June 27. Asset allocation trades today
I may be going to hell in a bucket, babe
But at least I’m enjoying the ride, at least I’ll enjoy the ride. The Grateful Dead
–New low 2/10 yesterday to 206 bps, down 2. Ten year yield fell 3.5 to 252.3. An early swoon in stocks was short lived, with some citing asset re-allocation going into the end of the first half. Might be a bit more of that today as stocks have rallied about 5% this quarter. Treasury vol eased on the rally. 30 yr bond vol had been holding in, but fell a couple of tenths yesterday to 7.1. Atm USU straddle from 3’12 to 3’04.
–Japan unemployment at 3.5%. Good, right? But Household Spending fell 8% in May as consumption had been brought forward to avoid the tax increase. Ten year JGB 55 bps. So are higher gasoline prices a “tax” on the US, destined to negatively impact US consumption patterns?
–Just a quick observation about the ten year inflation index note note yield. It began this year at around positive 80 bps and, with the surprising fixed income rally in general, the yield has dropped to a current level of just 23 bps. The five year is around NEGATIVE 50 bps. The five year tip yield hasn’t been positive since 2010. Acceptance of negative real rates just doesn’t seem to represent a robust underlying economy. Or, said another way, even with institutional rate repression, the economy really hasn’t hit escape velocity. Unless of course, we look at the absolute value of Q1 GDP. It moved to the 3% area, significantly accelerating away from zero. “You’re going the wrong way…”
June 26. Circle jerk
–Q1 GDP revised much lower to -2.9%, the worst since the crisis. Because it was cold. Yields fell, with tens down 3 bps to just under 255.
–In the last couple of quarterly cycles Green midcurve puts were bought heavily, mostly 9812 and 9825 puts. Late yesterday there was a sale of 20k Green Sept 9825/9887p 1×2 at 8.0 covered 9818.5, which was an exit. Perhaps the GDP data finally convinced some people to take NY Fed Dudley’s advice, and not put too much weight on projected rate hikes in mid-2015
–Today’s news includes Jobless Claims expected 310k. Personal Income and Spending expected +0.4 on both. Seven year auction.
–What has QE and ZIRP done? Created oodles of capital competing for a few extra bps out the curve funded at short term rates near zero. From Reuters: “JPMorgan’s emerging market Asian credit index is trading at a spread of 241 bps over comparable U.S. Treasuries, the narrowest in almost three years. …”The carry that we are getting in markets like Malaysia and Korea, which are relatively lower-yielding markets, is not attractive and not offsetting the duration risk we are holding,”
From BBG: “The yield on Kenya’s 10-year security has fallen 46 basis points to 6.41 percent since being announced on June 16, narrowing the premium over similarly dated U.S. Treasuries by 47 basis points to 381. …“The exceptionally low yields on frontier debt at present are likely to spur potential issuers into action,”
–With Japan at 56 bps for tens, and Germany 127 bps, the US looks darn good at 2 1/2%. Except of course, as compared to Kenya at 6.41. Low yields create premium selling in an attempt to manufacture extra yield performance. So, how does that circle back and affect the man on the street? Well, the Illinois Teacher’s Retirement fund just cut their projected return from 8% to 7.5%. “The lower rate will increase the system’s unfunded liability, which was $54 billion at the end of fiscal 2013…” and the gap falls to the taxpayers. And how does the system get a return of 7.5% with UST at 2.5%? KENYA. There’s your answer. Well technically Kenya PLUS the added 100 bps by selling Sept 2016 euro$ straddles. “But that’s over two years out…” And how do taxpayers make up for the fantasy shortfall of a projected 8% yield vs a fantasy 7.5% return? Chicago Mayor Rahm Emanuel has the answer: a telephone tax. “Emanuel originally wanted to use a property tax increase to come up with the tens of millions of dollars he needs this year to pay for a partial City Hall worker pension fix. On Wednesday, Emanuel formally introduced his alternative, an ordinance to raise monthly 911 charges on wireless phones and land lines by $1.40, to $3.90 for each line. In addition, the charge on prepaid phones would rise by 9 percent.”(Chgo Tribune). And what does that do? Takes money out of the pockets of consumers. Which leads to lower GDP. Which leads to more QE. Which intensifies the search for yield…
June 24. Continued low vol
–There’s very little comment to make regarding Monday’s price action apart from noting its absence. Option premium continues to erode, with most midcurve euro$ straddles settling 0.5 to 1.0 bp lower. For example, Green Sept 9812.5 straddle which was 37.0 one week ago and dwindled to 32.5 by Friday, closed at 31.5. Miniscule price range in ESU. Sparse volume in treasuries. Bloomberg notes that 3 month $/yen implied hit record low 5.7.
–BOE’s Carney who recently created a stir in short sterling by suggesting that a rate hike might occur sooner than markets expect, sounded a more dovish tone this morning, emphasizing muted wage growth and spare capacity. In the US, hawk Plosser speaks in the morning and Dudley in the afternoon. Economic news includes New Home Sales and Consumer Confidence. Auctions kick off with 2’s, followed by 5’s and 7’s Wed and Thursday.
–The realization of inflationary pressures seems to be gaining currency in the US, and the Fed’s assessments of Q1 growth being held back by weather and now bouncing back is perhaps contradictory with recent higher inflation data being currently termed “noisy”. Gold is up over $5 this morning near 1325, a two month high.
Strength in upper echelon masking weakness for the masses?
Two recent articles point up the same theme. First, ZeroHedge post notes the stark disparity in Nat’l Ass’n of Realtors data on existing home sales. Lower priced homes are seeing outright declines in sales activity, while sales of homes over $1m are seeing strong growth. This table is from the NAR:
| Regional Sales by Price | ||||||
| Existing Single Family Homes | ||||||
| May 2014 | ||||||
| % Change in Sales from 1 Year Ago | ||||||
| Region | $0-100K | $100-250K | $250-500K | $500-750K | $750K-1M | $1M+ |
| Northeast | -4.4% | -7.5% | -8.5% | -7.5% | -4.9% | 1.5% |
| Midwest | -13.5% | -3.4% | -0.1% | 2.1% | -11.4% | -4.8% |
| South | -13.2% | -1.2% | 1.9% | -0.3% | 4.2% | 3.6% |
| West | -39.8% | -19.7% | -4.3% | 0.2% | -2.0% | 6.0% |
| U.S. | -14.5% | -6.6% | -2.5% | -1.7% | -1.7% | 4.0% |
Perhaps the lower price properties are more suitable for rental units, and buying by investment funds for that purpose has abated. Here’s the ZH link:
http://www.zerohedge.com/news/2014-06-23/something-disturbing-happening-california-housing-market
Second article was on Huffington Post. http://www.huffingtonpost.com/2014/06/20/darden-earnings_n_5515101.html
This post claims that Darden Restaurants’ results are evidence of the same theme, noting that middle of the road restaurants Olive Garden and Red Lobster are seeing declines in same store sales, while the high end chain Capital Grille has reported 4% same-store growth.
June 23. Inflationary impulses could translate into steeper curve
–Long end weakness early Friday, but then bonds rallied back to leave the curve only marginally steeper. Red/gold euro$ pack spread closed up 1.25 bps to 223. As inflation concerns (or at least stiflingly high prices for necessities) creep back, it’s perhaps worth noting that ten yr tip/note spread is at its highest since early Jan at 230 bps. I don’t know why I even continue to watch this spread as it seems to have little predictive power, however, the last time it was this high (in January), red/gold was 285 vs Friday at 223 and 2/10 treasury spread was around 249 vs 216 now. Gasoline and oil are at new highs, and it doesn’t feel like peace is about to break out in mideast.
–This week the treasury auctions 2, 5 and 7 year notes. Chgo Fed Nat’l Activity Index today, was last -0.32.
–Employment report will be on July 3. Fed’s semi-annual testimony schedule hasn’t been confirmed to my knowledge, but should either be the week of July 14th or 21st. Midcurve July options expire Friday the 11th, but August treasury options expire 25th of July, so treasury options will capture this event.
–Implied vol wearing cement shoes. On Friday Green Sept 9812 straddle settled 32.5, versus 37.0 the week before. The red Sept 9925 straddle settled 42.0 (with 15 months to go) vs 44.5 the week prior. Ten year note contract has pretty much traded in a one point range between 123-24 to 124-24 for the entire month of June. TYQ 124.5^ settled 1’17.
June 20. Summer solstice….bonds always go down at this time of year, right?
–When I walked onto the old CBOT trading floor as a kid, the 30 year bond futures pit was IT, crammed with people for the 8 o’clock open. 8% notional coupon and traded well below par. Five year options pit had a few guys from Beverly that barely knew the difference between a put and a call. Unfortunately, we’re never going back to that. However, the 30 yr did show a spark of life yesterday…
–5/30 spread steepened 6.5 bps yesterday and appears to have bottomed. 30 year bond contract (US) had an outside day and closed lower, settled 135-08. A close below 134-16 would indicate substantially more downside. At odds with this bearish outlook on the long end is the fact that bond vol closed slightly lower with USU sub 7%. I would be a buyer of bond vol here. 30 yr yield was up 4 bps to 345.6.
–Though not as pronounced as the treasury curve, there were some steepening plays in dollars as well. For example, Blue Dec (3EZ) 9650/9675ps was bought vs 9775/9800cs sold for 2.0 vs 9715.5…new position in size of 40k. However, vol lower overall in dollars as well. For example, Green Sept 9812 straddle was 37 settle Tuesday, 35.5 trade pre-FOMC, and settled 33 yesterday having been sold heavily at 33.5.
–Red/gold pack spread closed up 2, just under 222. A minor bounce off the lows, but again, probably a low risk area to nibble at buying curve.
–Big movers yesterday were precious metals, with gold and silver going parabolic, gold up $49 or about 3% and silver up around 5%.
–July treasury options expire today.
June 19. FOMC: no change, keep reaching for yield
–The Fed claims to be concerned about “financial stability”, but its actions only fuel the trend of reaching for risk to capture the last few available basis points. New highs in stocks. New low in VIX. Bonds rally. The dollar falls.
–The dots are becoming less meaningful, though the slight increases in rate forecasts for 2015 and 2016 and the decline in the “longer term” rate was perhaps part of the reason for the flattening. Red/gold pack spread plunged nearly 7 bps to 220. In treasuries, 2/10 spread fell 3 to 214 (started the year at 260). Implied vol was already under pressure prior to the Fed announcement, but was hit further late in the session. For example, Green Sept 9812 straddle settled 37 on Monday, was sold at 35.5 before FOMC and settled 34.5. Large seller late of 30k Green July 9787p at 2.0 (just over 3 weeks until expiry, 22 bps away). I marked 30yr bond vol at 7.0%, close to the low of the year, which was 6.5. A piece on ZeroHedge from JPM suggests that low volatility is a function of low trading volumes and option hedging, but is likely too low given the “fundamentals”.
http://www.zerohedge.com/news/2014-06-18/beware-fridays-opex-jpmorgan-warns-volatility-too-low-disconnected-fundamentals
–Today’s news includes Jobless Claims expected 313k. Philly Fed 13.0 and Leading Indicators +0.6.
June 18. FOMC day, with press conference and SEP
–FOMC today. Interest rate futures traded under pressure yesterday with heavy put buying ahead of today’s meeting, with a high CPI reading of +0.4 (and Core yoy of 1.9) emboldening sellers.
–Once again some of the near euro$ calendar spreads made new highs. EDZ14/Z15 +1.5 to a new recent high of 76. There was heavy buying of the peak one year spread, EDZ15/EDZ16 at 110-110.5 in size of about 20k, appears to be new position. (peak one-yr spread last year hit 124).
–FFQ15, August Fed Funds settled almost exactly at 50 bps, down 2.5 on the day to 9951. There will be four FOMC meetings in 2015 prior to this contract, so as of now, the market expects relatively modest tightening by mid year. The tenth quarterly eurodollar contract, which is now EDZ16, settled at 9783 or 2.17%. That’s a new low for tenth qrtly, but only because of the roll with EDM4 having just expired. At end of March/early April the tenth contract put in a low just under 9790.
–Dots from the last FOMC: 2015 avg 1.125 (vs 9894 in EDZ15 or 1.06). 2016 avg 2.42 (vs 9783 in EDZ16 or 2.17%), Longer run 3.875 (vs 9706.5 in EDZ17 or 2.935%). Market currently is expensive to the dots, especially in back, though the critical piece of information will be if Yellen hints at an early tighten.
June 17. Flatter curve going into FOMC
–Going into the FOMC the curve continues to flatten, with 5/30 treasury spread at a new low just under 170. Red/gold pack spread fell 3.25 to 226. Since June of last year this spread’s range has been 189 to 306, so it’s now much nearer to the low despite the fact that all the Fed has done thus far is taper. The Fed is considering putting an exit fee on bond funds to prevent a panic sell off, but the market trades as if any actual tightening will spur long end BUYING. Near euro$ spreads edged to new highs. For example, EDU4/Z4 settled 4.5, up 0.5. EDU4/EDU5 settled 54.5, up 2. The widest one year calendar is still EDZ5/EDZ6, down 1 on the day to 108.
–The Fed’s concern with ‘reach for yield’ and financial instability is mostly a product of its own making. In terms of stocks, “The total number of outstanding shares of stock available has shrunk by nearly 10% since the end of 2010. This is according to S&P Dow Jones Indices.” [Buybacks of $477b last year, along with mergers/acquisitions]. There are reports of central banks diversifying into stocks for reserves, and of Japan’s pension funds also casting a wider asset net. This huge pool of liquidity only serves to push forward returns lower.
–Two snippets in the same day. Business Insider reports that the Chinese city of Wuhan is planning to build the tallest buildings in the world, ironically named the Phoenix project. The LA Times reports that Chinese investors are buying up US gold courses. A page right out of the Japanese (1980’s) playbook before the crash.
June 16. Austin Powers
Austin Powers: There are only two things in this world that scare me and one is nuclear war.
Basil: What’s the other?
Austin Powers: Huh?
Basil: What’s the other thing that scares you?
Austin Powers: Carnies. Circus folk. Nomads, you know. Smell like cabbage. Small hands.
Both prophecies are coming to pass. Carney dropped a bomb on the short term interest rate circus and the situation in Iraq threatens to draw the world closer to war.
June 16. Carney’s suggestion late Thursday that rates could rise faster than markets expect caused a huge sell off (and flattener) in short sterling, which spilled over into the US. Green euro$ pack was again the weakest part of the curve, closing -4.875. The 5 yr note rose 3.5 bps to 169, and tens were up 2 to 260. Near eurodollar calendar spreads were bid, as the market adjusted modestly to the idea of rates hikes in the US also moving forward. For example EDU4/EDU5 rose 3 to a new high of 52.5.
–Reds were the outperformer in terms of vol. For example, midcurve red Sept 9925^ settled 20 on Thursday and traded 22 Friday. 0EZ (Dec) 9900^ settled 36 on Thursday and was quoted 38 bid at one point on Friday, settled 37.5. Back end of the curve much more tame.
–One interesting trade that I noted from the week before last, buyer of 0EZ 9900^ at 36 vs sold 3EU 9737^ at 41. Settles Friday: 37.5 and 39.5, up 1.5 on both sides and actually a much bigger winner during the day Friday.
–The main event in the US this week will be the FOMC meeting on Wed, with new long term projections out to 2017. However, geopolitical events threaten to overshadow all else. There’s no way the US can sit back and watch Baghdad fall with Saudi Arabia next on the list. Iraq faces a brutal civil war with odds quickly increasing that oil revisits the $150 level from 2007; note that the surge in oil at that time was a precursor to the financial crisis. Priced in a weakening euro, pain for the EU would be even worse, compounding energy uncertainties which are already stoked by Russia/Ukraine. If implied volatility doesn’t come back in this environment, it never will.
