Sept 14. MBS new highs, but long end of treasury curve weaker
–FOMC announced open ended buying of $40b per month of MBS. With reinvestment of maturing issues and coupons, the total should be around $60b/month, against production of $80b. From Mortgage News Daily: “MBS Hit New All-Time Highs!…MBS can’t control their enthusiasm after the Fed announced MBS-Specific QE3 today, adding enough dedicated purchase money to the buy side each month to completely obviate any other buyers.” Surge of prepayments will shorten duration, leading to a steeper curve. Perhaps Japan will buy all US long treasuries as they struggle to hold down the yen vs the dollar…
–Gold and silver and oil and stocks all soared. Oct Crude right around $100 this morning, highest since May. High of the year was around $110 in March. My guess is that the domestic investor will shun the longer end of the treasury market because yields don’t cover (now increased) inflationary risks, which doesn’t mean that yields will rise, but it’s unlikely that they fall from here. The pledge to extend the period of low rates through mid-2015 locks the prices of the short end.
–For areas of underwater properties, this won’t help much. I suppose that on balance investors will be encouraged to buy to create rental units, given strong rents. In better areas, the market was already fine. My brother Aldo emphatically told me that rehab and new construction is blazing around Wicker Park and other hot areas of Chicago. The tract in the desert on the outskirts of Phoenix should have never been built anyway… I suppose it could also help employment to a degree as some construction guys are lured out of disablement and cash-only jobs. (With a month left in this fiscal year the govt spent $594.6b on social sec and disability, record 56.3 million people receiving benefits).
–News today includes CPI expected +0.6 with Core +0.2. Retail Sales +0.8. Ind Prod -0.1, Capacity 79.2. Oh, and a bond meltdown.
In: Eurodollar Options
Sept 12. Foreign policy issues looming larger?
–Financial Times: “German Court backs ESM bailout fund”. Barroso proposed a stronger european banking union giving the ECB more banking oversight. (Worked for the Fed, right?)
–Gold and silver are making new highs this morning with GCZ near 1750. Treasury yields are edging higher with tens now 1.75 vs 1.69 late yesterday. 10 yr note auction today. The euro is rallying, now over 129.
–1) US embassies in Egypt and Libya were mobbed yesterday, apparently the violence was much worse in Libya where at least one was killed. 2) The US, while not taking sides, urged China and Japan to resolve growing tensions over the Senkaku islands as China sent two patrol ships to the scene. 3) Obama won’t meet with Netanyahu when he’s here. The White House calls it a scheduling conflict, while the press calls it a snub. Three disparate foreign policy events which may appear minor, but could mushroom. It would be ironic if foreign policy became a bigger issue in the upcoming US election than the economy. A move by Israel against Iran is growing more likely…
–Three year auction saw record bid cover and a 33 bp yield. Tens and bonds might face a less welcome reception even though tomorrow’s FOMC announcement is widely expected to contain more cowbell.
In: Eurodollar Options
Sept 11.
–Small net changes in interest rate futures. AAPL had a reversal and closed down 2.6% so SPX closed lower. Today’s news includes 3 year auction, followed by tens and bonds on Wednesday and Thursday. There was a new buyer of 15k TYV 134c for 8 at the end of the day covered 132-25 to 25.5; Oct 133 straddle closed strong at 1’03. Vol bid in front of Thursday’s FOMC announcement? Not in dollars, October red midcurve 9962 straddle was sold 5k at 7.5. Breakeven on the Oct TY straddle is about 12.5 bps with 11 days to go vs 7.5 bps on EDZ13 with 32 days.
–Another $1T fiscal deficit for the US (though better than last year) with August awful at -$192B. According to Washington Times, Soc Security spending +6% and Medicare +4%. Long bond yield keeps looking as if it wants to surge higher, but can’t quite decide…weighing unsustainable fiscal trends against Federal Reserve monetization (which should ultimately be inflationary as well).
Below is about Chicago…just an aside.
–Chicago teachers strike is entering its second day. It’s amazing that agreement couldn’t be reached given that Obama is from Chicago, the mayor Rahm Emanuel was Obama’s Chief of Staff, and the Sec’y of Education Arne Duncan ran Chicago’s school system. According to press reports, one of the main sticking points isn’t money (the school board offered 16% raise over 4 yrs), but reliance on testing scores as a performance measure for teachers. The union contends that it’s unfair to teachers in impoverished areas, and I would have to say I’m sympathetic to that argument…cold and hungry kids that have bullets whizzing around them might not test well. (~350 murders in Chicago through August). I have to say that even I am surprised by some of the stats in these news articles:
(Reuters) More than 80 percent of Chicago students qualify for free lunches because they come from low-income households, and Chicago students have performed poorly compared with national averages on most reading, math and science tests.
Today, just 19 percent of the teaching force in Chicago is African American, down from 45 percent in 1995, the union says; organizers fear that shift means fewer teachers have deep roots in and passion for the communities where they work.
About 42 percent of the city’s 400,000 public school students are black and 87 percent are low-income, according to district figures.
http://www.reuters.com/article/2012/09/10/us-usa-chicago-schools-analysis-idUSBRE8890VS20120910
A Tale of Two Cities….
In: Eurodollar Options
Sept 10. Employment weaker than expected, but bonds close lower
–Unemployment report was a disappointment, with NFP up only 96k. Interest rate futures immediately erased morning losses and rallied to the highs, though not quite through contract highs made on Tuesday. However, the rally ran out of steam, especially at the long end, and by the end of the day the bond contract actually closed lower. Ten year yield fell only 1 bp to 1.66 while 30 yr was up 2 bps to 2.82. Red/gold pack spread fell 3.25 bps to 121.25 with golds +6, but eurodollar contracts beyond Dec’18 all closed lower.
–Gold (+35) and silver (+106) continued strong rallies as the prospect of QE was made clearer by the weak data, with prices further underpinned by european monetization. Since August GCZ has rallied from around 1600 to 1740, a run of nearly 9%. Silver was around 28 in Auguust, now up to 33.70, 20% jump in a month.
–The Fed is already absorbing the majority of longer dated treasury issuance, and will likely buy MBS. Credit standards have increased for mortgages, making MBS paper safer. Better credits have already refinanced or are able to buy homes. Since the gov’t owns the agencies anyways, wouldn’t it be much more stimulative to allow handcuffed homeowners to refinance at low rates?
–The ECB is going to target paper under three years. Chinese President Hu Jintao admitted that slowing exports are pressuring the economy and is pledging more fiscal stimulus. The Fed is the only one targeting longer rates, and the market appears ready to test whether that plan continues to lead to a flatter curve.
In: Eurodollar Options
Aug 31. Jax Hole. Bernanke vs Natasha, the genius chimp
Bernanke Jackson Hole speech today. Also Chicago PMI expected 53.0 from 53.7.
–Might as well lead off with something interesting rather than my bitter comments below.
http://www.huffingtonpost.com/2012/08/29/natasha-genius-chimp-intelligence-tests_n_1838963.html
(Story about Natasha, the genius chimp).
–I gather that the speech is supposed to outline policy guidelines…no real commitments. But as of yesterday’s close nearly all eurodollar calendar spreads are at their lows. Red/green euro$ pack spread is only 20 bps. Tens fell another 3 bps to 162. There was again heavy buying of green and blue September calls…2EU (green sept) 9950/9962 c spd was bought in size of about 40k for 1.5 (open interest -46k and -20k, so exit trade). 3EU (blue sept) 9925/9937cs bought for 1.5 40k, new. The front contracts are DEAD. In fact, total calls traded in the first 8 contracts, from Sept’12 to June’14, were less (at 54.5k) than 2EU 9950c alone (at 62k). No calls traded in red U,Z,or H.
–Persistent low rates and flat curve are likely to contribute to a zombie financial sector. The idea that open ended bond purchases will provide a shot of confidence to the business community is ludicrous. It may well be that when the music is playing, (paraphrasing Citi’s Chas Prince), that business will dance, but the minute the song dies out it’s over. Does anyone think that’s a path to permanent hiring? I think it’s more likely to spark a lingering fear of lost purchasing power. I actually got a splashy ad in my mailbox from the local bank offering a 2 yr CD at 1%. Great. So if I put my fake $100k in there, in one year I get $1000, perhaps enough to pay my real increase in property tax.
–Enjoy the labor day weekend. I will be out on Tuesday. In honor of the holiday Chicago Public School teachers are threatening to strike. Third largest system in the country. (Reuters) “Public schools CEO Jean-Claude Brizard has said that with a projected $3 billion deficit over the next three years, the school system cannot afford the raise the teachers want.” THREE BILLION OVER NEXT THREE YEARS! Maybe Bernanke will buy THOSE bonds. Even Natasha’s smart enough to know that’s the wrong strategy. Or at least she’s capable of learning it.
Aug 29. Spain closer to formally requesting aid?
–Extremely light volume Tuesday, with red euro$ contracts averaging about 60k and greens less than 50k. Not one contract month traded over 100k. Curve edged slightly lower. Red/gold near 120 is approaching this year’s low (107 in late July as opposed to over 200 in late March).
–From Draghi piece today in Die Zeit: “For fiscal policies, we need true oversight over national budgets. The consequences of misguided fiscal policies in a monetary union are too severe to remain self-policed.” Interesting that Draghi makes an appeal for unity in a German newspaper just before constitutional court ruling on ESM. Especially as Spain moves closer to formally requesting aid. Catalonia asked for aid from the national gov’t, and Reuters reports that in July nearly 5% of private deposits were withdrawn from Spain’s banks. Italy to auction E 7.5b 5’s and 10’s Thursday. If Spain asks for aid, then “true oversight” over its budget falls into place, and Draghi’s condition for bond buying is met…bullish for euro and bearish for long end of debt markets?
–In the US, Consumer Confidence slid yesterday. Today’s news includes Q2 GDP revision, expected up to 1.7 from 1.5, five yr note auction, and Beige Book.
–Zero Hedge reports that total US federal debt now stands at record $16T. Add in this: (Reuters) – America’s 50 state governments owe $4.19 trillion, including outstanding bonds, unfunded pension commitments and budget gaps, according to a new report. $20 trillion ( ! ) It’s a wonder that confidence remains so high in US debt markets…or is it just hope that Bernanke again signals unlimited support on Friday?
Aug 28. Bernanke Jax Hole address Friday; Dallas Fed paper notes limits on “ultra easy” policy
–Quiet Monday. Interest rate trades continue to be biased toward lower rates and a flatter curve following Fed minutes last week, and in front of Bernanke’s Jackson Hole address on Friday. For example there was a new buyer of 20k Gold Oct (4EV) 9850/9875/9900c fly for 4.5 (ref 9835.0). Red/gold pack spread eased to 124, down 3.375 bps. Ten year yield fell 3 bps to 165.
–Chicago Fed’s Evans unsurprisingly favors further immediate easing and unlimited bond buying, and would risk inflation up to 3%, on risks from Europe and the fiscal cliff. However, the Dallas Fed just released a paper noting unintended costs of unconventional easing, underscoring a rift within the Fed. http://www.dallasfed.org/assets/documents/institute/wpapers/2012/0126.pdf “The conclusion is that there are limits to what central banks can do.”
–ZeroHedge cites David Rosenberg on Core Capex (yoy 3 month moving avg) having moved into negative territory at -1.7%, often a precursor of recession.
–Crude oil fell yesterday as talk resurfaced about releasing supplies from the SPR, though it’s rebounding this morning.
–Today’s news includes Consumer Confidence expected 65.8 and Richmond Fed. Two yr auction today followed by 5’s and 7’s Wed and Thur.
–Just a couple of longer term thoughts about deleveraging in the US economy. From Flow of Funds Consumer Credit reports, the only true decline has been in Home Mortgages, which went from a peak of about 10.6T in 2008 to 9.75T now. Consumer Credit which peaked around 2.57T in 2008 is now near that level at 2.54T. Business debt is at record highs (11.9T). The real change of course has been in Fed’l Gov’t debt levels, which doubled from the first half of 2008, from 5.3T to 10.8T in Q1 2012. So a decline of less than 1T in household debt was “plugged” by 5.5T of gov’t debt, of which about 2T has ended up on the Fed’s balance sheet… Additionally, while it’s a positive that the Financial Obligation Ratio for households (debt service as % of Disp Pers Income) has fallen from 18.3 in 2008 to 16 now, it’s partially due to substitution effect of lower cost student loan debt for credit card debt, which may or may not be a long term positive.
August 27. “Turn” pressure on December euro$ contracts
–The Bundesbank’s Weidmann threw cold water once again on ECB plans to buy sovereign debt. (Reuters) …Weidmann, a former economic adviser to Merkel, said in a front-page interview in influential German magazine Der Spiegel that the bond buys could violate rules against the ECB providing outright financing to governments.
“Such a policy is for me close to state financing via the printing press,” Weidmann told Spiegel. “In democracies, it is parliaments and not central banks that should decide on such a comprehensive pooling of risks.”
–(BBG) “Premier Wen Jiabao said China needs targeted measures to promote steady export growth…” The question of course, is export to who? (especially now that Europe is imploding and the US lost the mortgage equity withdrawal piggy bank). It’s an admission that China is decelerating. (New lows in Shanghai Composite this morning).
–Reuters has an interesting article about Dexia, which was to sell its Dexia Luxembourg unit to a Qatari buyer. http://www.reuters.com/article/2012/08/25/us-dexia-capital-idUSBRE87O03O20120825 However, in order for the sale to go through, Dexia agreed to buy back the (hot potato) bond portfolio of the Lux arm, likely necessitating an additional public capital infusion, for the third time. You know who else had an “asset” that didn’t have value? Refco. And when that came to light the company closed and people went to jail. You know who else has assets that aren’t being carried at “value”? It’s just a wild guess on my part, but I would say a lot of european banks. Which the ECB wants to save. I think a wave of bank nationalizations will occur, maybe just idle speculation on my part.
–What is sort of interesting though, is a possible connection between ECB actions and the euro$ curve. As you can see from the attached euro$ butterfly spreadsheet, there is a bit of pressure on December eurodollar contracts. This used to be common in the old days due to end of the year funding demands…it was called the “turn”. There hasn’t really been turn pressure in a long time, perhaps ever since the Fed guaranteed to cap funding pressure over the turn of the millennium. However, if you look at the flies, it’s apparent that there is pressure on the EDZ’14 contract. (For example the 6 month fly starting EDZ14 is -10.5, while on either side of that contract they are -7.5 and -6.5). Why?? The only reason I can think of has to do with the ECB’s LTRO program (to save the banks with low, long term funding). Note that the initial 3 yr LTRO started in Dec 2011…with maturity dates on Jan 29, 2015 and Feb 26, 2015 (in the 3 month period priced by EDZ14). http://www.ecb.int/press/pr/date/2011/html/pr111208_1.en.html Is the market pricing in funding pressure for the maturity of these periods? It looks like it to me. Of course, it’s also the end of the Fed’s vow to keep low US rates until late 2014 (currently). And while there is a degree on pressure priced into the euribor curve on ERZ14, it’s not as noticeable as it is in dollars.
–NOTE: I probably haven’t done enough groundwork on the idea of this being related to the LTRO’s to put it out. I may be completely off base. Any comments are appreciated.
Aug 13. Possible tipping point in long treasuries?
–Rates drifted slightly lower Friday and the curve edged flatter, with tens down 4.5 bps to 164.5. Economic news is light today, with PPI and Retail Sales Tuesday.
–Implied vol was hit. Notably there was a seller of about 6k Blue Sept (3EU) 9900^ from 19.5 to 18.0 (new position). On Thursday this straddle was more like 21, and he sold those too. There is an existing long position of 50k 3EU 9875/9850 and 9862/9850 put spread from 4.0 (long both) so if it is the same player the downside is protected.
–Though treasuries bounced from the worst levels of the week, price action is still suspect. We know that the Fed is the main buyer of long treasuries, and going into the election there probably isn’t the political will to announce a massive new QE. We’re losing the major buyer. At the same time, Draghi said his focus would be on the short end, and that he is concerned about the transmission mechanism. The monetary transmission mechanism is broken for a simple reason. It’s like taking a guy who’s been stranded in the desert and feeding him nothing but chocolate cake and wondering why he doesn’t look any better. Corn syrup monetary policy. I believe we’re at a point where the market could suddenly lose confidence in the long end of the US. And perhaps Romney’s choice of Paul Ryan as running mate will bring unsustainable US fiscal policy into sharper focus…possible tipping point?
August 10, 2012. Beware a steepening curve.
–Corn made a new high in front of today’s USDA report, with good buying in CZ 900c by JPM.
–Interest rate futures made new lows in front of the 30 yr auction, but selling pressure abated upon completion and the market drifted higher. Implied vol eased as new lows were rejected.
–August midcurve option expiration in dollars.
–There are several new warnings about risk in the long end of the curve. From Pimco’s El-Erian (BBG) “What we would caution is rather than the level of the rates, the shape of the curve,” El-Erian said. “The long end is exposed to a lot more risk.” From Elliott Mgmt: “long-term government debt of the U.S., U.K., Europe and Japan probably will be the worst-performing asset class over the next ten to twenty years. We make this recommendation to our friends: if you own such debt, sell it now. You’ve had a great ride, don’t press your luck. From here it is basically all risk, with very little reward.” http://www.zerohedge.com/news/elliott-management-we-make-recommendation-our-friends-if-you-own-us-debt-sell-it-now
–I marked 2/10 at 142, a new recent high.
–Pension and health care costs continue to plague muni finance, but zero rates tend to pressure investment returns lower across the spectrum, creating a negative spiral in that pension funds that can’t hope to meet targets, so belt tightening occurs in other parts of the budget.
–President Obama, touting gov’t assistance for the auto industry: “I said, I believe in American workers, I believe in this American industry, and now the American auto industry has come roaring back,” he said. “Now I want to do the same thing with manufacturing jobs, not just in the auto industry, but in every industry.” Note: GM stock was around 40 in the beginning of 2011, now around 20. As I recall pension and health costs were shifted to the union, and the fact that the US gov’t is a big customer and regular buyers are being financed by Ally/GMAC at ever lower rates isn’t exactly the foundation for continued strength. (From Fed website, 48-mo new car loan rate has gone from 5.40 in Q4’11 to 5.07 in Q1’12 to 4.87 in Q2’12).
