July 9. Eminence Front, or eminent domain….
The news slows
People forget
The shares crash, hopes are dashed
People forget
Forget they’re hiding. (Eminence Front Lyrics-Who)
Friday’s trades continue to be geared to lower rates in a sluggish economic environment. For example, gold Sept (4EU, EDU’16 underlying) 9825/9837/9850/9862 call condor (4.0s) WITH gold Dec 9850/9862/9875/9887c cond (3.25s) were bought in total 40k…some in pit for package price of 7.0, new positions. TUU 110-08c were bought in size of 16k, mostly covered (straddle settled 11.5, I calculate straddle price about 8.25 bps).
–Ten year yield closed 1.54, down 6 bps on the day. All back month calendar spreads closed at new low settles. FOMC statements say fed funds will remain low at least through late 2014…Sept14/Sept15 one year calendar spread closed at a new recent low of 37 or 3/8%. The market has pushed the point of expected tightening further and further out the curve. A spread of 37 barely acknowledges the chance of tighter policy.
–This week brings 3,10, 30 year auctions in the US (Tues,Wed,Thur) and FOMC minutes on Wednesday.
–This is pretty amazing, from MSN.com: “Instead of tearing down property, California’s San Bernardino County and two of its largest cities, Ontario and Fontana, want to put eminent domain to an unorthodox use to keep people in their homes… The municipalities, about 45 minutes east of Los Angeles, would acquire underwater mortgages from investors and cut the loan principal to match the current property value. Then they would resell the reduced mortgages to new investors.
In 1984, the U.S. Supreme Court upheld Hawaii’s use of eminent domain to transfer residential tracts of land to renters to break up a landownership oligopoly and stabilize home prices. In 2005, the court affirmed a Connecticut town’s right to use eminent domain to transfer nonblighted homes to a private developer to spur redevelopment. That spurred several states to pass laws restricting these powers.” MSN.com
–Here is a link on Bloomberg that describes the same thing: http://www.bloomberg.com/news/2012-06-28/eminent-domain-is-bad-ploy-for-underwater-mortgages.html
–My understanding of eminent domain is that the gov’t must pay fair value for the property. But fair value may be substantially less than entities are holding paper on their books…
July 3.
–ISM was a large miss, expected 52 but actual was only 49.7, indicating mfg contraction. New Orders component collapsed (worst since just after 9/11 according to Business Insider), and prices were weak. Even though equities didn’t decline, the message from interest rate futures is quite clear, a slowing, stagnant economy. Ten year yield fell back to 1.58, down 7 bps. The curve flattened, more than reversing the bounce after late last week’s european deal to expand the ESM’s bailout role. Red/gold pack spread fell over 7.5 bps to 121. There was continued selling of TYU premium. TYU2 131/136 strangles sold 20k on block trades at 26 and 27 (adding to short, total position ~45k), forecasting a tight range in the ten year yield over the near term.
–CBS ran a story about explosive growth in disability benefits being paid in the US, From CBS News: “In May of this year, there were 142,287,000 people employed, and 8,707,185 workers taking federal disability payments. That equaled 1 worker taking disability payments for each 16.3 people working.” (In 1992 it was 1 per 35 workers). http://cnsnews.com/news/article/8733461-workers-federal-disability-exceed-population-new-york-city
–From ZeroHedge: As of the last day of June, the US had a record $15,856,367,214,324.44 in debt, a $75 billion increase overnight, and a post World-War II high Federal debt/GDP ratio of 101.5%.
June 29. Italy defeats Germany in soccer; Merkel retreats on all fronts
–Germany’s loss to Italy caused Merkel to lose her bearings. Europe agreed to a deal to help fund Spain’s banks (and Italy, and Ireland) which sent euro soaring, along with other risk assets. EUR was up to 126 (from 124.36 close in ECU2). Crude oil and silver, leaders on the way down, have had modest bounces while copper and stocks are seeing more powerful upside moves. From Reuters: “…European Stability Mechanism, would be able to lend directly to recapitalize banks without increasing a country’s budget deficit, and without preferential seniority status.” And “…European Central Bank to break the “vicious circle” of dependence between banks and sovereign governments.”
–In my opinion, this actually strengthens the linkage between banks and gov’ts, especially since banks were encouraged to buy sovereign debt funded by LTROs. Also, the ESM is not being increased, so the euphoria may be short-lived.
–Curve was much flatter yesterday but is steepening this morning on european announcement. Ten year yield fell 4 bps to 1.58 yesterday, but has jumped back up to 1.63 this morning. US news today includes several Fed speakers, Personal Income and Spending (expected +0.3 and 0.0) and Chicago PMI, expected 53.1 from 52.7.
–(dailycaller.com) “According to the USDA, greater food stamp usage can be an economic plus for states and communities. “Every $5 in new SNAP benefits generates $9.20 in an additional community spending,” the USDA contends in their outreach guidance. “If the national participation rate rose five percentage points, 1.9 million more low-income people would have an additional $1.3 billion in benefits per year to use to purchase healthy food and $2.5 billion total in new economic activity would be generated nationwide.” Zerohedge also covered this story: “Wal-Mart gets as much as 25% to 40% of revenue at some stores from food stamp dollars.”
June 27. Ants and grasshoppers
–In the grand scheme of things risk assets aren’t bouncing. Oil remains near its low following deep losses in the past two months. Gold and silver, which bounced higher Monday, gave those gains back yesterday. Copper is grinding lower and the euro remains under pressure. Grains are an exception, having surged higher in June. All of the liquidity inspired gains seen in metals, emerging market stocks, metals, etc, in the first three months or so of the year, have evaporated in the last two and a half months. Odds are that the next three months see even lower prices as deflationary psychology takes hold.
–Merkel said Europe would not share total debt liability “as long as I live”, The overwhelming theme that continues to course though global economies is how to share responsibility for vast public debts (that have in part been transferred from the private sector) and future commitments (health/pensions). In the US, Obama says the wealthy should contribute their “fair share”. Germany isn’t buying into that argument. On a smaller scale, the end result is Stockton, CA, which just declared bankruptcy…”suffering the combined effects of fiscal mismanagement over two decades, too much debt taken on in good times and generous pay and unsustainable benefits for city employees and retirees.”(Reuters). The global political gridlock caused by the ants (industrious savers) not wanting to bear more of the burden of their less industrious neighbors the grasshoppers, (over consuming, live for today) has cast a long shadow over economic performance as uncertainties about the strength of previously made promises grow. The result has been a larger role for central bankers/monetary policy, to “solve” these problems. But increased liquidity measures are losing their magic… as evidenced by the money driven sugar high in the first quarter that has reversed in Q2.
–Implied vol continues to contract in US rates as aggressive selling in TY strangles continues. TYU 131/136 strangle was sold from 39 to 36 on Monday, and yesterday another 7k were sold at 31 (20% decline in 2 days!) Also TYQ (august) 132/134.5 strangle was sold about 8k at 37.
June 22. The longest day (for long option holders in US rate futures)
–Risk assets look shaky as deflationary impulses continue. Crude oil has been the leader to the downside falling another 325 to just about $78/bbl, a remarkable plunge of over 25% since the beginning of May! Gold fell $50, and silver is fast on the heels of oil, threatening important lows from the end of May, as is copper, which is down about 14% since May 1. SPU was down 32, but equities have held in relatively well considering the carnage in other markets.
–Adding to the bad news that streams out of the european crisis, Moody’s downgraded banks, and US data keeps underperforming, with Job Claims nearing 400k again (387k yesterday) and Philly Fed -16.6 vs expected 0.
–Net change in US interest rates was small, though the curve was flatter with red/gold pack spread -5.5 bps. 2/10 treasury spread down 2 at 131.
–The real action was an implosion of implied vol in US rates. Last week TYU at the money straddle was 2’50, yesterday the 133.5 straddle settled 2’17. Eurodollar straddles were hammered as market makers dropped their bids following inaction by the FOMC. With three months to go, EDU2 9950 straddle fell 1.5 bps to 9.5. Red midcurve straddles were down 1.5 to 2 bps on long liquidation, for example EOH 9937 traded 27.5 the past few days, but settled 25.5 yesterday. Looks like the CBOE decision to start a volatility contract on interest rates (10 year swap) killed it.
–July treasury options expire today.
June 20. German rates now converging higher to meet peripherals…
– “When a management with a reputation of brilliance tackles a business with a reputation for bad economics, it is the reputation of the BUSINESS that remains intact.” – Warren Buffett
–Germany has a reputation for low inflation and monetary discipline. Peripheral countries are seen at the other end of the spectrum. There were several stories circulating yesterday that Merkel’s resistance to German support for the EFSF was fading, i.e. that Germany was preparing to tackle the bad economics of the south. Whether true or not, the market seized the idea and ran with it by pushing German yields significantly higher. Bunds were lower by 1 1/4 points, to levels not seen since mid-May. This trade already had legs: since the low yield on June 1 of 1.17, the bund yield has jumped to 1.53 as of yesterday. [1.63 this morning, 20-June]. No worries though, there are also plans to outlaw ratings agencies, so no one is likely to notice further financial deterioration. (Unless they watch bond yields).
–FOMC announcement at 12:30 EST, followed by new economic projections and a press conference. Trade in interest rate futures yesterday was dominated by call buying on EDU12 underlying, mostly of the 99.625 strike. Clearly the market expects the Fed to do SOMETHING, even though its efforts at lowering unemployment have run out of steam. On the longer end of the US curve, rates edged higher. Tens rose 3 bps to 1.62 as US stocks rallied, lured by the sirens call of endless liquidity.
June 19, 2012. Is this problem the Fed’s to solve?
Going into the FOMC announcement tomorrow, one can be forgiven for asking WHY the Fed needs to do something. Corporate profits are at a record high of GDP. Cash hoards at corporations are regularly noted in the financial press. SPX is as high as it has been for three years and is less than 5% below its recent high. Consumption as a percent of GDP is near record levels, even after the supposed “deleveraging” and housing bust. [I suspect it is within this context that Obama said the ‘private sector is doing fine’] Ten year treasury yield is around 1.60%. If it’s not broke, don’t fix it?
This panel shows SPX. Not exactly a dire picture.
The panels below are derived from St Louis Fed data. The first is Corporate Profits as a percent of GDP. Over 12% and rising. The second panel below shows Personal Spending as a percent of GDP, higher than it has been for most of the past decade, in fact near the highest it has ever been. Do either of these graphs indicate stress that needs to be addressed?
The concerns about financial stress are due to the interconnected health of the global banking system. The true US economic stress that the Fed keeps pointing to, perhaps rightly so, is the elevated unemployment rate. But at this point, is that a problem that needs to be addressed by monetary policy?
We know that the velocity of money has collapsed as the monetary base has exploded. The money simply isn’t flowing through the economy.
Zerohedge ran a piece citing Goldman’s belief that furhter accommodation will be undertaken by the Fed at this meeting. http://www.zerohedge.com/news/part-its-new-qe-qa-goldman-warns-possibility-50-75-billion-flow-program
One course of action that GS mentions is the possibility of extending the period that the Fed vows to keep rates low for ANOTHER three years. This idea, (and several others in the piece and the financial press in general), completely dismisses the federal government as an agent of change that might influence employment trends. We know that currently the Fedl Gov’t spends $1.50 for every $1.00 of tax revenue collected. Is that one of the factors causing business hiring restraint? Is it that far-fetched that a new administration could be elected and change the trajectory of business confidence regarding certainty of regulation/taxes and therefore the propensity to hire?
I’m sure the Fed will take Goldman’s ‘advice’ and attempt additional monetary ease. I’m just not sure that it matters.
June 18, 2012. Greek election gives euro short term boost
Not much change after Greek election, which eased fears of an immediate euro exit. EUR/USD rallied modestly, now above 127 having surpassed the high of the “Spanish bailout”. Underlying problems still remain, with markets now looking to Wednesday’s FOMC announcement to provide more accommodation. [Euro subsequently gave away all gains, currently 125.90 at 9:40 EST]
–In terms of global GDP share, the US is just under 25%, the eurozone is about the same, and China combined with Japan are probably just over 20%. China’s exports are nearly 40% of GDP and Germany is around 36%. Is it a surprise that export growth isn’t sparking a global recovery when nearly 3/4 of global GDP is comprised of heavily indebted economies? Perhaps China isn’t choked by debt, but the bulk of its growth came from US demand for trinkets as home prices rose and mortgage withdrawals spurred excessive demand. And now China is mired in its own problems, for example, Bloomberg just ran this story: “China’s home values fell in a record 54 of 70 cities tracked by the government in May as developers cut prices to boost sales amid housing curbs.”
–With the ten year note below 1.60% (closed Friday at 1.58), additional QE probably won’t have much of an impact. Near eurodollar contracts rallied sharply Friday, converging to the current 3 month libor rate, which has been just under 47 bps (~99.53) all month. EDH’13 is only 7 bps away at 9946.
June 7. Bernanke before Congress…Yellen sketches the outline for BB to color in
–Bernanke speaks before Congress on the economy today.
–Equity markets were cheered yesterday as WSJ’s Hilsenrath broke the story that the Fed was considering further easing, articulated last evening by Janet Yellen who advocated more support for the economy through balance sheet actions. Another positive factor was a rumored plan for Germany to provide aid to Spain’s banks. So the stage is set for BB to save the world with monetary policy (yet gold is lower this morning, somehow having given up all of yesterday’s gain). All this in spite of a Beige Book that painted a picture of a growing economy.
–The back end of the curve fell, with tens up 9 bps to 1.65%. Red/gold pack spread surged 9.5. The curve steepens as the Fed considers more bond buying; the market knows it’s all about keeping stocks up. It’s really quite amazing that at record low yields the central bank wants to add to its bond holdings to help stocks, while corporate profits are already at a RECORD percent of GDP (which should be a compelling factor in stock market valuation). Perhaps the Fed should simply be an unlimited seller of 1.75% strike puts on the ten year and abandon the promise of low rates at the front end.
–I saw a couple of clips this morning about widening indications of weakness in China, including lower steel consumption and channel stuffing of auto dealer inventories. (Yet another problem that can be helped with easier US monetary policy in the eyes of our chairman).
–With just over one week to go, midcurve red June 9937 straddle is 6. With three months to go, the Sept midcurve settled yesterday at 14.5. Decay of only 8 bps over three months…
June 4. Negative feedback loop
–After Friday’s dismal economic data with NFP at only 69k, less than half of what was expected, and soft ISM at 53.5, I can pretty much just write the same thing as I wrote after Thursday’s session: yields plunged, curve flattened to new lows. But the absolute levels still leave me slack-jawed. Ten year yield dropped another 11 bps to 1.47%. 2/10 treasury spread sank 10 bps to 122. The last time 10’s were this low was in April 1946 with a yield of 1.54%, after the conclusion of wrenching global conflict leading to a new world order, rather than what appears to be the cusp of global shifts currently.
–Eurodollar spreads imploded, with red/green pack spread at merely 16 bps and red/gold only 107. Fed funds contracts are essentially the same price for the next year out to May 2013, 9984 to 9983, and out to June 2014 the spread is only 8 bps more, to 9975. Outside of the US, our yields appear juicy as many countries now have negative rates. March’13 euroswiss is 100.22. German 2-yr yield hit zero. Rates in Denmark are negative out to 4 years.
–This is sort of simplistic, but I’m throwing it in anyway…in May 2011 140.028 million were employed. For May 2012 that number is 142.727 million, a change of 2.699. The deficit is running at about $1.3 trillion/yr. If one thought that an “ordinary” deficit were $300 billion, then the extra trillion dollars might be thought of as an amount to “buy” jobs. It would work out to about $370,000 per job.
–This topic isn’t simplistic, but it is simple to describe and somewhat astonishing. (The pricing example below is mine, but all the ideas are from Grant Williams “Things that make you go hmmm…”, and he cites others as well). On 8-Sept 2011, the HUI gold stocks index hit a high of 635. On 15-May 2012, its nadir was 376, a nine month drop of 41%. Over the same exact time frame GLD went from 182 to 150, a fall of only 17.5%. So last year it would have cost 3.5 shares of GLD to buy 1 HUI, and a couple of weeks ago only 2.5 shares of GLD were needed. The point is that mining shares are at historic lows when priced in gold itself. Gold surged $60 on Friday.
–Policy makers in the developed world are facing a nightmarish self-reinforcing negative feedback loop. Asset prices fall and beget falls in other prices. Rates are so low that the demographic bulge of older people can’t hope to survive on asset income. It makes me think of those ING retirement ads, where one guy is confidently strolling around with his big orange number that represents what he is going to need for comfortable old age. And those numbers are usually a bit over $1 million (but of course they are calculated to the dollar). Well what is that million going to throw off in terms of income with 1.5% ten year rates? $15k…not even enough to pay property taxes. What does that thought do for consumption? (which by the way, has never really adjusted down as a % of GDP; it’s still 71.2% vs 71.1 in 2011).
–Sorry a bit long…that’s all for today. We’ll leave Dodd-Frank backstopping financial derivative exchanges for another time…
