May 28. All aboard the pain train
–The decline in premium levels continues in dollars, with heavy selling of Short (red) Dec and March puts. One week ago 0EZ 9912^ was 37.5, shortly after yesterday’s open it was 34/35 but settled 35. As Izzy Mandelbaum would say, “All aboard the pain train”…(from FT) Citi warns trading revenue may fall 25%…RBS slashes US mortgage business. More cuts would appear to be looming. We’ll find all the Mandelbaums in hospital beds when things really start to unravel and the press bemoans the lack of liquidity.
–At the same, time stocks are levitating to new highs (ZH reports that company share buybacks are near record $160b in Q1, representing the biggest buyers), and corporate debt is reaching new highs, in large measure to fund said buybacks, while the WSJ runs this story: New Stars Ride Junk Bonds to Top. Never mind junk bonds, the 30 yr UST has gone from 3.97 to 3.36 this year. To the untrained eye, it seems that our current run to a permanently high plateau is being fueled by the substitution of debt for equity, and the illusion of liquidity.
–Precious metals were hit yesterday with gold down $26 to 1267, lowest since mid-Feb. The dollar index has strengthened, also to a level from mid-Feb and has now closed just above its 200 day moving avg. The Chinese yuan is making a new run for recent lows (6.255 this am).
–While some companies are simply issuing debt to buy shares, Amazon is investing in traditional capital expenditure, ramping up use of robots in its warehouses from 1000 to 10000. Probably not good for wage growth…http://www.geekwire.com/2014/amazon-will-10000-robots-warehouses-years-end-10-fold-bezos-says/ Also, data on total miles driven in the US has shown a small increase, but on a population adjusted basis, miles driven are down 9.3% from the high in June 2005 and back to the level from Dec 1994! http://advisorperspectives.com/dshort/updates/DOT-Miles-Driven.php Can we really continue expect auto companies to move 16 million units a year?
May 26. Bear market in volatility continues
–Though news reports about interest rate normalization have become much more prevalent recently, last week’s market action is anything but normal, like a black hole of vol and yield spread compression. There is now only one 1-yr calendar spread in euro$’s over 100 bps and that’s EDZ5/6 at only 102.5. (Down from 115 at the end of Apr and 107.5 from previous Friday). Red/green pack spread is just 98. As stocks move to new highs VIX has been crushed to new lows. Merrill MOVE index near new lows, FX vols also in the dirt.
(Helpful vol charts here: http://www.zerohedge.com/contributed/2014-05-23/trading-floor-insights-brad-thomas )
–As I googled ML MOVE index I happened upon Merrill’s Private Banking top ten themes for 2014 (written at the end of last year). The first one, ordinarily a slam dunk, was that stocks outperform bonds (duh). But not so far this year. Theme 5, “FI is challenged by greater interest rate volatility.” Nope. Theme 9: “Hedge funds and private equity beat commodities.” Yet hedge funds have negative performance for the year, gold doesn’t. CPI for beef and veal is up 10% in 2014. The Dept of Agriculture is warning of food sticker shock due to CA’s drought. The Chicago Fed’s cafeteria is raising its prices as “prices continue to rise between 3% – 33% We’ve got plenty of inflation, but not the critical piece: wage growth. (Mauldin) “Lower-wage industries constituted 22 percent of recession losses, but 44 percent of recovery growth.”
http://www.zerohedge.com/news/2014-05-25/and-worst-performing-strategy-2014
http://www.pbig.ml.com/publish/content/application/pdf/GWMOL/ARBPB3XY.pdf
–Current sentiment seems to reflect a massive pool of capital desperate to capture the remaining few bps still scurrying about, with the goal of “outperformance”. So naturally premium sales (everywhere) are the way forward to enhance yield. Mauldin’s latest missive refers to a “bubble in complacency.” There was a guest post on ZeroHedge which suggested the market wasn’t “paying attention” to this important vol implosion, but I can only comment that mkt participants are painfully aware of this forced environment. If the music’s playing, you’ve got to dance…
–Added to the concerns of capital pools seeking both safety and yield is the global rise of nationalism and related revolt against the status quo and inequalities. Elections in France and the UK present serious blows to the EU. It was nearly two years ago that Draghi used his “…whatever it takes” phrase to save the euro. We may be on the crest of a bigger challenge. Nationalistic moves in Ukraine, Russia, Vietnam, China, Japan may presage a reduction in global trade. Not too surprising to think that unfettered global capital seeks refuge in US markets. Or maybe it’s just that everything is smooth sailing from here…
–Circling back to the rate normalization theme, there has been a huge buyer in Short (red) Dec 9900/9875ps vs 9937c and in 9912/9887 put spreads. (ref 99.13 in EDZ5). Previously, heavy bets had been placed in Green June puts to play for the timing of the eventual Fed move, but with only 3 weeks to go, there has been a shift to this longer maturity option on a nearer contract. By far and away the most open interest was in Green June midcurve puts at 1.888 million. With huge put spread buying in the past two weeks, Short Dec is making a run at this amount, with 1.202 million puts on the books.
May 23. The start of summertime, when the livin’ is easy
–Another quiet session with downward price bias in bonds. Today is June option expiration in the treasuries; of near TY strikes the 126 call has the most open interest at 85k. On the put side, 126p have only 17k, 125.5 32k. Premium in general continues to erode, with most ED straddles down another 0.5 bp, though there was some responsive buying in green and blue straddles by the end of the day. For example 10k Blue July 9750^ bought for 29.5 covered 9744. June midcurves expire in 3 weeks, 13-June, just prior to the FOMC meeting. July treasury options expire on the Friday after the Fed meeting, so there might be some opportunities to sell ED midcurves and buy TYN premium. (Although Green and Blue June mids are already pretty cheap).
–EUR making new lows, 136.18 currently, continuing the slide which commenced on the May 8 ECB meeting. In the US, New Home Sales expected 420k. Shortened holiday session today.
–In continuing retail troubles, Sears is closing 80 stores, American Eagle Outfitters plans to close 150 stores. Yet McDonalds was the target of protests in an effort to force wages up to $15/hr. This at a time when the amount of panhandling on downtown Chicago corners is at an all time high. There were at least 4 or 5 guys on each side of the bridge over the Chicago River on Madison yesterday. While I don’t have hard data on “all time high”, I doubt that many would argue the point…
May 22. New low VIX. New high Oil
–Slight rise in yields yesterday. 5/30 treasury spread rose 4 bps to recent new high, having now bounced 20 bps off its low set in the beginning of the month. VIX index sank to a new low below 12 as stocks rallied, though there was a buyer yesterday of 150k Sept VIX 19/28 call spreads for 0.85. I would also note that crude oil yesterday surged over 1.50/bbl to trade new recent highs of $104. Inflationary, or just another increase in the price of necessities that crimps consumers in other areas?
–In any case, tens seem to be taking a pause around the lower end of the broad 2.50 to 3.00% range. Many are hoping and praying that the next strong move is a bounce in yields, but the market still doesn’t seem to respond to what should be bearish news. Today we have Job Claims expected 310k, Flash Mfg PMI 55.9, Existing Homes 4.69 and LEI +0.4.
–The peak one-year euro$ spread continues to be EDZ5/EDZ6 but it’s now only 105.5, a new low (-1.0). There was heavy buying of Short Dec (EDZ5 underlying) 9900/9875ps vs 9937c though trade was done covered. Also a large exit seller of Green June 9837p at 1.5. In the early part of the month EDM6 was below that strike, but it’s now a distant memory with vols compressing and the contract at 9860.5.
–While yesterday’s Fed minutes seemed to be mostly concerned with technicalities of how to get funding rates off the zero bound, I read an interesting note about a presentation given last week titled Slow and Low, which apparently is the framework Fed staffers are using, suggestive of a much lower potential growth rate of the US economy. I can’t properly summarize, but strongly recommend the link (thanks WHM). http://www.minyanville.com/articles/print.php?a=55016
May 21. With the propect of Fed hikes diminishing, plays for rolling up the curve re-emerge
–US yields fell again yesterday with tens at 251, down 2.5 on the day. Green euro$ pack was the strongest performer, +5.5. Red/green pack spread nearing 100 as suggested a couple of days ago (100.75s, -2.5 on the day). Red/blue also edged to a new low of 185.
–There has been discussion of what the catalyst is for this move to lower rates, and while I don’t really follow categories like Large Specs and Hedgers, what I do continue to see is buying. Yesterday there was reportedly a buyer of 75k EDZ15 9913 to 14, open interest increased 23.5k. We continue to see drops in open interest of nearer contracts, for example EDH’15, and gains in reds (EDZ5 and EDH6). Could just be a roll out the curve. EDZ4/H5 spread is 7 and EDU5/Z5 is 21.5, so the roll is worth 3 times as much being long EDZ5. If Fed hiking is taken off the table then ED contracts will float higher, simple as that. And bearish tightening positions in greens will be exited, while one-year butterflies will plummet. (Fro example EDh5/H6/H7 fly dropped 6 yesterday to -27.5; it had traded -4 when the market was beared up. It’s worth noting that bearish comments from Fed officials (Bullard last week and Plosser yesterday) are ignored and mildly dovish comments (Dudley) are embraced by the market. It’s also worth a mention that on the euribor curve, the first contract that is above 1% is ERZ17, 3 1/2 years from now, and that JGB’s remain under 60 bps.
–Yen appears to be breaking out, with $/yen now just below 101. Again, the yen is a risk-off canary, though for now US equities appear resilient.
–FOMC minutes today
May 20. US escalates tension in Asia by naming Chinese military members on FBI’s Most Wanted Cyber Crime list
–Another relatively quiet day Monday. Implied vol continues to compress with most euro$ straddles down 0.5 bps. Additional new selling in Blue Sept 9737.5 straddle at 43.5, seems quite low with 4 months to go. Back end of euro$ curve steepened with green pack up nearly 3 bps and gold pack -1 on the day; there was a buyer of 10k EDH6/EDU7 for 142 to 142.5 in 10k, settled 143.5. Just considering these two contracts, EDH6 settled 98.85 or 1.15%, which is consistent with 1% funds or perhaps a bit less. 22 MONTHS from now. Certainly the market has taken out the odds for aggressive tightening. EDU7 settled 9741.5. This is the contract that underlies blue sept midcurves, where the 9737 strike is being sold at 43.5. In a day of modest spread activity H6/U7 is able to gain 2.5 bps. I just can’t see being short that premium…
–USDJPY at 200 day moving average, though EURJPY still has some room to go. The yen is near recent highs, suggestive of risk-off.
–In terms of other commodities, Brent crude is remaining extremely firm on talk of Chinese stockpiling. June Brent at 110.44, nearing a series of old highs since December, around 111.06 to 111.42. In the other direction is the Chinese rebar contract, traded in Shanghai. Maybe I’m missing something but I suspect this contract is a fair reflection of construction activity in China, and it’s down 15% since the start of the year. (Chart below, May 19 post).
–In terms of risk off, the center of geopolitical tensions has shifted to Asia, with Thailand declaring martial law, China having to evacuate people from Vietnam due to conflict related to an oil rig in disputed waters, Philippines and China squabbling over fishing rights, and now the US piling on by listing members of the Chinese military on the FBI’s most wanted cyber criminal list. Kim Jong Un can’t even get a mention on the page 10 society column…
May 19. Housing as a barometer of economic strength
–In the US, the San Francisco Fed put out a paper titled “The Slowdown in Existing Home Sales” citing the increase in mortgage rates since May of 2013 as the culprit for recent lethargy in US home sales. There has also been much chatter about the possibility of a real estate crash (as opposed to slowdown) in China. I’m no expert, but the chart below, a heavily traded steel rebar contract (Shanghai) is in an unambiguous downward trend. Down over 15% since the beginning of the year. Clearly a reflection of diminished construction activity.
May 19. Theme of curve flattening
–Light news week coming up, with FOMC minutes released on Wednesday. Yields edged slightly higher on Friday, but the red pack to deferred closed at marginal new lows for the move. For example, red/green pack spread is nearing 100 bps, closed at 103.375.
–Three months ago EDM16 was in the same general area as it is now, around 9850. This was prior to the March FOMC when Yellen suggested tightening could begin 6 months after the end of tapering. A comparison between spread levels then and now reveals the extent of curve flattening. On Feb 18, red/green was 94, now 103 (+9). However, red/blue was 196, vs current 185 (-11), and red/gold was 279, now 241 (-38). A weekend article in Reuters says that Bernanke doesn’t expect the Fed to move for some time, and further doesn’t expect Fed Funds to normalize near 4% in his lifetime. Perhaps the heavy buying in EDZ’15 and EDH’16 contracts is a direct result of information gleaned from these private speaking events? In any case, red/green appears destined to move below 100 again.
–Several recent articles pertaining to the Fed have emphasized financial stability as a key responsibility of the central bank. Perhaps it’s due to Stein’s recent departure and his concern with the topic. However, the long period of zero rates has caused extreme spread compression, which could result in panicked unraveling should there be another whiff of financial crisis. Interesting to note the DB is raising another €11 billion of capital in this environment.
NY Fed’s Economic Projections
NY Fed released a summary of econ projections through 2015 (link above). Unsurprisingly, they expect growth to pick up and inflation to gently rise. Factors that had been restraints are abating.
From the NY FED:
From the end of the Great Recession in mid-2009 through mid-2013, the U.S. economy grew at a compound annual rate of 2.2 percent. Then, over the second half of 2013 growth picked up to 3.4 percent (annual rate), reflecting stronger growth of real personal consumption expenditures (PCE), business fixed investment, exports, and inventories. However, in the first quarter of 2014, real GDP was essentially unchanged. The growth contributions from inventories and net exports, which had been positive over the second half of last year, were negative in the first quarter, which was widely anticipated. But in addition, severe winter weather had a significant depressing effect on economic activity, particularly in January and February.
Despite the slow start in the first quarter, the staff forecast anticipates economic growth of around 3 percent (annual rate) over the remainder of 2014, with some additional strengthening to around 3½ percent in 2015. Several key underlying fundamentals of the economy have improved, setting the stage for a firming of growth. Household wealth has been restored, and the deleveraging process is largely over. For the first time since 2008, we are beginning to see growth of total household liabilities. The excess supply of housing has been largely worked off, and home prices have risen more than expected, contributing to higher household wealth. Fiscal restraint at the federal and the state and local levels of government now is, for the most part, behind us. And growth prospects among our major trading partners look somewhat better, particularly in the euro area.
As always, everyone from the Fed anticipates growth of 3% or more. Though, as can be seen from table below, the Fed’s Projections for growth are consistently lowered at every quarterly meeting. Actual 2013 growth was 1.9; at the March 2013 the estimate was 2.3 to 2.8. “Household wealth has been restored…” Sure, stocks have gone up and housing has improved due to repressed financing rates. But as soon as rates went up in the second half of 2013, mortgage applications started to fall and housing slowed (lower panels below). Additionally, home ownership rates have declined, activity is becoming more concentrated in the rental sector, more real estate deals are being done in cash. Non-revolving credit is NOT growing, student loan debt (non-revolving) has exploded. Corporate debt has increased to finance buybacks and dividend payouts. Is that really a solid foundation on which to project increased growth? I do agree that restraining factors in state and federal govt have largely abated. But I don’t exactly see how growth is expected to pick up in the eurozone when the ECB is increasingly expected to ease to offset deflationary pressure. Growth in China is also slowing.
What if stock prices sell off? And the much vaunted “wealth effect” goes into reverse?
|
2013 |
2014 |
||
| ACTUAL 2013 GDP GROWTH>> |
1.9 |
Q1 2014 0.1 | |
| MAR 2013 FOMC | |||
| Chg in GDP for 2013 | 2.3 to 2.8 | 2.9 to 3.4 | |
| Last meeting projection | 2.3 to 3.0 | 3.0 to 3.5 | |
| JUNE 2013 FOMC | |||
| Chg in GDP for 2013 | 2.2 to 2.6 | 3.0 to 3.5 | |
| Last meeting projection | 2.3 to 2.8 | 2.9 to 3.4 | |
| SEPT 2013 FOMC | |||
| Chg in GDP for 2013 | 2.2 to 2.3 | 2.9 to 3.1 | |
| Last meeting projection | 2.3 to 2.6 | 3.0 to 3.5 | |
| DEC 2013 FOMC | |||
| Chg in GDP for 2013 | 2.2 to 2.3 | 2.8 to 3.2 | |
| Last meeting projection | 2.0 to 2.3 | 2.9 to 3.1 | |
| MARCH 2014 FOMC | |||
| Chg in GDP for 2014 | 2.8 to 3.0 | ||
| Last meeting projection | 2.8 to 3.2 | ||
REVOLVING CREDIT GROWTH (source FRB)
Q1 2013 1.3%
Q2 2013 1.0%
Q3 2013 0.9%
Q4 2013 2.0%
Q1 2014 -0.4%
(is this a strongly improving trend?)
HOME MORTGAGE GROWTH (source FRB Z.1)
Q1 2013 -2.0%
Q2 2013 -1.1%
Q3 2013 0.9%
Q4 2013 -1.0%
(is this growth?)
CORPORATE CREDIT GROWTH (source FRB Z.1)
Q1 2013 7.2%
Q2 2013 9.3%
Q3 2013 10.3%
Q4 2013 8.2%
May 16. Bond rally continues
–This year’s bond rally refuses to die, in spite of higher inflation data over the last two days (Core yoy +1.8%). Tens fell another 4 bps to 250. All euro$ calendar spreads made new lows with highest one year spread EDZ5/Z6 now just 108.5 (-2.0 on the day). Red/gold pack spread reached a new low of 243, having started the year at 303. 2/10 treasury spread dropped 3 to 214.5, also a new low.
–I don’t think I have ever seen as many people confounded by such a strong move. There is now more discussion (which almost takes the form of an excuse) of the Fed’s “terminal rate”, which the market has been lowering despite the blue dots in the last Fed SEP which were indicative of 4%. Of course, now it becomes likely that the June meeting will feature a shift lower in the dots. Gold eurodollar pack at 96.77 (3.23%) is more consistent with something like 3%. My personal view is that the move to lower rates has a variety of factors including the slowdown in China/Asia, the continued deflationary quagmire in Europe, the fact that low rates favor capital over labor, thus holding down wages, etc. I think that the levels we have recently reached are getting attractive for curve steepening moves, though perhaps there is a bit more left in the bond bull. In any case, the slowdown being telegraphed by the bond market is starting to give stocks the jitters, which could force even more of a flight into fixed income.
