Oct 14. Closer to a SNAP?
–Another day closer to default as negotiations sputter. Some minor adjustments in pricing have occurred, for example t-bills maturing at the same time as a potential 6 week spending extension saw a jump in yields as the default scenario would shift to that time frame. In general though, markets have observed gov’t bickering with a yawn. Of course, in June 2007 when Bear Stearns announced problems with two of its funds related to subprime housing and infused capital to prevent collapse there wasn’t much of a reaction either. But that was a pretty clear indicator of things to come. What we now get are headlines like this one in the WSJ: “Shutdown Likely to Prolong Fed’s Stimulus”. Which means liquidity to support stocks, and low rates which allow companies to issue bonds and buy back shares. I.e. business as usual.
–I don’t mean to suggest we’re on the edge of abyss in markets. Far from it, though I don’t really think we are priced for much slower growth. However, on a social level troubling signs continue to appear that could lead to a more dangerous snap. SNAP stands for Supplemental Nutrition Assistance Program, which encountered a computer glitch rendering food stamp debit cards useless in 15 states for one day this weekend. 23 MILLION households on food stamps. Want to see a snap? If the guy that designed the Obamacare computer sign-up system were transferred to the food stamp program you’d see a Detroit style devil’s night in every major metro area in the country. Not like the Veteran’s march in Washington where protestors physically removed barricades from the Lincoln Memorial and put them in front of the White House. That didn’t turn into a riot, but the potential seems to be growing.
–In terms of interest rate markets Friday, there was a new monthly low made in red/green pack spread just under 84 bps. Last night and this morning the trend continues, as very near contracts are pressured by default concerns and slightly further back greens and blues are supported by a weaker growth scenario.
–Interesting snippet from Mortgage News Daily: “Higher Down-Payment Requirements Coming in November”
On November 16, Fannie Mae will implement scheduled changes to its automated underwriting system (DU or “Desktop Underwriter”). DU is used by lenders to approve loans, and several of the changes will make it harder for some borrowers to qualify. These include tougher debt calculations for Adjustable rate loans; a complete removal of interest-only options; a maximum loan term of 30yrs (instead of 40), and stricter requirements for down payments, increasing the minimum amount from 3% to 5% of the loan balance.
Oct 10. Short term debt limit increase looks likely
–Obama provided an opening on the debt ceiling impasse with the suggestion of a short-term increase to allow further negotiations and it looks like Republicans are going to crawl through it. Stocks are rebounding and treasuries fading. Tensions in the market were easing yesterday as implied vol slid. For example the Dec bond closed -9 at 133’04 but USZ 133p were unch’d. TYZ straddle went from 2’09 Tuesday to 2’01 yesterday as futures closed unchanged in spite of the ten year auction. 30 yr bonds auctioned today. Jobless Claims will also be released.
–Red/green pack spread made a new monthly low just under 86 bps. Since the beginning of August this spread has been between 80 and 109. Once again I would note it was around 30 in the beginning of May before it started its steady ascent, so in general I would say the market is comfortable with the idea of somewhat less accommodation going forward, in spite of Yellen’s nomination. Ten year inflation-index note yield holding around +45 is another reflection this (had negative real rates in the beginning of the year).
–VIX also was lower on the day. I would anticipate flattening of that curve as the gov’t lurches back into full operation. Even early yesterday we saw a seller of Nov 20/24c spreads vs 16puts at flat; Nov Vix 18.70s.
–In spite of reduced market tensions small business contacts are still uneasy with planning as policy dysfunction continues. Two days ago Gallup noted that their weekly confidence poll dropped the most since Lehman.
Oct 9. Yellen nomination should provide smooth 10 year auction today
Saw a man with the jinx in the third degree
From trying to deal with people–people you can’t see
Take away, take away, this house of mirrors
Give away, give away, all the souvenirs
We’re all in the same boat ready to float off the edge of the world
–LIFE IS A CARNIVAL by The Band
Oct 9. Reactions to reports that Obama will nominate Yellen as BB’s replacement include a small bounce in stocks and in fixed income. The dollar is also stronger this morning. It seems as if there is some chance of a short term debt limit extension, but when looking at the SPX, though we broke a trendline from last November’s low, we are still not through the lows set near the end of August when interest rates were on a tear higher. (DJIA did break slightly through Aug low). Seems as if continued Fed juicing is much more important to stocks than the gov’t shutdown.
–The market is becoming more attuned to the possibility of default with near t-bills jumping in yield and repo rates pressing higher. In euro$’s EDZ3 was the weakest contract, closing -3.5 at 9967.5. Implied vol in front exploded. For example, last week EDZ3 9937.5p were offered at 0.5 in size. Yesterday, 9862.5 puts trade small at 0.5…75 bp higher yield strike.
–Besides the pressure on repo rates associated with default, an article in the FT yesterday indicated that EU banks still reliant on ECB funding through LTRO would be penalized at upcoming stress tests. As the Bundesbank’s Weidmann has pointed out, it reveals a circular problem of the ECB providing cheap secure funding so that banks could buy (prop up) sovereign debt of dubious quality, leading to more risk in bank portfolios that could come back to further weaken sovereigns.
–In the US there is a similar circular conundrum, again related to cheap, secure and plentiful CB funding, but the beneficiary is financial assets, whose increased value was supposed to create confidence and escape velocity in the ‘real’ economy. Like a merry-go-round.
–But the immediate concern remains US gridlock and gov’t holiday. And the market reflection of dislocations is pressure on the front end and a bid in deferred contracts as growth prospects are jeopardized. While an extension agreement will cause reversion in some of these moves, what is still not being priced in my opinion is slower than expected growth. Markets revert quickly, longer term economic decisions don’t. Of course if there isn’t an extension, and the Treasury resorts to cheap chicanery like issuing ‘super premium bonds’ (from a UBS note), then the long end could run into a fresh set of problems.
Oct 8. Default concerns continue to trickle into markets
–The eurodollar curve flattened yesterday with reds -1.5 and golds +2.125. An early rally in interest rate futures faded toward the end of the day, as some pointed to a Forbes piece that said Obama is likely to choose Donald Kohn as the next Fed chief. The market’s view is that anyone besides Yellen is going to be less dovish, and Kohn is seen as unenthusiastic about QE results. The problem of course, is that if next year’s Fed tries to tackle the vortex of endless liquidity, stocks are going to be the asset of choice to sell, and this economy has been nudged forward by the shaky catalyst of asset reflation.
–The front end of the market is coming under a bit of pressure due to uncertainty regarding the debt ceiling, with near bills leading the charge to higher rates and repo rates also edging higher due to default concerns.
–While the trade data and JOLTS are being delayed, the NFIB small business optimism number will be released, expected 93.5 for September. I think 3 yr auction will also go forward and Fed minutes supposedly released tomorrow.
–China and Japan are both warning the US about nearing default, but current trends in US spending suggest that it’s a choice between crisis now and crisis later. 60 Minutes show on Sunday featured exponential growth in the US disability payment program (thanks MO), which now “has a budget of $135 billion — more than the government spent last year on the Department of Homeland Security, the Justice Department, and the Labor Department combined.”
–One last note that perhaps bears mention is the deteriorating condition of Puerto Rico, and the risk that rating agencies will downgrade its debt to junk. Not only does it risk contagion in the muni market, but also puts the administration in a delicate spot about trying to intervene…it’s one thing to inject federal resources into Detroit, but setting a more expansive precedent risks being forced to shoulder problems of, let’s say…Illinois.
Oct 7. Still closed.
–As gov’t deadlock continues, stock futures this Monday morning are approaching last week’s lows. But complacency has its own inertia, as this line from the WSJ demonstrates: “As they sift through the Washington mess, some money managers think it could be a blessing. Any stock selloff, they say, would be a buying opportunity.” In other words, the Fed MUST continue to provide liquidity. Even though the banking system has a record low loan to deposit ratio, as does the velocity of money. I’m not so sure it all stays the same…the current model seems to be running on fumes… Reuters reports “World Bank cuts China, East Asia growth forecasts”
–Treasuries are modestly higher, but haven’t quite reversed Friday’s sell off. BAML report notes that, “In late July 2011 Treasury GC [gen’l collateral] rates rose by nearly 30bp and MBS repo increased by 35bp as the “X” date approached, though this was exacerbated by heavy money fund outflows.” In euro$’s there has been some buying of puts on EDZ3 contract, likely related. If the week progresses without a negotiating breakthrough, near euro$ calendar spreads will probably see new lows.
–This doesn’t have anything to do with the markets, but I find it interesting: The US launched raids in Libya and Somalia to eliminate terrorist targets, the latter partly in response to the shopping mall massacre. It’s hard (for me) to understand the benefit of being involved in Somalia. The target group is al-Shabaab. What I find surprising is the tie to Minnesota. It’s been reported that some Somalis (very small numbers, reportedly 20 or so) have been returning from MN to join and train with this group. (According to one article I read, of 100k Somailis in the US, 32k live in MN, the land of 10000 lakes). The incongruity of the US deploying logistical military missions in foreign lands while closing national monuments during the shutdown and having to monitor domestic threats makes me think a lot more about what “essential gov’t services” are. Crazy world.
Oct 4. No employment report. Watch for front end scare if Stein gets misinterpreted
–No employment report today due to gov’t closure. However there will be several Fed speakers including Fisher, Stein, Lacker and Kocherlakota. Stein is speaking on tri-party repos, which will likely become the primary policy tool for setting short term rates (now in testing phase until January). Dudley has explained previously that Fed’s current testing of tri-party repos doesn’t signal any imminent change in short term rates, but suspicions linger. I would note that there has been some buying of EDZ puts, and of course of 9975 calls as libor setting has slipped below 1/4%, so front end vol has firmed slightly.
–New lows in some of the calendar spreads yesterday, notably red/green pack spread which eased 1.625 bps to 86.5. High of the year has been around 109 in mid September as contracts changed. In April before tightening fears gripped the market it averaged around 30 bps.
–New high in 5/30 treasury spread which I marked at 234, as 5 yr yield slipped just over 2 bps to 1.362.
–Weekend risk is that some agreement is hammered out on the debt ceiling, which would likely cause fixed income to sell off and stocks to rise.
Oct 3. Gov’t shutdown will drag on…
–The government shutdown continues, and the way it looks it will come down to the Oct 17 wire. Another shutdown, probably more harmful to the US economy, is the Silk Road website and arrest of Dread Pirate Roberts. (Used bitcoins as medium of exchange for drugs to avoid tracking). Of course I am joking about the economic impact, but press reports claim $1.2 billion in sales from the site.. And on a more serious note it seems that anonymity from the gov’t in any form is becoming more difficult, so expect some new computer glitches to surface, courtesy of Anonymous. It’s almost amusing that gov’t action to shut down bitcoins comes at a time when gov’t websites are likely at their most vulnerable in terms of staffing. Thank goodness the NSA is on vacation and isn’t watching this…
–In terms of the gov’t shutdown, it seems to me that many estimates of a pickup in 2nd half growth were predicated on gov’t headwinds abating (the sequester). The current round of gov’t stalemate will certainly have a negative impact and is probably being treated with too much complacency by the markets.
–While we saw a lot of put activity in interest rates in the beginning of the week, yesterday’s flows were weighted toward buying in the front end. There was a notable buy of about 140k EDU15 around 9906-07, and large buying of EDZ4 up to 9951. A couple of weeks ago it was EDU14 that was bought in size of 150k in a clip…that was around 9949 and the contract now trades 9957. In terms of open interest, EDU4 fell 39k, Z4 gained 91k and U5 was up 76k. New buyers, though likely a partial exit of EDU4 as it compresses toward nearer contracts.
–The other big feature of the day was selling of vol in interest rates. For example, early yesterday EDH5 9937^ was sold 20k (new position) down to 46.5, 2.5 bps lower than Tues settle. All ED straddles fell around 2-2.5 bps. USZ 133 straddle went from 4’00 to 3’52. While it might seem strange to see premium selling associated with economic uncertainty due to the gov’t shutdown, it probably makes sense in that the “heavy lifting” of keeping some economic momentum will fall to the Fed, and as we’ve seen previously, the tools the Fed uses tend to repress interest rate movement. It really amounts to a negative forecast for the economy….
Oct 2. Let’s all skip work
–ECB meeting today and ADP data in US (expected +170-180k). Draghi expected to continue to hint at another Long Term Repo Op without actually doing it. An FT piece the other day by Weidmann alludes to a central problem associated with LTRO, namely banks loading up on too much sovereign debt which gets preferential credit treatment in spite of riskiness of *certain* countries.
–Interest rate futures pulled back yesterday in spite of the gov’t shutdown. Early theme of the day was put buying, for example a large new buyer of TYZ 117.5/119.5/121.5p fly for 4. Also buying in green eurodollar put condors, flies etc. However, later in the day there was a buyer of 50k EDH4 9975/9987c spd for 1.25 and a good size seller (new position) of TYZ 124/128 strangles down to 56.
–While ISM was stronger than expected, a prolonged gov’t impasse will almost certainly have a negative influence on GDP and confidence going forward, with business leaders already pushing for a solution and warning of reduced employment given uncertainty. So any thoughts of a taper in October are out the window…the Fed might not even be open by then!
–Spectacular weather in Chicago, high 70’s under crystal blue skies, so I might want to skip out early as well…in solidarity with my brothers in the government.
Oct 1. 4th Quarter opens with a government holiday
–Not much of a reaction to the gov’t shutdown besides a weaker dollar and elevated levels of implied volatility in interest rate futures. Near eurodollar calendar spreads are making new lows, for example Dec’13/Dec’14 settled -2 at 22.5, down nearly 1/4% from the high of 54.5 set just prior to the last employment report. While there has been a reasonable amount of action around the previous few employment releases, this one will apparently be delayed due to the gov’t holiday. We will get PMI and ISM data today, with the latter expected 55.0.
–So, spreads in the front end of the curve have compressed, but much less so in back end, as Dec’15/Dec’16 is only down around 14 bps from the high. That’s the magic of credible forward guidance, with the ECB on deck this week to frost the cake with another LTRO. The front end locks up while the back end can flop around…relative increases in back end implied vol are a reflection of this idea, with midcurve green and blue premium bid.
–A couple of news snippets provide some evidence that recent turmoil associated with Fed tightening fears spilled into global activity. For example, S Korea exports (proxy for strength in Asian trade) fell 1.5% yoy in September, and Unilever issued a profit warning due to weakness in emerging markets.
–There continues to be buying of FVZ 118.5put vs selling 122.25call, about 90k over past two sessions. Approx -28 delta, net premium around zero, new position, likely protection for core long. Upper strike is about 23 bps out of the money, so on a parallel shift current fives would have to fall to about 1.16 yield for calls to be in the money. As a point of comparison, red Dec midcurve 9950c are out of the money by only 1 bp, and trade just 4.5 bps with fully 3 weeks more time value than Dec treasury options, and there are 470k open positions in the strike. Once again, compression in front, looseness in back.
Sept 30. Gov’t shutdown looms
–It’s all about the government shutdown now. S&P futures currently down 13. Eurodollar futures were higher overnight but gave back most gains, near contracts now -0.5 to 1.5 bps, while backs cling to small positive prints.
–Eurodollar calendar spreads continued to decline to new recent lows Friday, with the highest one year spread being EDZ15/EDZ16 at just 104, well off from high of the move in that part of the curve at 122.5. So market perception of tightening in a given year has edged down to just 1%, about the same as the difference in the Fed projections between 2015 and 2016. (difference between mean of blue dots).
–From Fed’s Dudley last week: “I can’t speak for the committee, but I can speak for myself. In my mind, beginning to decide to reduce the pace of asset purchases from the current $85 billion pace requires sort of two things, in my mind. Number one, improvement in the labor market. And, number two, confidence that the economy is strong enough to support that improvement in the future.” i.e. a taper is a tighten. And the market reacts to tightening…why did that prospect surprise the Fed?
–But while the Fed concentrates on Main St stuff like employment, here’s a quote from Blackstone’s head of private equity: “We are in the middle of an epic credit bubble, in my opinion, the likes of which I haven’t seen in my career in private equity,” Joseph Baratta. http://www.cnbc.com/id/101067072#ixzz2gHin3dGe
–And in yet another example of really hard mortgage math, “In addition to the unprecedented claims FHA has had to pay out since 2007 for defaults on mortgages it guaranteed, largely during the 2005-2007 real estate boom, the company has had losses totalling $5 billion in its Home Equity Conversion (HECM) or reverse mortgage.” Mortgage News Daily. So the FHA had to draw $5 billion from the treasury to cover losses.
In: Eurodollar Options
