June 13. When gov’t policies backfire: Japan
–Japan taking center stage again as Nikkei falls 6% and USD/JPY dipped below 94. But the turmoil sparked by Abenomics isn’t limited to Japan, it has also spilled into emerging markets. Indonesia hiked rates to stem the slide of the rupiah, Brazil again cut a financial transaction tax to help support the real, India and Thailand have been selling dollars. Reminiscent of the 1997/98 Asian crisis? Of course, there is no longer a Long Term Capital that can bring the entire global financial architecture down with the loss of $5 billion. Quaint by today’s standards. However, one large fund has released traders this week due to poor performance…
–Though treasuries weakened into the close in the wake of the ten year auction, shaky equity markets will likely cause safe haven flows into fixed income. 30 year bond auction today. Other economic news includes Jobless Claims, expected 350k, and Retail Sales expected +0.5.
–New highs yesterday in some of the one year eurodollar calendar spreads. EDU13/U14 up to 29, Dec/Dec to 34.5 and March/March to 41. The market has pushed forward the timeframe of less Fed accommodation. In the beginning of May Dec/Dec was as low as 12.
–FOMC next week. I am pretty sure the statement regarding change in QE won’t be altered from last time… ” The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” But as the budget deficit declines due to increased tax revenue, there is reduced need to issue bonds so the Fed becomes a larger percentage buyer of net issuance.
June 12. Bond yields spike, then close lower…
–Turnaround Tuesday as interest rate futures spiked to new lows in the morning and then rallied to close higher. There was a brief pullback after the 3 yr auction, but it was around that time that news reports surfaced about Japan’s FSA proposing to have investors “bail-in” banks in case of problems. Japan FSA plans to adopt bail-in policy for failing banks, to force losses on investors if necessary – Nikkei News The yen surged and US treasuries finally turned positive. (USD/JPY was down 2.8% on the day).
–Ten year note closed just above 219, down 2 bps on the day, but had traded over 229 in the morning. The curve flattened with red/gold euro$ pack spread down by over 4 bps to just above 200 (above 210 in the morning). Ten year auction today.
–There has been a lot of press about emerging market volatility in the past week. Indeed, the emerging market etf (EEM) has fallen over 10% in the past month. Reuters posts this story: “If currency turbulence in emerging markets escalates into full-scale investor flight, the Federal Reserve may have a fresh headache in deciding when to slow its dollar printing policy.” http://www.reuters.com/article/2013/06/12/us-investment-emerging-fed-analysis-idUSBRE95B04B20130612
–I believe that Japanese policy of importing inflation and exporting deflation has more to do with market turmoil than decisions out of the Fed, and that the ten year inflation index note yield moving from negative 20 or so to positive 6 bps is a reflection of declining US inflation expectations. Next week’s FOMC will likely highlight disinflationary concerns.
June 11. Negative convexity pressure in the face of falling inflation
–US interest rates continue to rise with tens up 5.5 bps to 221.5 as of Friday pit session close, now 2.25. Bullard made comments yesterday that low inflation could prolong QE, and indeed ten yr treasury to tip spread made a new low just under 215. However, all eurodollar calendar spreads made new highs, with red/gold pack spread (up 5.75 to just under 205) surpassing the peak made in March 2012 when ten yr treasury yield rose above 240. Also worth noting is that near Fed Fund contracts are edging to new highs, with FFM now 99.91 or 9 bps.
–Some large moves overnight as BOJ left policy unchanged. USD/JPY much lower, currently 9702 or down 1.76%, having been as low as 9646. New lows for the move in Aussie and in Mexican Peso. ESM (mini SP) is in the process of erasing Friday’s rally.
–Treasury auctions kick off with three year today. NFIB small business optimism also on tap, expected 92.3 which remains in dismal territory.
–Midcurve options expire Friday, with all June contracts now having dropped below important strikes: EDM14 just under 9950, EDM15 under 9900, EDM16 just below 9825 and EDM17 just under 9750. Those who are short puts have to decide whether to cover or sell futures in the hole. For example, EDM16 has already fallen over 75 bps since the high set in the beginning of May…same problem faced by MBS portfolios.
June 10. Fundamental economic picture diverges with bond market technicals
–Friday’s reaction to unemployment underscored the sentiment shift in the bond market as the ten year note jumped 9 bps to nearly 217. NFP was about as expected though some aspects of the report were weak, including wage growth (avg hourly earnings up 0.0). However, all back month eurodollar calendar spreads made new highs; red/gold pack spread gained over 10.5 bps to reach 199, just below the highs set in March ’12.
–In my opinion, the economy is again slowing and inflation is declining, apparent in sev’l economic reports but also on display in markets like silver, which is trading at its lowest level in 14 sessions and nearing spike lows from mid-April and May. However, when the fundamental outlook is at odds with market technicals, it’s best to go with the latter. A couple of analysts have noted that ten year yields around 2.20-2.25 could unleash forced selling related to MBS convexity issues.
–Data from the weekend exposed weakness in China’s trade… (RTRS) ” Exports to the United States, China’s top export destination, fell 1.6 percent in May, the third straight month of declines, while those to the European Union, the second most important market, fell 9.7 percent, also the third straight month of declines.” Conversely, Q1 GDP in Japan was revised higher. Japan’s strategy of importing inflation and exporting deflation has worked so far, in part at the expense of other Asian exporters.
–This week features treasury auctions of 3’s, 10’s and 30 yr bonds. June midcurve options expire Friday. FOMC is next week.
June 7. Payroll day. Yen surge
–Obama vowed to run history’s most transparent administration. We just didn’t know he meant private citizens’ phone calls, texts, financial records, internet communications would be made transparent to the gov’t… Is that part of the reason the dollar was crushed like an errant protester yesterday? Euro surged to its highest level in three months. Yen exploded higher, apparently blowing through large stops, and is higher this morning. USD/JPY had been near 104 in the middle of last month, now around 96. Everything has been correlated to the yen, including US equities. However, stocks staged a furious late day rally from new recent lows and closed higher. Weak growth means that the QE gravy train keeps on rolling, right?
–Nonfarm payrolls today expected +170k. But with euro$ vol smackdown seen the last two sessions, it’s hard to conclude that the big players are afraid of a big jump in interest rates associated with an upside surprise in NFP. For example, EDM4 9950 straddle was 32 in the early part of the week, now 28.5. Longest dated EDH6 9862 straddle was 109.5, settled 105 yesterday. However, colleague Art Main noted (citing CMEgroup Dave Reif) “As of last night we have a new record OI in the Weekly Treasury Options, 257,249. Most of the OI is in the Week 1 Ten Year and Week 1 Bond which all expire tomorrow June 7 after the Non-Farm Payroll report. …No huge put/call biases going into this number however there is greater open interest in Out of the money strikes than we would typically see.”
June 6. Both inflation spreads and labor data suggest delay in tapering
–Such is the concern that income from the “wealth effect” must be “created” to keep the economy improving, that the merest hint of a correction sends yields lower. Tens fell 4 bps to 209.5. Of course, data this week did nothing to convince policy makers that we’ve hit escape velocity, with ISM below 50 (49) and the employment component in non-mfg ISM the lowest of the year at 50.1…it started Jan at 57.5 and has declined every single month. If income isn’t being manufactured thru stocks then we have to hire fewer burger flippers, manicurists, etc…the trickle down effect. Beige report described the economy as modest to moderate. ADP was weak as well, now it’s all about payrolls tomorrow.
–There were some large put sales in EDM4 (20k 95p, new) and EDU4 (10k 93p) on blocks, but straddles settled a bit lower than one can attribute to these sales. For example, EDH6 9862^, the longest dated, had been bought up to 110 earlier in the week, was 109 bid in the morning, but settled 106.5. The second that buyers lose their appetite, market makers are happy to mark down their short inventory.
–Again, I’m not even sure why I keep watching this, but I marked a new low for this calendar year in ten year vs tip spread at 220. The first quarter this spread was mostly 250-260. If this spread does have bearing on inflation expectations, then the trend would suggest that QE tapering is a ways off.
June 3. Hindenburg omen for stocks, support for treasuries?
–There was record volume in interest rate futures Friday as the ten year note yield rose 4.5 bps to nearly 217 (at 2:00pm floor close). As the floor session for interest rates was closing, stocks began to sell off, in part due to index rebalancing, and TY rallied half a point to the 129.5 strike. The ugly close in stocks may provide some support for fixed income this week. In the last hour ESM plunged 20 handles to 1626.25 low. Several sources cite an appearance of the Hindenburg omen, a possible crash signal. http://www.businessinsider.com/the-hindenburg-omen-has-appeared-2013-5
–US stocks may also take their cue from the Nikkei; the futures index started May at 13750, rallied 16% to 16000, but collapsed in the last six sessions to close around 13450.
–In spite of extraordinary volume, open interest was down across the treasury complex, with fives -58k, tens -35k, bonds -26k (mostly due to roll, but still somewhat significant). Total OI in euro$’s was up 60k.
–Implied vol is rising. When ten year yield hit 2.40 in March 2012, TY vol spiked to 6.75, vs around 5.5 now. There is some talk that the 2.20 yield forces MBS negative convexity hedging, which seems apparent from trade action. It may be a more active June than usual, as the middle of the month has FOMC with press conference (19th) and a G8 meeting (17th-18th). This Friday employment data is released (to the general public). Obama will learn about it from watching newscasts. Today’s news includes PMI and ISM, expected 51 from 50.7. Fed’s Williams speaks.
–The curve steepened, with nearly all euro$ calendar spreads making new highs. Red/gold pack spread up nearly 7 bps to 195.75. (High last in March ’12 was around 200 corresponding with 2.40 in tens and 3.50 in bonds). I marked 2/10 at 186.
–I am not sure how to assess the importance of the following, but ZeroHedge and BBG ran stories on Sallie Mae’s plan to split the company in two, sort of a good bank/bad bank deal, with current bondholders secured by the bad bank. Sallie is the student loan agency; SLM 10 year paper sold off several points to yield 6.02% on the news. The bad bank will have the servicing rights to gov’t guaranteed loans (slow or no growth) and also the current unsecured loan portfolio, while the “good” part is going to focus on making higher yielding (>10%) private loans. Ratings agencies downgraded the debt. The takeaway for me is that the BELL HAS RUNG for the “reach for yield” mentality. Currently there is $1T student debt, $850B guaranteed by gov’t. Again this year in July, the rate for gov’t student loans is set to double from 3.4% to 6.8%. The administration has proposed a plan of market rates plus 0.93 spread, or currently around 3.1% given the ten year, fixed over the life of the loan. The House plan is the ten year plus 2.5% and floats every year. Certainly there will be another “last minute” save, but the market action and downgrade of Sallie bonds is indicative of a large gov’t subsidy (given delinquency rates), and perhaps another sign that government (whether the Fed or the administration) setting of rates is likely to eventually cause problems.
http://www.zerohedge.com/news/2013-05-31/will-sallie-maes-break-end-cov-lite-cravings
http://www.bloomberg.com/news/2013-05-31/sallie-mae-split-marks-bet-on-much-abused-private-student-loans.html
http://www.reuters.com/article/2013/05/31/usa-studentloans-obama-idUSL2N0EC13120130531
May 31. The month has seen a sentiment shift toward less Fed accommodation.
–Starting the day, and ending the month, with some weakness in stock index futures (ESM -12) as dollar/yen drifts lower (100.45). Interest rate futures are continuing their bounce from Wednesday’s plunge.
–Interestingly the long dated Green (third year) straddles remain very well bid, closing slightly higher on the day in spite of treasury vol selling. In the same spirit, red/green eurodollar pack spead edged higher with green/blue slightly lower. In my opinion, it’s a curve sentiment shift forward for the Fed to remove accommodation in 2015, rather than further out. In the beginning of May, red/grn pack was around 28 vs 52 in green/blue, so the former spread was about 53% of the latter. That ratio has now moved close to 70%, 48.25s red/grn and 70.5s grn/blue.
–Today’s news includes Personal Income +0.1 with Spending 0.0 and PCE Price Index expected -0.2. Chicago PMI 50 (from 49 last). Consumer Sentiment 83.7.
–From BBG: “Alcoa Cut to Junk by Moody’s as Aluminum Price Declines”. Also, India GDP growth still sluggish, below 5% as emerging market economies fail to provide much of a spark for global growth.
May 30. Abenomics continues to provide volatility, Nikkei -5%
–After an early plunge, US interest rate futures came back to close nearly unchanged. Ten year yield ended just above 212, having tested 220 early in the day. Red eurodollars were the weakest at settlement, down 2.5 bps, while golds closed up a similar amount (+2.375). While there is still a lot of put buying, the flatter curve may indicate that the rate flush has been stanched for now. Total open interest in ED was -164k, though TY added 46k.
–Implied vol exploded. TYU 129.5 straddle closed 235 on Tuesday but 245 yesterday with futures little changed. EDH15 settled -2.5 at 9926.5; atm calls were unchanged. Long dated green straddles were up 2.5 bps. Near calendar spreads made new highs as the market pushes forward the timing for Fed exit. For example EDZ13/EDZ14 was 11.5/12 in the beginning of the month, now 26, having gained 1.5 yesterday.
–Japan’s stocks fell 5% as Abenomics stokes volatility in financial markets. Brazil yesterday raised rates more than expected to 8% to fight inflation, in spite of sluggish growth. Inflation is just over 6.5%, the top of the band. Quite a contrast between the two countries, one would be tempted to think GDP growth in Brazil is much larger, but Q1 was 3.5 (annualized) in Japan and 0.60 for the quarter in Brazil.
–Revision of US GDP expected unchanged from previous 2.5. Jobless Claims expected 340k. Seven year auction.
May 29. US yields jump on heavy volume
–Huge jump in US rates yesterday with tens up 12.5 bps to 213, and up to 217 shortly after close of open outcry. Now at 219 as JGB’s also rose in yield to 93. Bruce Krasting had a piece [Bond Vortex…] which suggested a lot of negative convexity hedging would come into play around 220 yield; it’s now there. http://brucekrasting.com/bond-vortex-in-the-works/
–The point is that market movements in this environment won’t be driven by economic data, but rather by position adjustments, some of which are forced. The last time yields were this high, including 5’s being above 1%, was in April 2012. It was in March of 2012 that tens hit 240, and there is a previous high there as well from October 2011. According to my calculations TYM would be around the 128 strike (or just slightly above) at 240. Five year auction today, followed by 7’s tomorrow.
–All euro$ calendar spreads made new highs. Volume was heavy. There had been substantial buying in several spreads in the past few weeks, for example EDM15/EDM16 around 47-48, now trades 68. From the highs at the beginning of the month, EDM6 has dropped 60 bps (from 9903.5 to 9843). Red/gold pack spread is now around 200, which had been the high in March 2012 (202/203). Straddles exploded higher. On a more mechanical note, it’s worth noting that some of the interest rate market making groups have pulled back, and there are generally fewer people on the floor. The “request for quote” function on the screen didn’t seem to be updating quickly either. Trading bottlenecks are likely to occur…
