June 13. Friday the 13th
–Crazy late day action provides a reminder of our elusive friend, volatility. About 10 minutes after the floor close huge buying came into the front pack (approx 40k) and red pack (20k), catching the market completely by surprise. Then BOE’s Carney suggested rates might rise sooner than markets expect. As example, consider EDM6. Late in the da there was a seller of at least 20k Green July 9850p at 2.0 with futures trading 9848.5. The 9850 straddle was quoted 3.0/3.5 with one day to go (expires today). The contract traded to 9851.5 on late buying of reds, but then ultimately traded to 9840 last night on Carney’s hint of tightening.
–Carney’s comments provide further fuel for flattening trend in US. The 30 year bond auction had already provided evidence of strong demand at the long end, coming in at 3.444 vs w/i just prior to auction of 3.465. 5/30 settled at recent low of 176, but should challenge the early May low of 170, with FVU -7 and USU +8 this morning.
–The disintegration of Iraq caused crude to surge, up 250 late to 106.90/bbl. I think events in the mideast are an extraordinarily negative development, but for now US markets appear to emphasize local concerns.
–A couple of other notes, copper was down 2.50 to settle 301.70, again testing 3.00. EURJPY posted new low under 138. Low of year has been 136.23 on Feb 14.
–PPI today expected +0.1.
June 12. Oil finally reacts to events in Iraq. Central banks cheer as there’s now a chance to hit inflation targets
–Crude oil up over $1/bbl this morning to new high over 105.50. Slo-motion reaction to events in Iraq.
–Quiet in US rates yesterday. There were some exit trades associated with expiring midcurves, other than that, net premium selling. TYN 124.0 straddle sold at 50, red midcurve Dec 9900 straddle sold at 36. EUR continues to break down, nearing the spike 135 low on the ECB meeting.
–Today’s news includes Jobless Claims, expected 309k from 312. Retail Sales expected +0.6% and +0.5 less auto and gas. It would be surprising if retail sales came out weak given the massive increase seen in the last consumer credit report.
–Crop report was released yesterday but caused little reaction. However, over the past 5 weeks or so Corn has traded steadily lower, from 520 to 440, and Wheat has gone from 740 to 592. Beans are at the lower end of a 1450 to 1500 range. I guess we’ll have to rely on higher oil prices and minimum wage increases to hit the 2% inflation targets. “We seem to be paying some of our employees an awful lot of money. Louis: Can‘t get around the old minimum wage, Mortimer.”
–Interesting note on Bloomberg: Regulations are causing a shift of risk in the credit derivatives markets from banks to non-bank investors. “Vilified for worsening the financial crisis, the credit derivatives market is undergoing a structural shift as money managers take on risk shunned by banks after regulators forced lenders to shrink their dealings.” That’s good right? Because non-banks (like AIG or LTCM) could never threaten financial stability.
http://www.bloomberg.com/news/2014-06-12/debt-risk-shifting-to-investors-as-bank-regulations-bite.html
June 11. On the verge of higher yields? Higher energy prices? Both?
–Yields have continued to press higher since the end of last month, for example EDU6 traded 9845 at its high on 29-May, and settled 9838.5; so in 8 trading sessions we’re down fully 24 bps on settlement basis to 9814.5. Ten year yield gained another 2.5 to 263.5. There’s a good piece on ZeroHedge from Citi’s Technical group that makes a case for higher rates and mentions 280 as a level of resistance…that’s about 1 1/4 points from here in TYU contract, or 122-24. There was heavy (new) buying yesterday of TYQ 124/123/122p fly and 123.5/122.5/121.5p fly (as pkg for 21/64’s), appears to target this yield level. Closer in on the curve we still see green euro$ pack leading the way down, along with 5’s on the treasury curve. Green pack -3.25 yest, while golds were -1.625. 5/30 treasury spread notched down to 176, closing in on 170, the low from early May. I would also note a marginal new high on the near EDZ14/EDZ15 one year calendar spread, up 2.5 to 74 bps. The market is gently urging short rate “normalization”, but it will probably only force further flattening in the long end.
http://www.zerohedge.com/news/2014-06-10/1994-2004-2014-bounce-yields-start-something-bigger
–While data has improved- ISM strong and yesterday’s NFIB optimism index reached highest since late 2007- there are still plenty of reasons yields may be restrained on the upside. For example, I marked bund/ten yr treasury spread at 124 bps, a new high for the past 5 years. The last time it was near this level was mid-2009, of course yields on both instruments subsequently fell in that instance. This time one might expect both bond yields to move higher, especially as the ECB looks to depreciate the euro, however, a weaker yen hasn’t led to higher JGB yields…
–The other thing worth a mention is that crude oil continues to moves higher and there are reports that al-qaeda has overrun Iraq’s second largest city to the north, Mosul. I am actually surprised oil isn’t higher. Recall that in 2007 and early 2008 the surge in oil prices to $140 was an important aspect to the financial crisis. I don’t know what will happen this time around, but with winter only 7 months away and europe already on the edge with regard to Russia’s Nat Gas supplies, the energy complex could get a bit more, well, complex.
June 10. Curve flattening, hint of slightly more aggressive Fed posture next week?
–Green euro$ pack continues to lead to the downside, closing -4.75 yesterday. Since last Thursday close (ECB day), green/gold pack spread has declined 5.5 bps to 122.5. Similarly, five year yield was up 3 bps yesterday to 170, while tens only rose 1.5 to 261. 5/30 made new recent low 177 yesterday, down 1.5 to 2 bps. TYU has so far held Thursday’s ECB spike low to 124-01, while FVU made a new low yesterday. (Saw a trade last week to express relative increase in near vol, buying 0EZ 9900^ at 36 vs selling 3EU 9737^ at 41.0). Given weakness in greens, I would think blue Dec atm straddle would again be trading at parity to green, but blue (97.125^) settled 2.0 over green (97.875^).
–Three year auction today; further pressure on belly of curve. Five year yield should have very strong resistance at 180 yield with several old highs around that level (185 in Sept, 177 in early January and 179 in beginning of April).
–EUR looks to revisit the spike low made on the ECB day of 135. Notably, EURJPY is just through its low from that day, at 138.62. EURUSD is below 200 day moving average, and below 136 which had served as support prior to ECB.
–Crude oil continues to strengthen, pushing to recent highs around 104.50 (CLN +175 yesterday to 104.44).
–FOMC next week on the 18th. July treasury options expire Friday 20th. TUN 109.75 straddle was around 7/64’s yesterday….worth taking a look?
June 8. A lack of volatility as the Fed ponders “financial stability”
–What used to be the biggest data of the month has now just become another bland Friday, with NFP 217k and rate of 6.3, right on expectations. Straddles that expire this Friday (13-June) were crushed. For example, Green June 9850 from 12.5 settle Thursday to 7.5 settle Friday. Blue June 9750 from 14 to 9.0. Ten year week 2 124.5^ was 58-60 late Wed, settled 49 Thursday, traded 44 prior to NFP, and was 31-33 shortly after the release, smoking a cigarette. However, by the end of the day on Friday, vol buyers came back in, with about 5k bought up to 34 (33s), and in TYU 124.5^ 5k bought 2’04 to 2’05. Ten year yield was up only 1.4 bps to 259.5.
–However, the green euro$ pack was down 4.5 on the day; the weakest part of the curve. 5/30 treasury spread fell 2 bps to just under 179. For the past three months 5/30 has been a bit over 190 to just under 170, so it’s just about mid-range going into auctions this week of 3’s, 10’s and 30’s.
–The explosive data Friday was Consumer Credit, which increased a whopping $26.8B. I almost think it’s a mistake, as Revolving Credit posted an annual rate of 12.3 in April vs recent growth of 1.9 in Q1, 2.0 in Q4, 0.9 in Q3 and 1.0 in Q2. Non-revolving accelerated as well, to 9.5 in April, vs 8.4 in Q1. Perhaps the wealth effect is finally kicking in, with households willing to borrow as Household Net Worth jumped $1.49T over Q1, yoy growth of 10.8%, and new highs in stocks. (Fed’s Flow of Funds was released Thursday). The other surprise on Friday was Banco De Mexico rate cut of 50 bps, from 3.5 to 3.0%. The Finance Minister said it’s “consistent with what other central banks are doing…” noting the ECB cut.
–But before sounding the all clear, let’s attempt to tie up a couple of other pieces of information. First, China Trade data showed a surplus surge in May to $36B, as exports grew 7% yoy while imports declined 1.6%. Perhaps not much of a surprise as the currency weakens, but a reminder that China is also seen as exporting deflation. The other note with regard to China are growing concerns about commodity based financing. ZeroHedge has written sev’l pieces about this, noting that banks are trying to confirm the existence of metal inventories posted as collateral. http://www.zerohedge.com/news/2014-06-07/western-banks-scramble-chinas-rehypothecation-evaporation-goes-global
I’m sure I am thinking too simplistically about it, but it seems to me an absolute necessity for inventories to be double posted as collateral for this “financing” to work. Let’s say you want to post copper as collateral to get a bank loan. How do you get the copper in the first place? You borrow to buy the copper. Then you post it as collateral for yet another loan and re-invest the proceeds in higher yielding dollar vehicles. Same inventory, two loans… and the more times you can post the same inventory the better. I don’t see any other way around it. Was all this copper just sitting around and fully owned? Then why is China importing it? If you look at the futures curve for copper, Friday settle for HGU’14 was 305.00 and for HGU’15 306.20. That’s just 40 bps over a year, not enough to compensate for interest and storage. Now, one might compare this situation to another example of over-levered assets, for example US housing in 2007. But in that case at least the collateral was thought to be going up in value. It all comes down to the confidence in the value of the assets and in the cash flows derived from those assets. Perhaps that’s why Larry Fink of Blackrock is warning about leveraged ETFs. I would also note that with the ECB cut, ten year yields in Spain, 2.65%, Italy 2.75% and France 1.70% are quite low. Then consider the perceived market “value” of Uber, at some $18B, justified by some due to the possibility of using the logistical infrastructure as a means of expansion into other areas. Really? So it’s worth 43% of Fed Ex? And double the amount of Expeditors (EXPD) And half the amount of American Airlines (AAL) ?? Maybe it should be considered more like Priceline at $65B… but maybe it’s just plain old stupid. And that’s where the whole idea of “financial stability” comes in. The Fed is beginning to emphasize this topic more and more. It will probably be a key area of discussion at Jackson Hole in late August. The last Flow of Funds Z.1 report shows that Corporate Borrowing is at a record $9.625T outstanding, having grown at a 9.3% rate in Q1. Total growth for all sectors was 5%. And from that derives Q1 GDP growth of zero? Well, if that funding is mostly going into stock buybacks and acquisitions as opposed to Capital Expenditures (which might actually drive future growth), then it all falls into place.
–So how does the Fed maintain financial stability and curtail a reach for yield which is unsupported by prospective asset cash flows? One way is through regulatory channels, for example not letting KKR get a bank loan for a leveraged buyout. But the other way is to raise short term financing rates as a reminder that it won’t all be free forever.
June 6. Employment report. Initial signs for ECB cut don’t look promising
–Employment report today with NFP expected +215k, rate 6.4 to 6.5 and Avg Hourly Earnings +0.2.
–ECB announced a range of easing measures including negative deposit rate, targeted LTRO, etc. Japan has been a bit more successful with manufacturing inflation, mostly thru currency depreciation. On that score, initial signs don’t look great for the ECB as the euro initially plunged to a new recent low near 135, but then snapped back to 136.20. EURJPY had been edging lower, threatening to break below 200 day MA but rallied yesterday and has held for now. As an aside CNY (yuan) is holding above 6.25, a new leg lower (i.e. CNY up trading thru 6.27) would signal continued deflationary pressure for developed economies as Asian exports get cheaper. If EUR can’t manage to depreciate against Asia and the US, then prospects for a big pick-up in inflation are muted.
–US interest rate futures traded much like EUR, initially breaking down as TYU tested 124-00, the 50% retrace level of April low to last week’s high, had an outside day and closed higher. Anything can happen on payroll day, but 2.68 is line in the sand for me, approximately the 123.5 strike. Implied vol was hit, with TYU 124.5^ going from 2’17 prior to ECB to 2’11 at close, 4.8 vol, -0.2. The week-2 124.5^ that expires with June midcurves next Friday, settled at just 49/64’s, from 58/59 late Wednesday. 49 is worth about 10 bps, vs 14.0 settled fro Blue June 9750 straddle. To me, the risk appears to be that a lower than expected payroll number will be met with new waves of buying.
June 5. ECB meeting to increase financial speculation?
–ECB today expected to introduce a negative deposit rate and host of other stimulus measures. This, at the same time many Fed officials are wringing their hands over financial stability and excessive reach for yield. In a way, moves by the ECB could spur a flow of funds into US assets, further compressing spreads that the Fed is concerned will sow the seeds of the next disaster. But rather than raise rates here, the Fed appears to be relying more on increased regulation to stifle excess risk. For now. Which probably also contributes to smothered volatility.
–The easy trade would appear to be a steeper curve and lower EUR. And indeed the market is leaning that way. For example, there was a buyer of 30k TYN 123.5/122.5 put spreads yesterday for 13, and EUR is hovering around 136, hoping Draghi will provide an excuse for the next leg down. However, ultimately Draghi needs help in the form of stronger US growth, which makes Friday’s employment report loom a little larger, and ADP data yesterday was a bit softer than expected. IF employment data turns out to be weak, another rally in bonds will be violent and painful, and would probably also clean out some EUR shorts.
–It also doesn’t help that China is having continued issues with its shadow finance system. Story on ZH yesterday says that “there is a discrepancy in metal that should be there and metal that is actually there.” Which in this case is copper and aluminum, commonly pledged to secure cheap financing with which sophisticated players can invest in higher yielding assets. Or play the ponies. The problem of course, is when the same metal is pledged over and over again in order to pyramid into financial assets. Then, poof. It’s gone.
June 3. Is the long upward squeeze in bond prices over?
–Interest rate futures prices continued to slip Monday as ISM was ultimately set at 55.4 following an initial errant release (or two). Bear steepener as reds fell only 3.625 while golds plunged 10.5. Ten yr yield rose back above 2.5%, adding over 7 bps to 253. Implied vol firmed with TYU 125^ settling 2’21 or 5.0%. With the ECB expected to take strong action to fight deflation and China taking steps to loosen financial conditions, there is hope that this year’s bond rally has finally run its course.
–With regard to inaccurate (fudged) data, I ran across this snippet from Warren Mosler blog: “During the first quarter (i.e., from January through March) the growth rate of the seasonally adjusted CPI-U index published by the Bureau of Labor Statistics (BLS) was over a half percent higher at a 1.80% (annualized) rate, and the price index reported by the Billion Prices Project (BPP – which arguably reflected the real experiences of American households while recording sharply increasing consumer prices during the first quarter) was over two and a half percent higher at 3.91%.” Certainly a ten year yield of 2.5% doesn’t compensate for this alternative inflation measure. On the other hand, a consumer that’s squeezed by rising prices of necessities curtails discretionary spending that spurs growth at the margin. At peak prices of gasoline a few years ago, I spent $60 to fill my car. This weekend, $64. No wonder 1/3 of 18-34 yr olds live with their parents…
June 2. US bonds still attractive to foreign buyers
–Green euro$ pack fell 4.5 bps on Friday and was the weakest part of the curve, while the ten year note yield rose just 1 bp to 2.455. Implied vol firmed in front of this week’s events: the expected easing of the ECB and the US employment report.
–On a long term yield graph, US tens have been in a downward sloping trend since 1986. Actually rates have been falling since 1981, but the clearly defined trend channel starts in ’85-86. Upside breakout level is around 3.10%. Given the surprising fixed income rally this year, the press is giving a megaphone to those trying to call a top. For example Reuters: “US bond mkt faces possible reckoning.” FT: “US inflation rise adds to Fed confidence… A pick-up in prices could mean an earlier jump in interest rates.” GS has consensus client call for end of year bond yield of 3-3.25, along with 3% GDP growth. BAML also looking for yields to base. http://www.zerohedge.com/news/2014-05-31/groupthink-101-what-all-goldman-clients-believe-will-happen
–However, from the perspective of non-US investors, dollar based assets probably still look attractive. The EU vote is anti EUR and the ECB is facing deflation. Japan’s only choice appears to be massive devaluation. China appears to be slowing and struggling with its own housing issues. The point is, at the margin, both US stocks and bonds have relative appeal. Strength in the dollar index may be the big trade for the rest of the year. The inflation indexed ten year (TIP) yield has gone from around 3/4% to just 20 bps this year. Why is that trend supposed to stop? And why has it been so aggressive thus far? My guess is that ECB stress test info has already dribbled out and isn’t particularly robust. China’s financial system is facing a hard landing, Brazil is likely to face a World Cup hangover. To think that US growth will snap back to 3% if the rest of the world is faltering is wishful thinking. From Paul McCulley (cited on Prudent Bear), “And ultimately we had to get to this point where the marketplace broadly defined – all asset classes are accepting that risk-free cash trades at par – you get it back tomorrow – should not provide a real rate of return. It’s preservation of capital – period. If you want to have a real rate of return you have to be in assets.”
May 29. Financial conditions warning from Goldman
–The bond rally continues. Ten year yield dropped nearly 8 bps to 244. The peak one year euro$ calendar spread, EDZ5/6 has fallen below 100 bps to 99.5, down 3.5 on the day. Curve flattened hard; 2/10 made new low at 207.5, falling 5.5 on the day. The dollar index strengthened well above its 200 day moving average though has given up ground this morning. Goldman is blaming low trading volumes and “abnormal” market conditions for expected further job cuts. Almost reminiscent of Cramer’s CNBC outburst around the beginning of the crisis (Aug 2007) saying the Fed had no idea how bad things were. Except now the warnings are coming directly from the financial companies. Ruh-oh. Maybe that’s the reason for the bond rally. Or maybe the bond rally is what has caused financials’ pain as opportunities for carry dwindle. Chicken or egg? In any event, back in 2007 the Fed had room to maneuver, much less so now. Or maybe the fixed income rally is just a reflection of the expected negative revision to Q1 GDP. Simple.
–On Tuesday the Blue June 9762,5 straddle traded 16. This morning it is 12.5 in the money with EDM7 9775 trade and still two weeks to go.
–Job Claims this morning expected 317k 7 yr this afternoon closes out the week’s round of auctions.
–How do you let a two goal lead in the first 5 minutes go to double overtime?
