March 19. FOMC announcement and Press Conference this afternoon
–FOMC meeting and projections/press conference today. 6.5 employment threshold expected to be dropped. December’s projections had 12 of 17 members expecting the first rate hike in 2015. However, the “blue dot” average rate seen by Fed members in 2015 is just slightly over 1%. (Reds settled 0.88 yield as a pack). Blue dot average rate for 2016 is just over 2%, and green pack settled around 1.88%. So in terms of red/green pack spread at 100 bps, the market pretty much is in sync with the Fed or vice versa. However, over the “longer run” the dots are around 4%, yet gold pack is still only 2.52%. So while there may be some price adjustments after the FOMC projections, the market appears more comfortable with the suggestion in Hilsenrath’s piece yesterday, that funding rates will likely “normalize” at a much lower rate than in the past.
–In terms of market action, there wasn’t much yesterday, save premium sales in continuation of safety unwind. Longer maturity euro$ straddles barely moved, but 1.5 bps were taken out of Green and Blue April straddles (settled 20.0 and 22.0).. In addition there was a consistent seller of TYM 122.5/126 strangle from 52 down to 48 (settled 48). New position, open interest up 13k. So while TYM 124.5^ settled 2’10 on Friday, yesterday’s close was 2’00.
–With focus having turned to China and commodity financing gone sour, it’s worth remembering that EU stress tests could also reveal cracks. Reuters has a piece saying banks are concerned negative data could leak out…”The problem is that the health checks will be done in different stages. Right now, more than 1,000 auditors and independent specialist appraisers are trawling through trillions of euros of assets, checking whether banks have set aside enough capital to cover potential losses. [I’m sure nothing bad could leak from 1000 auditors]. A stress test will follow in May and June to check how banks hold up under potentially damaging scenarios.” Final result expected in October.
March 18. Instability…first the US, then Europe, now Asia?
–Quiet Monday, marked by slight pullbacks from Friday’s panicky trade. Back month eurodollars fell over 5 bps in price as the ten year note similarly rose 5 bps in yield near 270. However, option premium remained fairly well bid. TYM straddle slipped only 4/64’s from 210 to 206. Blue April 9750 straddle eased from 24 to 23.5. Stocks jumped.
–Domestic focus remains on the FOMC announcement and press conference tomorrow. Today’s news includes CPI expected +0.1 and Housing Starts at 910k. Several Fed members recently stressed that “financial stability” was one of the goals of monetary policy. But I saw at least 5 references this morning to possible China instability. Business Insider cited Lombard research, “China Bear Stearns Moment may Strike Any Time”, Telegraph…looming property default, FT… renminbi nears 6.20, and FT …concern by the central bank over shadow financing, and of course ZeroHedge. The question the Fed may face is, “what if a new round of financial instability is sparked by Asia?” For example, a dramatic unwind of yen carry trades (now 101.50). Or a cascading flood of corporate defaults in China. How can the Fed respond besides suspending the taper? It won’t happen at this Fed meeting, but perhaps by the end of April.
–As March contracts rolled off the board red/green/blue pack fly now starts with June, and settled yesterday at +8. Red/green pack spread is just barely over 100. High point of one year spreads still EDZ5/6 at 104, +2 on the day.
Alex Manzara 312 281 4424
links:
http://www.businessinsider.com/chinas-bear-stearns-moment-may-strike-2014-3
http://www.telegraph.co.uk/finance/china-business/10703990/Looming-property-default-in-China-raises-fears-of-broader-crisis.html
http://www.ft.com/intl/cms/s/0/e5590566-ae6c-11e3-aaa6-00144feab7de.html?siteedition=intl#axzz2wJ8jtFUA
http://www.zerohedge.com/news/2014-03-17/yuan-tumbles-11-month-lows-china-home-price-growth-slows
March 17, Crimea annexed without a shot
March 17. Russia annexes Crimea in referendum win. Markets have, for now, reversed some of the nervous trade seen at the end of last week, with dollar/yen back up to 101.80. However, the Chinese yuan is weaker this morning as China widened its trading band to 2%.
–For now, US markets are content to focus on the domestic picture, with the FOMC result and economic projections due on Wednesday. Today includes Empire State expected 6.5 and Industrial Production at +0.3 vs -0.3 last.
–I would say that the slowdown in China and a weaker currency, along with light sanctions on Russia are likely to be disinflationary at the margin. At the same both Abe and Obama are begging for higher wage growth to spur inflation, with Abe making a hard push to counter the effects of a tax increase.
–5/30 edged to a new low Friday just below 206. doesn’t appear to have much of a bounce this morning, though I am sure vol will be under pressure as Ukraine was split without military action.
–The Fed has, for the most part, been inaccurate in forward projections, over estimating growth and under estimating the fall in the unemployment rate. Both Yellen and Fischer seem more concerned with sluggish employment.
–Here’s an interesting snippet: At the Bank of Israel, Fischer “…decided to keep the rate unchanged until the following month, he recalled telling his advisers, when the situation would be clearer. “It is never clear next time; it is just unclear in a different way,” came the response from his second-in-command. And so, Fischer said Friday, he learned his lesson: “don’t overestimate the benefits of waiting for the situation to clarify.”
http://wsau.com/news/articles/2014/mar/15/fed-nominee-fischer-policy-decisions-are-best-made-early/
March 15. Weekly interest rate option summary
-Interest rate futures option vol surges at the end of the week.
-Geopolitical tensions completely reverse move to higher yields associated with improved domestic employment picture.
Early in the week implied vol was sold, with TYM straddle trading as low as 4.5 as futures churned around the 123.5 strike. As the week progressed and TY futures rallied well through highs just prior to the employment report, implied vol firmed, surging notably on Friday morning. One week ago TYM 123.5^ at 2’07 was 4.7 vol, on Monday the 124^ traded 2’02 or 4.5, and on Friday the 124.5^ settled 2’10 or 5.0.
It was two Monday’s ago on March 3 that TYM reached its high of 125-07 as the Russia/Ukraine situation spurred an initial flight to quality bid. Friday’s high was 125-00, but interestingly the 30 yr bond contract traded almost exactly at March 3 high, and back month blue and gold Eurodollars exceeded those highs, though fell back by the end of the day. 5/30 treasury spread ended the week at a new recent low just below 206.
Besides the most obvious tensions due to Russia, it’s worth noting that China appears to be slowing considerably, with Premier Li warning of further defaults and other challenges. Copper continued its descent. Brazil Bovespa closed the week on its low below 45000, essentially matching the low last summer associated with the tighten/taper swoon. The US ten year yield ended the week at 2.65, down 15 bps. Given the yield range of 2.50 to 3.00 for the past seven months or so, it would be reasonable to position short in treasuries as we approach the lower boundary. I don’t think many people allow much of a chance for a hard break through the lower bound, but even if the Russian situation comes off the boil, problems in China and Japan (and EM) could still keep a solid underlying bid in treasuries; I wouldn’t be surprised by a move to 2.25 by the beginning of May, which would cause a considerable amount of pain.
Now for a couple of specific trades: TYM 119/121 put spread was bought heavily early in the week (50k) for 12/64, covered 123-20 to 21 with 10 delta. Great trade; by the end of the week the put spread settled 8 with futures up a full point to 124-21. These puts are among the largest in open interest, with 140k open in 121p and 119k in 119p. Probably still worth buying put spreads delta neutral. Early Friday morning there was a large buyer of TYJ 126 calls (short cover) to buy TYK 123/126 combo (new position). I believe the combo traded 1 for put with futures ref 124-195. In any case, on Thursday, TYK 123p settled 16 and 126c 18 vs 124-20 (strangle at 34). On Friday the 123p settled 18 and the call 22 with futures only up 1 at 124-21. Gives an idea of change in skew and vol…strangle was +6/64’s to 40. Fear of the upside. As I noted last week, after the employment report there was put selling and call spread buying, and vol was mired at the low, indicating little fear of the downside.
In Eurodollars vol surged as well. For example, on Thursday blue April (3EJ) 9750^ settled 22.5 and 9762^ 23.0 vs 9754. Straddle strip settled 45.5. On Friday there was a buyer of the strip at 48, followed by the best offer being only 49.5, though it ended 48/49. 3EJ 9750^ settled 24.
There has been continuous buying of Short June (0EM) 9937 puts outright, and Green June 9850 puts, the latter mostly as part of 9850/9825/9800 put flies, which have traded 4.0 to 4.5 in price. Short June 9937^ was unchanged on the week at 19.5. Green June 9850 straddle settled 37.0.
It was a month ago on Feb 18 that 2EM 9825/9875 strangles were sold in size of about 40k from 20.5 to 19.5, followed by additional sales of similar quantity in 9837/9887 strangles. At the time 2EM 9850 straddle was around 41. On Friday, 2EM 9825/9875 strangle settled 16.5 ref 9852.5.
Over the past week, green/blue pack spread has flattened by about 5 bps. Green/blue atm straddle spreads remain pretty tight at around 4 bps. For example, 2EM 9850^ 37.0s vs 3EM 9750^ 41.5s. Due to flattening bias and the pit being positioned with heavy long inventory in green calls, I favor buying blue calls vs greens.
March 14. Market disocations generally support bonds
–Slightly stronger than expected headline Retail Sales and lower Job Claims caused an initial flurry of selling in interest rate futures, but pressure quickly abated as previous retail numbers were revised lower and tensions flared in Ukraine. Ten year yield fell nearly 8 bps to 265.4. Blue eurodollar pack was the strongest point of the curve, up nearly 10 bps. Red/gold pack spread made a new low of 263, down nearly 5 bps on the day. Like every thing in the interest rate world, it was May thru July of 2013 that saw wrenching adjustments in spreads, red/gold went from 150 to 280. Should now find some support around 250. One year calendar spreads declined, with green/blue spreads posting new lows. EDZ15/16 still the highest, but now only 100.5 bps.
–Though Russia/Ukraine is cited as a reason for market moves, that situation is probably more of a sideshow as compared to the continued plunge in raw materials that threatens to cause massive financial dislocations in China. TV analysts were happy to credit China’s rise and more recently Japan’s success with QE as tailwinds to the inexorable rise in US stocks, but turn a blind eye to the problems. Japan -3% today, near a new low for this calendar year. Hong Kong -1%.
–GS cut its Q1 GDP tracking from 1.7 to 1.5. Perhaps it’s due to weather but no matter what, inflation is still running below Fed’s target (PPI today expected +0.2). The other day I was directed to a BBG article (thx WHM) which noted that housing accounts for 17% of CPI and the article cited several professionals that say rents have stalled…disinflationary. Fischer speaks today, and in recent comments highlighted weak employment and low inflation. He also mentioned that his time at Citi gave him invaluable experience, otherwise he would have joined the Fed as an academic.
–ZH has an interesting article about Glencore and copper prices (thx JK). http://www.zerohedge.com/news/2014-03-13/cheapest-and-most-levered-way-play-chinese-credit-commodity-crunch Probably starting today and going into next week there will be continuous rumors of large trading firms “being in trouble.” Hopefully Fischer’s corporate banking experience helps him and the Fed respond.
March 13. This month’s employment report sell off in tens was erased yesterday
–The grinding rally in interest rate futures has now erased losses associated with the employment report. Curve continues to flatten, with red/gold pack spread losing nearly 4 bps to 268.25, hovering near its monthly low. 5/30 is also on its low at 208 as the treasury auctions 30 yr bonds today. Tens saw good demand at 1.4 bps through w/i at 272.9. An early explosion in NYC was initially thought to be terrorist related and sparked a new high in tens, but as reports immediately revealed it to be an accident, the bid in fixed income never really faded.
–China states the obvious. (Reuters) “Chinese Premier Li Keqiang warned on Thursday that the economy faces “severe challenges” in 2014 – comments that came as weak data fanned speculation the central bank would relax monetary policy to support stuttering growth.” Li says “defaults unavoidable. (FT).
–Highest point on the eurodollar curve for one year calandars remains EDZ5/EDZ6 at 104, down 0.5 on the day. Any further weakness in econ data could push every spread below 100. Today’s news includes Retail Sales expected +0.2 and Jobless Claims at 332k. Reuters notes that ten year Irish yields sank below 3%.
–Vol still under pressure. I marked TYK as low as 4.5. There was a synthetic straddle seller in 2EU 9825^ at 54 during the day. Had settled 56.5 the day before. (Settled 55.0).
–In an ironic twist parts of Washington DC experienced a black out yesterday; the Capitol Dome was unlit…this morning the WSJ says “US Grid Vulnerable to Sabotage”. As noted yesterday, Drudge Report ran a story about more frequent attacks on power substations.
March 12. Copper takes it on the chin
–The latest victim of the knockout game is copper. Down 10% in last 4 sessions. Probably has something to do with inventory finance in China, where there are reports of using the same collateral for multiple loans. And while there are rumors of additional defaults coming, the PBoC likely accelerated the conflagration with this: “China’s top central banker put the country on course to free up interest rates on bank deposits within two years, an unprecedented move that would force the nation’s lenders to compete for customers by offering the best terms.” (WSJ). Nikkei down 2.5% today.
–In the US example of tightened finance, Congress proposes to wind down housing GSE’s: “The bill will call for replacing Fannie and Freddie with a new system of federally insured mortgage securities in which private insurers would be required to take initial losses before any government guarantee would be triggered.” Wait…PRIVATE LOSSES?! Inconceivable! Of course, the Flow of Funds report last week showed the gov’t both gives and takes, as mortgage debt continued to FALL in Q4. In 2013, Mortgage debt declined by $75 billion, but student loan debt increased by $61 billion. I’d rather have the house as collateral than junoir’s art history degree.
–Net changes in interest rates weren’t all that large, but the back end continues to lead a grinding rally higher. Ten year auction today.
–Interesting story on Drudge about geographically diverse and perhaps random attacks on the US electrical grid. http://freebeacon.com/report-u-s-electric-grid-inherently-vulnerable-to-sabotage/
March 11. Option vol suggests limited downside in interest rate futures
–Fairly quiet day yesterday with interest rate futures floating slightly higher in the wake of Friday’s employment data. Green and blue midcurve straddles eased 1-1.5 bps. Bond vol was smoked, with USM 131^ settling at 3’24, just 7.2 vol. Not exactly indicative of a bear market.
–April treasury options expire one week from Friday. There were some adjustment trades, including an exit sale of 20k TYJ 122p at 4 and a new buyer of about 15k USJ 129p at 6-8. TYJ 123.5^ is 54 and this Friday’s straddle is 32.
–Eurodollar curve was flatter with red/gold pack spread down 2.625 to 275.5. Three year auction today, followed by 10’s tomorrow and 30’s on Thursday.
–Negative signs for global growth continue to emanate from emerging markets. The lowest level for Brazil Bovespa in 4 years was just above 44000 in June of last year as tapering/tightening fears rattled EM. Subsequent rally went over 56000. Yesterday’s sell off nearly completed a nine month round trip to just above 45000. Copper looks the same, lows for the last 4 years in the NY contract have been around 3.00 which was tested early yesterday morning. Iron ore is extending its bear market according to various sources. And the tapering schedule is likely to continue at next week’s FOMC.
–While industrial metals trade heavy, gold is currently threatening a new high for the year, up nearly $5 at 1346.30, apparently regaining safe haven status in times of global strife. (Global excluding the US of A of course).
March 8. End of week summary
Employment data was a bit stronger than expected at 175k with average hourly earnings of +0.4%. Interest rate futures contracts made new recent lows with weakness most notable at the front end of the curve, which I think is probably the biggest takeaway from the week.
While there had been consistent put buying in front of Friday’s data, trade immediately following showed little enthusiasm for further downside. For example, TYJ 122.5/123.5 put spreads were bought in decent size early in the week for 20-22, but right after the number there was a block seller of 10k at 18. Later in the day there was a buyer of TYJ 124/125 call spreads for 12-13 in size of about 20k (appears to be exit).
There was buying during the week of May 124/122.5/121 p fly for 16, which settled 22 on Friday with TYM 123-175. The middle strike of that fly equates to a yield of about 2.93-2.94% on the w/i note to be auctioned this week. Market positioning seems to indicate that the high ten year yield of just over 3% is unlikely to be seriously challenged over the near term. (This level was first hit in August with the Fed’s change of stance last summer, and again at the very end of 2013).
The net result of the week is that treasury vol was hit after the data, and remains under pressure. I marked the TYM 123.5^ at 2’07, or 4.7 vol. Green March Eurodollar 9862^ opened the day around 11.5 bps and closed at 8.5 with a week to go. 2EH 9862 puts settled 2.5, up just 0.5 on the day, with EDH6 at 9866, -8.5 on the day.
When looking at yield levels of 5’s, 10’s and 30’s it’s pretty easy to observe the flattening tendency. For example, high to low yields this calendar year are approx as follow: Fives, 177 to 144, currently 163.5 or 11.5 bps from high. Tens, 301 to 258, currently 279 or 22 from high. 30 yr, 396 to 353, currently 372 or 24 from the high. 5/30 yield spread remains under pressure and is near the lowest level of the past year and a half at 209. Charts of EDM5, EDM6, EDM7 and EDM8 show the same bias. Reds and greens took out Feb lows, golds didn’t. Green to blue midcurve straddles (strikes 100 bps apart) are at their tightest spreads of the year with 2EM 9837^ at 39.5 and 3EM 9737^ at 43.0.
The fact that vol has trouble going bid at new lows is troubling for bears. In the beginning of Feb when we had a stock market scare and large buyer of TYH 125 puts, vol surged to 6.4. Since then it’s been all down hill, with TY vol struggling to even test 5% on the Russia/Ukraine situation. Five year vol has held up relatively well at 3.0, a reflection of curve dynamics.
Rather than list large open interest strikes, I would just note the following. Green June 9837 and 9825 puts have sizable open interest with the upper strike now right at the money. There is a large open short position in 2EM 9825/9975 strangle and in 9837/9887 strangle. Though lower strikes are being threatened, with EDH6 at 9866 vs 9839 in EDM6, the roll of 27 bps makes further downside a steep hurdle to overcome without more bearish fuel.
While the schedule in the US is quiet this week (treasury auctions 3, 10, 30 yr paper), the global situation is much more interesting. As a percent of global GDP, the US share has declined and of course China/Asia has risen. Focus has shifted to China’s economic problems and weakness in the renminbi, and spillover is likely to have major consequences for markets. Whatever the economic data say, the picture from the markets is clearly telegraphing Chinese problems. With last week’s default of solar panel maker Chaori, the copper market was crushed, falling 4% on Friday and 9.5% since the start of the year. Shanghai rebar contract is down 9.7% since the start of the year and closed at a new low. Brazil’s Bovespa had the lowest close in seven months. Gold/silver ratio is again moving higher at 64 and looks as though it may threaten last year’s high of 67. Today from BBG: “China’s exports fell the most since the global financial crisis, dealing another blow to confidence as Communist Party leaders meeting in Beijing assess the risk from the nation’s first onshore bond default… Shipments abroad dropped 18.1 percent from a year earlier, the customs administration said in Beijing today, trailing the median estimate for a 7.5 percent increase in a Bloomberg News survey of 45 economists. Imports rose a more-than-projected 10.1 percent, leaving a trade deficit of $23 billion, the biggest in two years.” While the Chinese may not sell US treasuries, they certainly aren’t buyers if dollars aren’t coming in from exports. Also, the recent weakness in renminbi may accelerate in response to bad trade data. In the US, I think fears will again shift to deflation, but not soon enough for the Fed to change the tapering schedule next week. 5/30 should make new lows.
I’ll end with these predictions about the Year of the Horse:
“If you have a business involving wood or fire you will do well, according to Canadian Feng Shui expert Paul Ng. This includes lumber companies, agriculture and media companies. Property companies won’t do as well and as the horse is a galloper, the potential is for the prices to gallop downwards over the first six months. However, supported by the fire element in the latter half of the year they may gallop back up, according to Lynn Yap, Singapore’s Feng Shui Queen. Metals and waters will do badly: this will affect metal mining and precious metals as well as fishing. Financial business also have the potential to be unstable. We could have predicted that one though.”
http://www.independent.co.uk/news/world/chinese-new-year-2014-what-the-year-of-the-horse-means-for-you-9096775.html
March 6. ECB meeting today. US Employment tomorrow.
–Quiet day Wednesday with a decidedly bearish tone. Both ADP and Non-mfg ISM were large misses, with the latter at 51.6, the lowest it’s been since early 2010. Additionally, it’s at about the same level as seen in late 2007, just before the whole house of cards collapsed. However, there was almost no bounce from the lows in TYM, only enough to muster an unchanged close. (268 yield in tens). When a market fails to respond to bullish news, there’s usually a reason. US stocks continue to make new highs. Nikkei has taken out February’s high overnight. However, some emerging markets remain under pressure, including Brazil which remains near the lows of the past 4.5 years.
–Implied vol in tens and 5’s hit as the market stabilized on weak ISM. FVM 119.75 straddle was 1’26 on Tuesday but settled 1’21 yesterday. TYJ straddle trade 111 early but closed 107. In eurodollars there continues to be buying of March midcurve puts, for example Blue 9762p for 5.0. Additional buying on red June midcurve put structures (Williams).
–Yellen vows to “do all I can” to boost the economy while SF Fed’s Williams suggested that rate hikes could start by the middle of next year.
–ECB meeting today with some expecting a rate cut amidst deflationary pressure and low to negative changes in bank lending, but more likely that SMP purchases will no longer be sterilized, giving a slight boost to liquidity. EUR has ended the US day around 137.30 for the past three days. US news includes Jobless Claims (which appear to be trending higher) at 338k and Factory Orders at -0.5.
