EDZ14…9950c strike getting interesting

 Midcurve EDZ4 (0EZ4) 9950c have 463k in open interest (1.5/2.0 ref 9936, delta ~ 18).  Most of which is a result of sales of 0EZ 9900/9950 strangles and 0EZ 9912/9950 strangles vs blue midcurve put spreads.  The 9950c leg was sold down to 1.0.

The high in EDZ4 in August (on the 12^th) was 9942.5.  The high prior to the selloff was 9959.0.  Currently EDU4 trades 9950, so the roll should take EDZ4 up to strike.  If the market continues to rally, shorts could have a problem in these calls…total open interest in EDZ4 is 871k.

 

 

 

 

 

 

 

 

 

 

 

 

 

Sept 16. Summers drops bid to become Fed Chairman

–Markets exploded as Summers withdrew his name from consideration for Fed chair.  Ten year rallied over a point, green eurodollars were 18 higher, blues up 23 before settling back.  Mini-SP’s rose over 20 handles to new highs.  Mimosas all around at the opening of the FOMC meeting…
–Though Yellen is the frontrunner, a modest tapering is still likely to be initiated as improvement in the federal deficit requires less bond issuance.  However, there is probably much less uncertainty about potentially large changes in the future course of monetary policy.  And economic headwinds are still apparent for the second half, as reflected by the plunge in Consumer Sentiment Friday (expected 82, 76.8 actual).  A Gallup poll notes the same: ”Americans’ trust and confidence in the federal government’s ability to solve problems internationally as well as domestically has fallen to historic lows this year,” Gallup said. “There are a number of possible explanations for this loss of confidence: controversy surrounding potential U.S. action in Syria, an enduring low assessment of the state of the economy, or low levels of confidence in Congress.”  I would add that uncertainty about Obamacare is becoming a much greater issue as well, as companies from IBM to Trader Joe’s announce healthcare benefits changes, and unions become more vocal in demanding modifications.  While decreased confidence doesn’t necessarily translate into lower spending, several retailers have recently warned about 2H sluggishness, and sequential drops in revolving consumer credit are another warning flag.

Sept 13. Fed meeting next week

–Much lower than expected Jobless Claims caused a spike lower in treasury futures which instantly reversed as data was skewed by technical glitches.  However, the trend in claims remains lower.  By the end of the day, treasuries had given up intraday highs and were around unchanged, the eurodollar curve steepened with reds closing +1.5 and blues -1.5. (There was a buyer of 70k Blue Oct 9675/9650 ps for 4.5).
–Today’s news includes PPI expected +0.2 with +0.1 core.  Retail Sales expected +0.5 and +0.3 ex-auto.  It’s a bit hard to see where growth in retail sales comes from with revolving credit falling the past two months. Income growth remains tepid. Maybe it’s just all “back to school” purchases made with soaring (non-revolving) educational loans.  Textbooks.  Pencils.  The occasional iPad.
–Fed meeting next week with widespread expectation of small taper.  The question of forward guidance is probably the larger issue.  A note by Goldman’s Hatzius predicts “…the statement will make the 6.5% unemployment threshold conditional on a return of inflation to the 2% target and will indicate even more explicitly that continued below-target inflation would translate into a longer lag between reaching the 6.5% threshold and the first hike.”  There could be a reduction in the unemp threshold to 6.0%.
–Japan’s Nikkei reports that Summers will be nominated by Obama as early as next week.  Perhaps the current Fed will be even more aggressive in trying to lock in forward guidance to handcuff Summers over the short term, which probably argues for a steeper curve.

–Gold is down another $15 this morning around $1315, off just over $100 from the high made in late August.

Sept 11. Economic data doesn’t seem to justify 3% tens…

–Interest rate futures slipped lower Tuesday, with ten year yield rising 6 bps to 2.96.  Curve steepened with 2/10 up 3 to just over 249.  A reduction in tensions concerning Syria removed some of the safety bid, and treasury supply of tens today and 30’s tomorrow also weighed on the market.  Verizon deal is also in the mix, with reports of $100 billion in orders for the expected $49b multi tranche sale.  According to WSJ, “The demand for the debt has surprised even the banks selling the bonds…”
–NFIB small business optimism index improved marginally though the report said the survey indicates the economy is “going nowhere.”  JOLTS data also paints a tepid picture of the economy.  And on the home page of the Fed’s website there is a graph of the growth rate of total bank credit, in constant decline from Q4 2011 until now, with current level of only 0.9%.  http://www.federalreserve.gov/
–Headline on FT says “BOJ warns of need for wage increases”.  Dollar/yen appears to be breaking out to the upside of a large triangle and is now again above 100.  (target around 110).  While the devaluation of the yen has raised domestic inflation, increasing prices (for energy for example), presents a problem without corresponding wage gains.  JGB 10’s continue to yield just 72 bps.  And of course the weaker yen means Japan is exporting deflation…
–An item on Bloomberg notes that cities in Michigan are having trouble tapping the muni bond market due to Detroit’s issues.  In a related story, Puerto Rico GO bonds maturing in 2040 traded to yield over 10%…”The average yield was almost five percentage points above benchmark munis.”  The Illinois Policy Institute notes that unpaid bills in the state are expected to hit $8.1 billion in Q3, up from about $6 billion 2 1/2 years ago and that  “Illinois is required by law to pay interest of 1% a month on its unpaid bills, also called invoices, when they become more than 90 days old…” In today’s world of financial engineering, a plan presents itself:  Have Puerto Rico issue 10% 30 year munis, lend the proceeds to Illinois at 11%, and Illinois can pay off its old bills while saving 1% in financing costs…

Sept 10. Will austerity ever hit Illinois?

Here’s some excerpts from a Bloomberg article in Jan 2011, 2.75 years ago:

http://www.bloomberg.com/news/2011-01-12/illinois-governor-quinn-calls-67-increase-in-income-tax-crucial-to-state.html

Illinois Governor Pat Quinn will ask lawmakers next month to authorize an $8.75 billion bond sale to pay at least $6 billion in overdue bills.  ….Money reaped by raising the [income tax] rate to 5 percent from 3 percent is first dedicated to debt-service and payroll, Kraft said. There is not enough money from the tax increase to pay all vendors, which is why the borrowing is needed, Kraft said.

 

 

Now, in Q3 2013 the estimate for unpaid bills is $8.1 billion.  From the Illinois Policy Institute:  “Illinois is required by law to pay interest of 1% a month on its unpaid bills, also called invoices, when they become more than 90 days old.
According to the comptroller’s most recent numbers, Illinois paid $186 million in interest payments on its unpaid bills in fiscal year 2013. That’s 215 times the $866,000 in interest payments paid by the state in fiscal year 2003.. 

 

http://illinoispolicy.org/blog/blog.asp?ArticleSource=6062&utm_source=Illinois+Policy+Institute&utm_campaign=137200ea15-0615_HPP_pensions&utm_medium=email&utm_term=0_0f5a22f52c-137200ea15-11867909

 

Just as a note of comparison, Illinois pays $186 million a year in interest on unpaid bills, while Emanuel’s school closing program was expected to save $43 million a year and $560 million in ten years in lessened capital costs….call it $100 million a year.

Sept 9. Obama presses case against Syria on 9/11 anniversary

–Interest rate futures bounced on Friday’s employment data as NFP was only 169k with downward revisions to previous months, with a new 35 yr low in the labor participation rate. At the initial participation level, unemployment would be 10.8%.  At this rate we’re nearly a decade away from pre-recession employment.
–In terms of the continuing recovery, disquieting news is still prevalent.  For example, “in June, the number of households receiving foodstamps rose to 23.117 million, an increase of 45.9k in one month, and also a new record high.” (ZH)  The group hitting record employment levels are those over 55 (St L Fed), and I would suspect that this group mostly feel forced to take any job possible to cover overhead expenses.  In that regard, IBM is moving 110k retirees off its company health plan and giving them a payment for health insurance exchanges…”even big, well-capitalized employers aren’t likely to keep providing the once-common benefits as medical costs continue to rise.” (foxnews)  Big cities continue to have fiscal challenges, Philly needs to borrow $50m to pay school employees this year and a deal for Chicago to lease out Midway airport just fell through as the city doesn’t feel it’s getting enough. And while the housing recovery has been impressive, a graphic in the WSJ shows that Fannie, Freddie and other govt agencies issue well over 90% of new mortgages, indicative of a subsidy.
–That’s the longer term stuff, but this week of the 9/11 anniversary, geopolitical issues will dominate the news as Obama presses for military action against Syria, which appears increasingly unpopular both domestically and abroad.  Either way it represents a loss in presidential credibility, perhaps with ramifications on the debt ceiling, etc.
–While bonds rallied, the ten year yield only fell about 4 bps to 2.935, still fairly close to 3%.  As John Brady mentioned on BBG Friday, there’s a global pool of money out there searching for returns, and 3% starts to look pretty attractive.  Crude oil had a strong rally Friday and though down slightly this morning, at $110/bbl is still around the highs made since the spike in 2008 (the spike, by the way, that made a strong contribution to the financial crisis).

Sept 6. Payroll day

–Employment data today with nonfarms expected +175k, rate of 7.4, hourly earnings +0.2.  Rates continued to march higher with tens up 8 bps to 2.975. Near eurodollar calendar spreads hit new highs, with EDZ3/EDZ4 climbing above 1/2% to 54.5, up 6.5 on the day.  However, back spreads declined.  Green pack was weakest -13.125, blues -11.375 and golds -8.875.  5/30 treasury spread edged to a new recent low of 204.5. I recall late in 1994 tightening cycle that back spreads collapsed, I think it was reds to greens back then, after a 75 bp hike.  Now we’re getting the same cyclical move in the curve without the Fed ever having actually done ANYTHING.
–From the low just below 1.40 in July 2012 to current level of nearly 3%, ten year yield has more than doubled.  In the past 35 years there is only one instance of this: 1977 to early 1980, from 6.8 to 13.6%.  Honorable mention was a spike crisis low of 2.07 in late 2008, to a high of 3.95 in June of 2009.  The yield rise in 10’s in late 1993 to late 1994 went from 5.17 to 8.0 (associated with Mex peso devaluation and other financial dislocations).  The point is that financial conditions are tightening, and the market has little confidence that a new Fed can adhere to forward guidance.
–While straddle levels in eurodollars have swelled on this move, with the last red straddle again nearing 100bps (EDM5 98.625^ 95.5s), VIX edged a bit lower yesterday to only 15.6.
–While the back end of the curve flattened and selling pressure concentrated on greens, there was a notable new curve trade in options of 100k contracts.  Sold red midcurve Oct 9912/9950 strangle and bought blue Oct 9675/9650ps for credit of 1.5.  As of settle, the red put is 2.5 bps out of money, while blue is 23.5 out.

Sept 5. Five year note being gutted

–Relentless rise in yields continues as the five year note rose nearly 7 bps to 1.74.  Tens up nearly 5 bps to 289.5.  Five year note futures added 24k in open interest as there was a buyer of 50k FVX 118/117.5p spreads.  With FVZ closing just below 119, the upper strike is about 19 bps out of the money, suggesting a target of 2% in the 5 yr note yield.  5/30 continues to flatten on the bear move, down nearly 5 to just under 206.  In May, the 5 yr note was yielding around 64-65 bps,  In terms of the percentage increase in rates further out the curve, I would say that this has been an historic move, though major cracks have yet to surface.  In fact, auto sales have completely recovered to pre-crisis levels even though miles driven continue to decline, and the Beige Book mentioned that the rise in rates is spurring home buying in some districts to lock in relatively attractive funding rates.
–Kocherlakota suggested last night that the Fed needs to provide more accommodation.  ECB meeting today; Draghi is expected to lean against the recent rate rise and stress fragility of the recovery.  Russia and China are urging caution in US monetary policy as G20 meeting starts, warning of (further) spillover effects as policy tightens. Eurodollar calendar spreads are widening, with new highs in near one-year spreads.  Dec’13/Dec’14 settled at a new high 48, up 4.5 on the day.
–Besides the ECB, there is plenty of US news including ADP expected 177k, Jobless Claims 330k, Factory Orders -3.4% and Service ISM, 55 from 56 last.  Though the US population appears solidly against involvement in Syria, a Senate panel yesterday backed Obama’s plan for a limited strike.  The Fed’s transparency with regard to tapering has sparked a pre-emptive market adjustment that has likely taken Fed officials by surprise.  The process of transparency on the Syrian situation also allows for posturing before the fact which may similarly lead to unintended fallout, almost exactly 12 years after 9/11.

Sept 3. Relentless rise to higher yields

Sept 3.  Ten year posted a new high yield at 291 yesterday before easing back to close just under 285 (up 9 bps from Friday).  Option trade still leans heavily to put buying, with implied vol strengthening on the down trade.  Ten year inflation indexed note also gained about 9 bps from Friday, having now done a full round turn from a yield of around -70 bps in Q1 to +73 bps yesterday (chart attached).  As previously noted by many analysts the rise in real yields in the US has corresponded with a receding tide in emerging markets, and to paraphrase Warren Buffet, we now have discovered many bathers without swimsuits.  New low yesterday in Russian Ruble and in rupiah.  Turkey, Mexico, India, Brazil remain very weak.
–I saw a note yesterday that said a long term average in real yield is about 2%, which would indicate a long way to go for reversion.  However, US inflation levels still remain quite tame (according to official readings) and it’s far from clear that the US economy can weather a Syrian strike, the impact of higher funding costs on interest rate sensitive parts of the economy like housing, an equity market that has suddenly become less buoyant, and an emerging market meltdown.
–The only notable put seller yesterday was in FVV 117.75p, about 40k sold as new position (likely against other existing long puts) at 9-10.
–Today’s news includes Trade data and the Beige Book this afternoon.  Also a few fed speakers…

Sept 2. Bonds shorts are firmly in control

–From BBG: “Stocks climbed around the world and copper rallied as manufacturing in China and Europe expanded and prospects of an imminent strike on Syria faded. The yen weakened, bonds declined and crude oil fell for a third day.”  PMI data from the EU better than expected.  Dollar/yen has been moving sideways since April but now appears to favor breaking out above 100 (current 9925) as Fukushima continues to worsen.
–Obama’s decision to seek congressional approval for a Syrian attack has alleviated selling pressure on stocks and caused bonds to erase all gains from last week. Improving EU data also puts US bonds on the defensive going into nonfarm payrolls on Friday. (New two year high in UK gilt yield).
–New monthly low on Friday in 5/30 at 207 (and a couple lower yet this morning).  2/10 at 237 is around the midpoint of the recent range.  This morning EDZ6 trades 9715, so the huge buyer of blue dec and blue nov put condors with top strike of 9712.5 (25 wide) is close to being in the money.  Shorts maintain control of the market with the Fed poised to cede further ground as the FOMC tapering decision nears (FOMC Sept 18).  Indonesian rupiah near new lows underscores general weakness in EM due to the surge in real US rates and also pressures treasuries as UST reserves are sold for currency intervention.
–Shortened session due to US holiday.  Noon close (CST) for interest rates.

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.

  The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.