0.
July 16. Flatter curve after Yellen
–The curve flattened hard late in the day after Yellen’s comments. 5/30 treasury spread notched a new recent low of 167.5 (-2 bps). Red/gold eurodollar pack spread plunged 6.25 to 208, a new low for the year, as the red pack was down 5.0 and golds were +1.25. 2/10 remains at lower end of range at 207. The market is signalling that any tightening will tilt the economy into a slowdown; it won’t be able to withstand a substantial rate increase. Indeed after Carney’s warning that rate hikes might come more rapidly than market expectations, the 30 bp plunge in futures was met with heavy put selling at the new strike.
–Implied vol in the longer end declined. USU 137 straddle fell from 236 to 226, with vol -0.4 to just 6.8, as futures were essentially unchanged on the day.
–There was a reasonable amount of new back month put buying. For example Green Dec 9775p and Gold Dec 9650p were bought as a package for 27.0, in 20k. (2EZ 9775p 16.25s, 39d. 4EZ 9650p 11.75s, 31d). However, the biggest short positions -in the form of long puts- remains in nearer contracts, with Short August 9912p trading up to 3.0 and having 202k open after buys in the past 3 days of 120k.
–Yellen continues testimony today. Other news includes PPI expected +0.3 with Core +0.2. Industrial Production +0.4. Beige Book released in the afternoon.
–Though it was an outside day in ESU with a marginally lower close, stocks are firmer this morning and ready to test new highs.
July 15. Yellen semi-annual testimony today, risk of a less dovish stance
–In spite of it being a low volume day in ten year futures, there were sev’l interesting aspects of Monday’s trade. There was a buyer of at least 80k Short (red) August 9912p for 2.0. (EDU5 9924.0s). Additionally, there was buying of EDM5 9925 and EDU5 9900 straddle strip up to 49.0. On Friday the settlements were 26.0 and 41.0 respectively, so the strip had settled 47.0. Yesterday 27.0 and 42.0; all long dated straddles from EDM5 forward gained 1 to 1.5 bps. These trades indicate concern that perhaps Yellen will hint at tightening in her testimony today. However, the Short Sept 9925 straddle actually closed down 0.5 bp to 15.5. Might be worth buying short midcurves and selling long dated straddles at this point. Note that the straddle buying wasn’t particularly large; vol sellers have become scarcer.
–Another big trade Monday concerns precious metals, which came under heavy selling pressure from the open. Gold was down over $30, erasing the grinding gain from the past three weeks. Same with silver, which dropped $0.50. Interest rate markets are sensitive to the timing of potential Fed hikes and inflationary impulses, but the CRB index has plunged over 5% since the end of June as crude oil has shrugged off geopolitical problems in energy producing countries. Grains had already been under pressure due to good growing conditions. Cattle has shown signs of a top. And now precious metals crushed…
–From FT: JGB rally bodes ill for a resurgent Japan… Bond market activity suggests growth strategy falling short. Ten year JGB at just 53 bps.
–Retail Sales expected +0.6.
July 11. Midcurve euro$ expiration. Fed semi annual testimony next week
–Curve steepened a little bit as Portugal’s Espirito Santo Bank is a reminder that not all is well with the world. Red/gold euro$ pack spread rebounded 2.75 bps to 213. More pronounced moves occurred in the back end of the Fed Funds curve, with contracts from June’15 to Dec’15 up 5 to 6 bps, partially due to a re-think of tightening given financial strains, and partially because of the Fed’s discussion on changes to base rates. I focus mostly on FFQ15 as I think it gives a pretty clean estimate of the FF target by the middle of next year (or used to). It has been hanging around 50 bp, but yesterday rallied 5.5 to 9957.
–However, there are still plenty of put structures being bought for ‘Fed normalization’, For example, yesterday 25k 0EZ 9900/9875ps bought for 8.0.
–Today is July midcurve expiration. Here are settles in one day straddles:
0EN 9925.0^ 2.5 ref 9925.
2EN 9825.0^ 4.5 ref 9823.5 in U6,
3EN 9737.5^ 5.0 ref 9740 in U7.
4EN 9687.5^ 4.5, ref 9689.
–Fed’s semi-annual testimony to Congress is next week starting Tuesday. Given the new dislocations in the middle east, perhaps it’s also worth noting that the ‘deadline’ for an agreement regarding Iran’s nuclear weapon capability is July 20. No worries, we have Kerry on the case, negotiating in Vienna. Of course, no one bothered to tell him the actual meeting is in Tehran…
–Some interesting stories on ZeroHedge about Chinese (and others) parking their money in luxury condo projects in Manhattan, with many units being left empty. There have been previous articles on a crackdown of capital controls as wealthy Chinese siphon money away from the country. If prices are set at the margin, and the flow of foreign funds to prop up the higher end of the real estate market begins to slow, then prices should begin to ease…
July 10. Fraying at the periphery; say a prayer to the holy ghost…
–Yields ended lower yesterday, with tens down 1.7 bps to 254.6. New low in red/green pack spread to 98.375, -1.625 on the day. There was a brief sell off following a tepid 10 yr auction (259.7 vs w/i 258.5) but buyers came in after Fed minutes and futures closed at the high. I didn’t fully read minutes but the discussion on rate normalization appears to have little sense of urgency. I did find the following passage rather interesting though: “Market participants continued to discuss the decreases in long forward rates since the beginning of the year and pointed to a variety of domestic and global factors possibly contributing to this trend, including lower expectations for potential growth and policy rates in the longer run, a decline in inflation risk premiums, purchases of longer-term securities by price-insensitive investors, unwinding of short Treasury positions, and falling interest rate uncertainty.” Rather than a sophisticated panel of central bankers, this sentence sounds like it’s describing a few phone clerks discussing why bonds rallied over a few beers after work…”short covering” and “oh…that guy doesn’t care about the price when he buys because he’s got something else against it…” WTF! Might as well throw in “…we hit buy stops…” And, while the bond rally might be because of lower expected potential growth, the discussion of stocks says they were “apparently boosted by a more optimistic assessment of near-term economic prospects.” The central bank doesn’t seem to have a very cohesive view of domestic markets. Bonds rally due to subdued forward economic prospects but stocks rally because of near term growth optimism. How much money would you let a guy manage who came to you with that pitch? $4 TRILLION I guess.
–Besides obvious dislocations in geopolitical events, there appears to be fraying at the edges of the financial system that could lay bare structural problems in the center that were never properly addressed. For example, Portugal yields are rising as Espirito Santo missed a debt payment. Austrian Erste Bank several days ago restated financial results. (This as the ECB is in the midst of the stress tests and trying to determine how to account for expected US imposed fines a la BNP). Puerto Rico bonds are crashing, dragging muni funds lower. Japan machine orders plunged by nearly 20% (I guess that “arrow” was pointed at the ground). Both Walmart and The Container Store have cast suspicions about the underlying strength of the US consumer. The problems work their way in, from the periphery to the center…
–Jobless Claims today expected 315k. 30 yr bond auction. Stanley Fischer speaks after the close on the topic of central bank regulation.
–July midcurves expire tomorrow. Late yesterday there was a buyer of Blue July 9750c for 0.25 ref 9739. Now trading 9742. Maybe it’s not such a reach, with SP’s -15.00.
July 9. Fed minutes today…
— Ten year note auction today, followed by Fed minutes. Yellen’s semi-annual testimony to the Fed will be next week on July 15.
–Back end of the curve continued to rally with the ten year yield falling over 5 bps to 256.3. Red/gold pack spread made a new low of just 210 bps, also down 5 on the day. Red/green pack spread closed at 100 bps, right at its recent low. As I mentioned yesterday, red/gold should have strong support from 206 (50% retrace 2012 low to 2013 high) to 200 bps.
–Peak one year calendar is still EDZ15/EDZ16, but it closed at only 104 yesterday, down 2.5.
–While the back end of the curve flattens, the front end is still pricing for initial Fed hikes next year. FFQ15 (August next year Fed Fund) is still near 50 bps, settling yesterday at 9951 or 49 bps.
–Between today’s minutes and next week’s Humphrey Hawkins testimony, the market will be trying to pin down the timing for the onset of rate normalization. Just as a point of comparison, I looked at the 4th quarterly contract in 2004, when the Fed first started to lift rates from the 1% FF rate. In mid March, the 4th contract was 9850 or 1.5%. By mid May it had dropped 150 bps to 9694. The first actual rate hike was at the end of June 2004.
July 6. Strong headline employment data pulls tightening schedule slightly closer
–Stronger than expected NFP on Thursday of 288k, with rate of 6.1% sent interest rate futures lower, but final net change was modest. Greens were weakest at -5.5 bps. Ten year yield was up only 2.2 to 264.7. The eurodollar curve flattened with red/gold pack spread down nearly 4 bps to 220.25; reds -5.125 and golds -1.25.
–In the near part of the curve, Dec 14/Dec 15 and March 15/16 one year calendars made new highs as the market again moves the tightening schedule forward. EDH15/H16 settled 93.5, up 4 on the day.
–There was heavy buying of EDM5 9900p for 4.0 bps covered 43.5 to 45. Settled 4.0 ref 9944.0. Total volume was 120k in this strike, though according to prelim open interest sheets, net change was only -5183. Some of these puts were bought vs Short June 9725 puts, (flat prem 4.0 and 4.0). The other big trade in front was a buy of 75k EDZ4 9962/9950ps for 0.75 covered 9972.
–There hasn’t been much trade in front quarterly options and it seems to me that the June puts reflect a lackadaisical sense of complacency, almost bordering on contempt. With over 11 months until expiration and the possibility of tightening next year. 4 bps doesn’t seem like much for less than 50 bps away. Inflation seems to be picking up. FOMC minutes on Wednesday, Fed semi annual testimony later this month. Stanley Fischer speaks Thursday. It’s been a long time, but when the first rate hike actually comes, the immediate reaction is going to be ugly.
–3’s, 10’s and 30’s auctioned this week.
July 2. Put buying in interest rate markets suggest a move toward rate “normalization”
—Yields edged higher on Tuesday with tens up 5 bps to 256.5. The curve steepened, red/gold pack spread up 2.25 bps to 220. At the end of last year both the ten yr treasury yield and red/gold pack spread were a little over 300 bps, so at midyear, tens are about 50 bps lower while the pack spread is 85 lower.
–There continues to be put accumulation in midcurves. Notably, another 20k Short (red) March 9850p were bought (13.5s, 30 bps out of money). Green Dec midcurve put structures also popular. And in treasuries, a new buyer of 12k TYV 122.5put for 32. Rough calculation, about 20 bps away for premium outlay of about 6.5 bps. Given the flattening of the euro$ curve noted above, I thought perhaps buying blue or gold midcurves would provide better bang for the buck than treasuries, but upon reflection maybe not. On Dec 31, the first gold euro$ was 9641, currently 9686.5…so about 45 bps lower in yield vs about 50 bps lower in ten yr yield. (Also, 4EU 9662.5p settled 6.75…this put is just over 20 bps away- similar pricing to Oct TY put).
–Today’s news includes ADP, Factory Orders (expected -0.3) and a speech by Yellen. The market has Yellen pegged as dovish, but could her presentation be slightly modified by Bullard’s recent hawkish comments? After all, the highest one year calendar is now only 105 bps (EDZ15/Z16) and on Monday the red/green pack spread settled at a new recent low of exactly 100 bps. The market is at levels that suggest much greater downside than upside risk. Any hint by Yellen of labor market/wage improvement just prior to payrolls would likely be seen as quite bearish.
Alex Manzara
I am a registered futures/option account representative, specializing primarily in interest rate option execution for institutional clients. I will also accept large individuals as accounts, for both clearing and execution. For more information please call me at 312 281 4424 or email amanzara@rjobrien.com
June 30. The BIS weighs in on financial stability
–BIS is warning about a disconnect between euphoric financial markets (an echo of irrational exuberance?) and underlying economic trends, Bullard also warned last week that the market doesn’t get it, and neither does the Fed itself, but he’s quite sure that near term rate hikes are are the correct course of action. On the other hand, BoE’s Cunliffe warned against raising rates too quickly against the backdrop of a still fragile economy.
–Low volatility levels run through every asset class. Central banks have created the financial conditions that cause reach for yield, which in turn encourages premium sales as a way to enhance yield. Bill Gross alluded to premium selling strategies at his Morningstar speech.
–The problem is that at ever lower vol levels, gamma can quickly wipe those strategies out. And by “strategies” I mean “capital”. You make a bit of incremental yield slowly over time and then “Poof. It’s gone.” As a result of one violent move.
–Bernanke constantly assured the markets that when the time came to remove the kool-aid, the Fed would know it and would have the tools to shape a graceful exit. After an initial stumble, the tapering process has been pretty smooth. But now it seems that the stakes are being raised by the BIS, making Yellen’s upcoming performances at Humphery Hawkins later this month and Jackson Hole in late August loom large.
–ZeroHedge had a post citing Barclays Joe Abate that treasury delivery fails have been on the rise. The article notes that otr fives have been special (making it expensive to carry shorts) due to lack of collateral. Don Soldatis of our desk makes a related observation, that the put/call ratio in Five is quite high at 3.08 to 1. As always, it’s a bet on timing. The drip of negative carry versus the catalyst that creates the dislocations on which years are made and lost.
Midcurve euro$ vol
In the past two weeks EDM6/EDU6 spread has declined 1.5 bps, from 29 to 27.5. 2EU premium has been under constant pressure…two weeks ago the 2EU 9812 straddle was 37, now the 2EU 9825 straddle (next strike higher) is only 30/30.5 ref 9827.0. 2EU 9825c is 16/16.5 and 9837c 9.5/10.5.
When people say vol is “cheap to the curve”, I think this is a pretty good example. The roll of the curve in three months, as EDU6 rolls up toward EDM6 should be around 27.5 bps. This theoretical roll is worth nearly twice as much as the time decay of the call. In other words, the atm straddle is approximately equal to the 3 month calendar spread, (and actually there are 77 days until expiration for Sept midcurves). I’ve seen this happen many times in a very steep curve, but in a relatively flat curve, in what could be argued the most volatile segment when the Fed may be in play, it seems too cheap. As an aside, I’ve had pit market makers say that one of the larger local groups has been leaning toward heavy vol accumulation, and I have seen consistent (passive) buying of 2EZ 9800 straddle at 48 and 3EZ 9725 straddle 49.5.
Below is calendar spread EDM6/EDU6 .
