April 8. Increased deflationary pressure from Asia?
–Stocks continued to fall yesterday, supporting a bid in fixed income. Yields fell 2.5 to 4 bps across the curve. Implied vol being relentlessly hammered with treasury vol at new lows. I marked TYM 124^ at 4.0, down 0.4. There was a new seller yesterday of 20k Green Sept 9800 straddle at 50.5 and continued exit of Short (red) Sept 9900/9862 put 1×2, suggesting diminished confidence in the idea of rate hikes beginning in spring of 2015.
–While five year vol has fallen significantly from the high, from 3.3 to 2.7 currently, eurodollar calendar spreads remain elevated. Peak one-year calendar EDZ5/EDZ6 is 117, only 1.5 off the high. Vol becoming cheap relative to curve? Probably not, but bears watching.
–Nikkei hit overnight as BoJ refrains from adding to monetary stimulus. US warns China on currency moves. It appears as if China has a choice of either depreciating its currency to support exports (unleashing deflationary pressure on developed markets), or doing nothing to offset its monetary reforms, which could threaten a domestic asset deflation spiral given a huge debt overload. Having already used the situation in Ukraine to push Russia to look toward Asia for economic deals, the US is now intent on antagonizing China.
–On a related topic, with the increased consumption tax in Japan, and the Chinese now taking forceful steps to counter Japan’s yen devaluation, how can the Nikkei maintain its inflated level?
———————————————————————-
Business Insider released its “Most Important Charts” piece (with a notable contribution from colleague Todd Colvin)
Quite interesting, with many charts focused on China, and many charts which suggest tight spreads or stretched values across markets, vulnerable to reversals
http://www.businessinsider.com/the-most-important-charts-in-the-world-2014-4
April 7. What if HFT regulation causes liquidity to drop?
–Employment data was only slightly weaker than expected, but failed to provide confirmation of economic lift off, causing massive liquidation of bearish bets. Implied vol was crushed right across the curve. Open interest in tens fell 195k (nearly 8%), as the yield fell over 6 bps to 272.4. Green euro$ pack gained just under 10 bps, blues and golds a bit over 10.
–Tech stocks were hammered, with many large names -4.5 to 5%. From this year’s highs, NFLX is down 25%, FB and AMZN about 21%. Not exactly a flash crash, but new found scrutiny of HFT could easily factor into continued volatility. Market News reported that Brussels is stepping up EU oversight of HFT firms, even those that don’t take outside investor funding. The Hill has a piece suggesting new momentum for a financial transaction tax. http://thehill.com/blogs/on-the-money/banking-financial-institutions/202722-will-flash-trades-lead-to-a-financial
–In today’s environment of regulatory zeal, I can imagine a day that starts off ugly, causing HFT shops to collectively say, ‘hey we better shut down today, because we might get blamed for this…” Ironically, the very regulators that are supposed to ensure liquid and orderly markets might contribute to a black hole.
–Bullard speaks today at 11:45 NY time. Fed minutes on Wednesday.
–A couple of quick notes after Fri trade:
1) 0EU 9900/9862/9825p fly 40k sold at 5.0 (some covered 9914). Exit trade. Entry price was 5.5 versus 9909, so pretty much of a scratch. This trade was looking for forward timing regarding Fed rate hikes…data didn’t provide confirmation so position was cut.
2) According to prelims lost 195k open interest in tens. Again, just a lack of confirmation about a more aggressive Fed
3) 2EM 82/83ps sold at 6.5 covered 26. Just a roll into long 9825p’s
4) Option vol smashed. West coast continues to sell strangles, i.e TYM 22/24.5 from 51 to 49.
5) FV vol, which had been strong at around 3.3 settled 2.9 (after taking out weekend). So atm straddle went from around 1’09 to 1’00s Friday. All treasury vol at new monthly lows. Bond at only 6.8. Atm straddle went from 2’58 to 2’38 (131^ to 133^).
6) No reaching for fixed income calls as the result of Nasdaq sell off. No real panic.
April 4. NFP report.
Small net changes in front of today’s NFP, expected 200k. Dollar curve was slightly flatter with reds unch and golds +2.375. Back month eurodollar straddles had 0.5 to 1.5 bps sucked out. Bond rally at the end of last month has faded as some attributed the strength to Japanese year end buying. However, 5/30 still at low end of range at 184, and June bond vol stuck in the mud at 7.5.
–Several exiting adjustment trades yesterday. 2EM 9875/9900 c spd bought 100k for 1.25. Exit. Had been against 9775/9750 p spread which is likely still open though 9775 put open interest fell by 15k (settled 4.25). Sell 1 put for every 4 call spreads and completely remove upside risk? There was new buying of TYK 122p as some look for a blockbuster number.
–If there was ever a time to put the ‘one way ticket to Rio’ trade on before data, it’s probably to buy EDU4/EDZ4 for 6. If the market moves up odds (currently near zero) for an end of year hike, this spread should perform. Probably only 2 bps of risk in short term. By the way regulators, I am not truly recommending such rash behavior. (You should probably buy a ROUND TRIP ticket).
–I watched one of those nature programs on PBS last night, about the re-introduction of the wolf into Yellowstone, which had been previously hunted to extinction. There was a lot of concern prior to the release, about safety, environmental impact, etc. Without the wolf, the elk population had exploded, grazing the landscape to the ground. Plant and animal diversity receded. After wolves came back, the elk population thinned, which in turn allowed plant life to flourish. As willows were allowed to grow, beavers came back, which built river dams. River dams tend to slow the pace of flow, of course, and widen waterways, which attracted other wildlife. The eco-system generally diversified and became more robust. In the current analogy, (yes, there is one), the Fed’s meddling may be the human intervention equivalent of removing the wolf. Perhaps we will be a lot better off just letting nature run its course. Maybe today’s data will force the issue.
March 31. Euro$ option premium suggests demand for insurance for the week ahead.
–Ten year yield rose 4 bps Friday to 271. Implied vol in interest rates firmed and closed at the highest levels of the week. Friday to Friday changes in futures levels were fairly small. For example, EDM6 fell 2 bps from 9824 to 9822, yet Green April 9825 straddle actually gained value, from 18.5 to 19.5. Green June straddle rose from 36 to 37.5. Blue June 9725^ rose from 37.5 one week ago to 39.5 Friday, with futures having changed only 0.5 from 9725 to 9724.5. Week over week change in TYM 123.5^ was 1’57 (ref 123-145) to 1’56 (123-18). Premium demand due to geopolitical concerns and a fairly big news week ahead, with a Yellen speech this morning, ECB meeting and US employment data.
–As mentioned in weekly comment ( below ), green June midcurve put open interest has exploded to 2.4 million contracts, which compares to 761k open in EDM6 underlying future. The market has moved toward the idea of rate hikes starting next spring or summer, with 25 per meeting, just as occurred in 2003. However, with 8 Fed meetings per year, complete certainty of such a scenario would suggest one year calendar spreads of 150. The peak is still EDU15/EDU16 at 114.5. Some of the nearer one year spreads did make new recent highs on Friday, for example EDH15/16 rose 3 to 103.
–Interesting piece in the Telegraph with several banks warning about potential capital outflows from China.
http://www.telegraph.co.uk/finance/china-business/10732889/Global-banks-issue-alerts-on-China-carry-trade-as-Fed-tightens-and-yuan-falls.html
March 31. End of quarter; weekly wrap in US interest rates
The week can be easily summed up: continued reaction to the last FOMC meeting, which solidified expectations that the taper is on course to end in October and initial rate hikes will begin about six months later. From Friday to Friday red euro$ pack was -1.375, green -1.875, blue +0.625 and gold +2.125. On the day prior to the Fed, green/gold pack spread was 163.875, now it’s 142.625, a plunge of over 20 bps. The 30yr bond yield fell 7 bps over the week from 361 to 354. So the greens, or really 2016 contracts, are the weakest part of the curve, but thereafter the curve has flattened, which makes sense if one believes that the terminal rate will be much lower than it was in the past.
Implied vol again had an end of week resurgence, with ten year moving from around 4.7 to 5.0 from Wed to Friday. Euro$ vol also went bid Friday, for example 2EM 9825^ from 36.5 to 37.5. There has been a consistent seller of TYM 122/125.5 strangles around 40 (yield equivalent strikes currently around 2.92 to 2.46; Friday close 2.71). From a longer term perspective though, these are low vol levels. When looking back at the taper/tighten swoon of last summer, ten year vol went from around 6% in late June to briefly spike at 8% in the beginning of July. Bond went from around 10.25 to 11.7. Fives from around 4.0 to 5.0. I marked bond vol at 7.6 on Friday. Now that tapering is actually under way, the market has become quite comfortable with the idea that inflation will stay under control and there’s little chance of a big economic growth spurt, in other words, yield increases at the back end will be limited. The normalization trade has embraced the idea of a lower real FF rate than in the past. Though I am notoriously bad at anything having to do with the stock market, I would say that even here, the air is coming out like a tire with a small leak….when the Fed is pumping hard, the tire stays full, but when the pace slows there is a bit of deflation, and confidence in organic growth just isn’t strong enough to keep it rolling.
There has simply been an explosive increase in Green June put open interest as the market has targeted the initial hike for late next spring. Open interest in EDM6, the underlying contract, finished Friday with 761k open which is about 7% of total euro$ open interest. Green June puts, not including April or May expiries, have 2.402 million open. Here is a sample:
STRIKE PREM DELTA OPEN INT
9850p 35.25 73 180k
9837p 27.00 63 159k
9825p 20.25 52 243k
9812p 14.75 42 273k
9800p 10.25 32 431k
9787p 7.00 24 256k
9775p 4.75 17 462k
There has been tremendous size buying in, for example, 9812/9800/9787/9775p condor for 2.5 [Makes 10 on settle between 9800 and 9787.5] and trades like 9825/9800/9775 p fly. Now it’s all about perceived timing of Fed hikes and market control. The August 2015 FF contract is 99.47. In looking at the calendar, I believe there will be an FOMC meeting on July 29, 2015. Let’s say that FF are correctly predicting a 50 bp FF target at that meeting. (So perhaps the first official move to 25 is at previous meeting on June 17, 2015). If there were hikes of 25 at every subsequent meeting, then by the late April meeting in 2016 the rate would be 2%. So a price for EDM6 or somewhere around 9775 makes sense. But we won’t know the actual outcome, because Green June options expire June 13, 2014, in just 11 weeks. And, with this type of open interest (in puts relative to underlying), there would appear to be more than enough firepower to peg and defend this area. More on FOMC meetings and pegged trades below.
Implications for futures calendar spreads are pretty clear if one buys into this argument of Fed timing. Contracts like EDZ4 at 9954.5 and EDH5 at 9933.0 should be immune from perceived hikes and therefore have a steady roll up the curve. However, contracts from EDU15 thru EDU16 will be pegged with vigorous defense, and likely will NOT be allowed to participate in the normal roll. It’s not exactly an earth shattering revelation; this phenomenon has already been reflected in futures flies like EDH5/H6/H7 which has rallied from -20 to -4 since the FOMC.
Last year when the Fed was talking about the initiation of the taper, financial dislocations across the US curve and in EM caused the Fed to backpedal and non-taper in September. (Payroll data on Sept 6, 2013 was also soft). It seems very unlikely the Fed will backtrack on the taper schedule this time even if data were to be a tad weak, and the fact that the back end of the curve is controlled at low vol also suggests a Fed goal of financial stability has passed the smell test, even if there are still lingering vulnerabilities in EM. So what could possibly throw a monkey wrench into the greens from here? I hardly think it will be that data is so strong that the Fed will have to be even MORE aggressive than currently priced. No…it’s more likely to come from geopolitical problems, something that shakes the belief in the Fed’s tightening schedule. My guess would be something in China or Japan.
FED MEETINGS (2015 and beyond approximate) w/ FF target IF first hike is June 2015
2014 2015 FF Target?? 2016 FF Target??
_______________________________________________________________________
1/29 1/28 1/27 1.50
3/19 3/18 3/16 1.75
4/30 4/29 4/27 2.00
6/18 6/17 0.25 6/15 or 22 2.25 (EDM16 exp 6/13/16)
7/30 7/29 0.50*** 8/3
9/17 9/16 0.75 9/14
10/29 10/28 1.00 10/26
12/17 12/16 1.25
***FFQ5 9947.0 currently, so that fits with 50 bp target at 7/29 meeting
Other trades that are targeting this schedule: 0EU 9900/9862/9825 put fly for 5.5. EDU5 currently 9908. With expected hikes of 25 on Sept 16 and Oct 28, contract should price a bit under 9900. Breakeven is 9894.5. 0EZ 9875/9837/9800 put fly for 5.5. With expected FF target 1.25 on Dec 16 and another hike in late Jan, contract should price just under 9850. Currently 9880.5.
Call for trade ideas.
Alex Manzara 312 281 4411
March 27. In addition to Fed taper, other signs of tighter credit
–The Fed rejected Citi’s dividend plan, helping to press US stocks lower. The sense of more stringent access to capital could evolve into a global theme, a concern for equity markets. ECB stress tests are starting, and according to several Reuters stories, banks in China are tightening standards as well. A bank run in a rural Chinese city is perhaps emblematic of unease about the strength of China’s financial sector. http://www.reuters.com/article/2014/03/27/us-china-banking-idUSBREA2Q06F20140327
–Treasuries maintained a solid underlying bid throughout the day as the five year auction found strong demand. Durables data revealed continuing softness in capex, “…orders for non-defense capital goods excluding aircraft unexpectedly fell 1.3 percent after rising 0.8 percent in January. This core capital goods measure is a closely watched proxy for business spending plans.” (Reuters)
–News today includes: Q4 GDP 2.7 from 2.4. Job Claims 323k.
–Implied vol in treasuries is anchored to the lower end of range. TYM 124 straddle at 1’53, 4.6. With just over 2 weeks to go, Green April 9825 ^ settled 18.5 ref 9826.5 and Blue April 9725^ at 19.0 ref 9728.0. The much lower strike on the blue suggests more room to move, but the market remains focused on greens as the pivot point with respect to Fed tightening.
March 26. A pause in belly selling as fives are auctioned today
–Fairly quiet day yesterday, with minor reversals in several recent trends. For example, green eurodollar pack was strongest on the board, closing +2.75 while reds were +1.875 and blues +1.75. Some large block trades (-TU, +FV, -Ultra as fly) suggested profit taking on curve trades.
–Today’s news includes Durables expected +1.0, and 5 year note auction.
–Draghi’s comments yesterday about eurozone needing lower real rates sent the euro briefly tumbling to 137.50, but it quickly rebounded above 138, though it’s weaker again this morning at 137.95.
–Treasury vol remains pegged to the low end of the range with May straddle at 118 or 4.5. There has been a consistent seller of USM 132 puts around 1’03 to 1’02, another 10k yesterday bringing 2 day total to 20k.
–In eurodollars there was an exit trade sale of 50k EDZ4 9962/9950p spreads at 2.0. While there was a pause for breath on relative weakness in greens, option trades pile on. For example, buyer of 2EM 9812/9800ps vs 0EM 9925/9912ps, 1.5 paid for green around 25k. Also, green Dec 9762^ bought vs blue Dec 9687^, paying 2.0 over for green, A few weeks ago all blue midcurve straddles were higher than greens on absolute tick basis. Greens are still higher in June and Sept, but just barely. For example green Sept 9800^ 56.0 vs blue 9700 at 57.5.
–Side note, Goldman (GS) was quite weak yesterday, closing -1.5% in an up market, and is now below its 200 day MA.
March 25. Curve being steamrolled
Curve trades are dominant theme. Once again the green euro$ pack is the weakest part, closing -4.25. New high in red/green pack spread to 112, (+1.25 on the day). New low in red/gold to just under 254 as gold pack edged higher by 0.75 bp. S&P cut Brazil to just above junk with negative outlook. Weakness in greens is predicated on a “Fed normalization” path. The back end is compressing the inflation premium. Will perception of tighter monetary policy withstand trembles out of EM?
–Big buyer yesterday of TYM 119p yesterday vs 121p on ratio. For example early block +60k 119p vs -15k 121p for 4 debit. Open interest fell in those options by nearly exact amount of block trade: 119p -58k and 121p -14k. There was also a new seller of about 10k USM 132p from 110 down to 103. Settled 103 vs 13303. Total premium credit from that trade can pay for a LOT of little puts further up the curve… Not that the trades are related, but there was a good buyer of Green April 9800p for 3.0 late. Could do 14 to 1 that way flat premium. If the premium works out even there’s no risk, right?
[that’s an inside joke, for any regulatory body that thinks I am making a recommendation]
–Using w/i 5yr yield, 5/30 is right at 190. But using the current five year 5/30 plunged to new low of 184. Note as well that the 2 yr being auction today is nearly 1/2% (closed 48.5/48.0).
–(Reuters) “Xi tells Obama to adopt ‘fair’ attitude on China’s maritime disputes.” In other words, we saw your impotence on display in Ukraine, and we intend to pay our ‘fair share’, oops no, make that “take” our fair share in Asian seas.
–Draghi speech in Paris today, “A consistent strategy for a sustained recovery”. I think it’s at 11:00 NY time.
March 24. The market robotically moves tightening forward on the curve
–Friday’s trade continues to indicate a perception of the Fed’s first tightening moving forward on the calendar. However, there is no reaching for puts, just pressure on the front end of the curve that is alleviating sell pressure on the back end. Like a half empty tube of toothpaste; squeeze the front and it goes to the back. The cap is still on.
–So, while the five year was unchanged at 171, tens fell 3 bps to 274.5, and 30’s fell 5 to 361. New low in 5/30 spread to 190. Red/gold pack spread at new recent low 257.5, a level last seen in June. Treasury auctions 2, 5 and 7 year notes this week, just to drive home the flattening. The ultra bond contract is right back where it was prior to FOMC. Implied vol in tens is back down around 4.6. Big (25k) buyer of TYM 124/125 call spreads covered on Friday, position exit.
–In eurodollars, downside trades show similar restraint. In midcurves, buyer of short (red) June 9925/9900p 1×2 (EDM5 underlying). Next contract back and a strike lower, a buyer of 50k 0EU 9900/9862/9825p fly for 5.5 (ref 9909). Next contract back and a strike lower, a buyer of 5-10k 0EZ 9875/9837/9800p fly for 5.5 (ref 9882). These contracts will all expire THIS year before the first actual hike. Just a telegraphed repricing of dependable 25 bps rate hikes. I hope it’s not actually that boring. And to add a little spice, some buying of green puts vs golds, and further tightening or inversion of back month green midcurve straddles relative to blues (eg 2EZ 9775^ 71.5 and 3EZ 9687^ 71.0). Peanut butter and jelly on wonder bread.
–Where there does seem to be action is China. “The flash Markit/HSBC Purchasing Managers’ Index (PMI) fell to an eight-month low of 48.1 in March from February’s final reading of 48.5” (Reuters). So, in a part of the world where we might expect control, there has been currency depreciation, growing cracks in commodity financing, and an onset of bankruptcies. El-Erian just had a piece out suggesting (my conclusion) that the bell distribution curve might be pushed a bit lower and wide, but with fatter tails. http://www.businessinsider.com/el-erian-state-of-the-new-normal-2014-3 I think that China represents the fat tail risk. Not so much Russia. They claimed their strategic port, and now just need to keep up a stream of steady threats to keep energy prices high…let the west funnel money into what’s left of Ukraine which in turn pays Russia for higher nat gas.
–Speaking of money transfers, Fisher suggested that QE was simply a gift intended to boost wealth. Then what happens when that gift is taken back?
March 20. Yellen defines “considerable period” as 6 months, Draghi does face-plant
–I didn’t think the dots mattered that much. I was wrong. From Reuters…”Yellen’s remarks at her first news conference as the head of the central bank pointed to a more aggressive path toward higher interest rates than many had anticipated, and bets in financial markets shifted accordingly.” The dots shifted higher for 2016 even as the upper band for economic projections was lowered by 2/10ths, sending the green euro$ pack down 23.25. Red/green spread gained nearly 10 bps, though even reds plunged 13.625 as initial rate hike expectations moved forward. Red/gold was up only 1.5 to 265.5 as the carnage was centered in greens and blues. Five year treasury yield jumped 15, but 30 year bond yield rose only 4, sending 5/30 spread to 197, the lowest in a year and a half. All near euro$ one year calendars made new recent highs, with EDH5/6 gaining the most, up 15 to 96.5. Peak is now EDU5/EDU16 at 112.5, same as EDZ5/6. Recall highest one year spread last year was 122.5.
–From ZH citing Soc Gen: “Erratic dot movements + vague guidance = more rate volatility”. Tym 123.5^ closed 2’04 or 5.0 vol. TYM 122.5/126 strangle that had been heavily sold 52 to 48 settled 54. That seller will probably continue, but move to lower strikes. FVM straddle at 3.2, equaling its recent high.
–CNY nearly 6.23 this morning as China’s currency chart is beginning to resemble Japan’s initial devaluation from a year and a half ago. Copper had a wild reversal off a plunge to new lows yesterday and closed stronger, but as of this writing is -4 to 294.60. We’ll see if this new palpable threat of US tightening exposes fresh cracks in EM.
–US data today includes Job Claims expected 325k, Philly Fed 3.0, Existing Homes 4.60m rate, and Leading Indicators +0.3.
