Nov 23. Liquidity issues…

–The IMF announced a new liquidity program which very briefly rallied the stock market, but the close was on the lows. (Reuters) “The IMF said the new liquidity line would be available for six months to countries with relatively good policies that are facing short-term balance of payments needs due to events not of their own making.” I.e. the desperate need not apply.
–I have a friend who, in the dark days of 2008/09 said, ‘the Fed will ease and it will boost the market.  It always does.’ And of course, he was right (I was wrong).  And in thinking about the current state of affairs, it’s all about liquidity: both the Fed and the BOE considered additional easing.  The IMF announced the measure noted above.  The CME announced it was upping its contribution to the MF Global fund to $550m (“Poof – gone”).  All leaning toward liquidity injections.  But lining up on the other side (and threatening to overwhelm half-measures) are items like the revision downward in Q3 GDP from 2.5 to 2.0, China PMI which fell from 51 to 48, and Fed plans for new rigorous stress tests to be conducted on the largest US financial institutions.  The latter is likely to mean that more capital will be required.  And for stocks like BAC and JEF, the market is providing the stress test right NOW.  We’re near the point where additional liquidity finds its way to the mattress, not the broader economy.  Like the scene in the Godfather where Clemenza says ‘we’re going to the mattresses’…strap in for a long fight.  The question is, could the ECB go all in, in conjunction with the Fed, and backstop all impaired debt?  And I think it’s unlikely.  New measures to help alleviate the problem will continue to dribble out… So treasuries continue to find a safe haven bid (tens down a couple of bps to 1.94 yesterday), and near euro$ contracts reflect demand for shorter term dollar funding (though they bounced yesterday).
–News today includes Pesonal Income and Spending both expected +0.3. Durables expected -1.0. Jobless Claims 390k. 7 year auction.

Nov 22. Spain, Italy, France yields all higher. Nikkei made new low…

–News this morning is a roundup of the usual suspects.  Man Global  missing funds estimate doubles to at least $1.2B.  Jefferies (JEF) continues to trade under pressure.  Concerns about China property values slipping (FT).  ZH has a piece on a probable Austria credit downgrade due to loan exposure to Hungary.  And from Reuters: ‘Almost all of the 52 [US] mayors of cities of 20,000 people or more said they “are anxiously seeking new revenue sources other than taxes” and 65 percent are considering raising fees for services.’  So expect more traffic monitoring in the name of safety (which also happens to raise revenue). It’s not surprising to see the super committee fail.  The problems of cities cited in the Reuters piece is the aggregate problem of the country.  When real estate boomed everyone increased budgets, now the process is in reverse.
–Yesterday the Chicago Fed Natl Activity Index was released, softer than expected at -0.13.  The only negative component of 4 was personal consumption and housing, enough to keep the entire series below zero. 
–New low in 2/10 treasury spread, which I marked at 169.  Ten year yield slipped to 1.96%.  Euro$ curve continued to flatten, with heavy pressure on near contracts.  Stocks, grains, metals were all down yesterday, with SPZ holding around the halfway mark of October’s low to high.

Nov 21. Stocks weak; news ultimately bullish for gold

–Super Committee results due this week, and every indication is that they’ve grasped failure. Stocks opening quite weak as a result.  However, several items also point to trouble in the supposed engine of growth, China/Asia.  (Reuters) – Chinese Vice-Premier Wang Qishan warned on Monday the global economy is in a grim state and that an “unbalanced recovery” might be the best option, at talks where senior U.S. officials said the mood at home toward China was souring.  And it’s not just the developed world that has excess debt problems.  According to Larry Lang, a finance professor at HK University: “… the regime’s [China’s] debt sits at about 36 trillion yuan (US$5.68 trillion). This calculation is arrived at by adding up Chinese local govt debt (between 16 trillion and 19.5 trillion yuan, or US$2.5 trillion and US$3 trillion), and the debt owed by state-owned enterprises (another 16 trillion, he said). But with interest of two trillion per year, he thinks things will unravel quickly.”
http://www.mining.com/2011/11/16/every-province-in-china-is-greece-larry-lang/
–There’s also news that Greece is trying to force repatriation from Swiss bank accounts. >>>GOLD. 
–Treasury auctions 2’s (today), 5’s and 7’s in this holiday shortened week.

Nov 18. Eurodollar curve reflects stress in financial markets

The eurodollar curve continues to express its own form of operation twist, with near contracts getting hammered and backs floating higher.  Red pack fell 4.75 bps while golds were up 8.125; the pack spread closed at 154, a new low and about 1/2 the highest level of the year when it had gotten above 300 (in March).  Leading Indicators are released today (expected +0.5), and I know that one of the internal indicators is the curve.  It’s a bit hard for the curve to go negative at zero rates, but I am going to go out on a limb and say that a drop of 32 bps in a few days isn’t presaging robust econ activity, just the opposite. It’s change at the margin that’s important. EDH2 has risen 25 bps in yield this month as has EDM2.  Outside of money markets it probably doesn’t seem like much, but the option pit is reflecting concern.  A couple of weeks ago the EDM2 9750p were 1 bid/2 ask.  Yesterday they were 4.5 bid!  Pretty juiced up for a 2.5% strike where the Fed is vowing zero funds.
–Ten yr yield fell below 2% (1.96) and 30 yr bond below 3% (down 8 bps to 2.97).  It’s a grudging flight to safety at these low yields in a world where every central bank and gov’t wants to stimulate and fire up printing presses. Makes it especially hard to buy at these levels…but US bonds sure aren’t going down.
–Yesterday equities (finally) responded to stresses apparent in money markets.  However, given low treasury yields and squabbling gov’t authorities (that could be accused of recklessness), perhaps big cap US stocks are taking their spot as the flight to safety haven.  If you want to be short equities, avoid the big cap indexes.
–I still think there’s a big negative shoe to drop related to the Man bankruptcy.  I know several people who cleared Man, still no idea of margins, let alone cash.  It seems to me that the CME probably isn’t margining accounts correctly, though perhaps the aggregate is sufficient.  Here’s a quote from a market maker who trades across several products:  “The way they’ve (CME and new clearing firms) treated the options accounts tells you all you need to know… 2 weeks into new clearer…nothing on statement is understandable but inventory.”  In other words, cash isn’t right, margin requirements are not right and haven’t been since the bankruptcy, but positions have transferred.

Nov 17. Fitch warns on US banks due to contagion risks

Late day equity sell off was sparked by a Fitch report that US banks were at risk from european contagion.  The front end of the dollar market has been hinting at that for a month, with EDH2 beginning November at 9942.5 and tumbling to 9922.5 by yesterday (-5 bps on the day at 77.5 yield). Underlying 3M LIBOR was 47bps yesterday, so EDH2 was at a 30 bp spread. Implied vol in the front end surged, with EDH2 9925 straddle settling 37 from 34 trade early in the day. Swap spreads widened in another sign of stress, while the eurodollar curve flattened to new lows.  Red/green pack spread fell to only 33 bps, while red/gold sank nearly 11 bps to 167. Ten year yield ended at 2.02, down 4 bps.
–Treasury vol was somewhat surprisingly under pressure throughout the day.  TYZ 130.5^ settled 1’08.  Even though there is only a week to go for Dec options, buy out of the money calls.  This thing could unravel by Thanksgiving, as every new european action has less beneficial effect.
–After a string of better than expected US data, the question is whether the brewing financial crisis will spill over into real economic activity.   My guess is that it will, and it appears that interest rate spreads support that view, while stocks are beginning to at least consider a more negative outlook.

Nov 16. Now France yields moving higher

Tuesday morning began with lower treasury yields and higher implied vols as yields in France joined Spain and Italy on an upward trajectory.  However as the day continued concern subsided and US rate futures closed with little change while stocks closed positive.
–The ECB is again buying Italy and Spain debt.  This morning I saw headlines that Italy 10 yr yield was back below 7%, but a quote on Bloomberg said there are really no buyers except for the ECB.  So for now, it’s the ECB (like the Fed) as the last line of defense while the political process plays out and hopefully sends reinforcements to the front line.  In my mind there is not enough time for the fundamental process to catch up because uncertainty begets weaker economic activity and lower tax revenues, exacerbating the problem of having to roll debt (and issue more).  And Germany doesn’t want to dilute its wealth by backstopping the rest of the EU.  It’s not as if Germany runs big budget surpluses…debt to GDP is still around 83%.
–In the US economic news has been improving.  Retail Sales were stronger than expected yesterday.  Today Jobless Claims are expected 395k and Philly Fed expected 9.0 from 8.7.

Nov 15. SF Fed warns of possible recession due to internat’l turbulence

Near eurodollar contracts continue to trade under pressure, but the back end of the curve rallied, bringing US ten year yield closer to 2% again.  Eurodollar curve remains quite flat with red/green pack spread at only 38 and red/gold at 176.  EDH12 contract settled 9930 or 70 bps.  Given the Fed’s pledge to keep rates low, this contract might seem “cheap”, but with continued financial uncertainties, the tendency to hoard near term liquidity comes into play, and pushes the spread higher. It’s probably more of a stigma than ever to turn to the lender of last resort for cheap financing. I would be wary of a waterfall in near contracts that could occur due to massive position exits, and there’s a lot less leniency for margin financing at this particular juncture, i.e. no one wants to let a position play out based on what we used to call “fundamentals”.
–I skimmed a couple of articles about recent downgrades to Hungary by the rating agencies.  The economy is only about 1/2 the size of Greece ($130 B), and, from what I’ve read, credit downgrades were priced in.  What I do find somewhat surprising is that Govt debt to GDP is only about 80%, which compares to 83-84% for Germany. Probably more important is that Moody’s put CS on negative review, a reminder of a trend toward less risk appetite.  And if that’s not enough, the SF Fed also put out a note: “…the odds are greater than 50% that we will experience a recession sometime early in 2012. Because the international odds of recession are more imprecisely estimated, one must be careful with a strict interpretation of this result. But the message is clear. Prudence suggests that the fragile state of the U.S. economy would not easily withstand turbulence coming across the Atlantic.”

Nov 14. MF Global implications

Some fairly large moves Friday, with pronounced weakness in US rate futures.  As of noon CST settle I estimate that tens were up about 7 bps to 2.12%.  EDZ12 fell 4.5 bps to 99.245, pegging a strike for midcurve Nov expiration.  While 3-month libor settings have been trending higher, it’s still interesting that EDH12 through EDM13 are all within 10 bps of each other at rates of 68-78 bps, (these contracts cover the period for which the Fed has pledged low/zero rates).  Most at-the-money straddles shifted to lower strikes; vol was MUCH firmer.  Stocks levitated Friday with SPX up about 2% and the DJIA up 2.19%…just about the same amount that one gets in interest over a YEAR in tens.
–Just a few notes about MF bankruptcy.  The CME announced a $300m guaranteed fund to facilitate release of cust seg funds!  The bankruptcy trustee fired 1066 employees and is disposing of almost all office space.  The missing money isn’t going to be magically found, and it’s likely a lot more than $600m. People have talked about MF as a “canary in the coalmine.”  Using the same analogy I would go a few steps further and say this part of the mine shaft has collapsed, and the entire mine is vulnerable.  The CME had an audit of MF on Oct 26 that supposedly went ok. Must have been pretty rigorous. My info is that MF customers aren’t certain of their positions or margin requirements and don’t know about their cash. As of Friday stock capitalization of CME was $17.27B.  The fallout of lower trading volumes and distrust of clearing firms probably can’t be repaired with $300m.
–Had MF’s position been small it wouldn’t have wiped out the firm.  But a large leveraged position is a big issue, the one that european banks are facing.  Perceptions of one area after another in the “risk management” universe are eroding…sovereign CDS because the Greek default wasn’t considered a credit event, “segregated funds” at brokers, bank safety, and even the integrity of exchanges themselves.

Nov 11. Italy and Jefferson County, AL

The trading floor is closed for US rate products, screens are open.  Equities were able to stage a rebound as Italian yields fell from well above 7%.  The market was roiled early by S&P saying France was on review for a downgrade, (which they subsequently said was erroneous). 
–Ten yr treasury yield rose back above 2% to 205, as the 30 year bond auction was a bit sloppy.  The eurodollar curve steepened but red/green pack spread is still only 39 bps.  November eurodollar options expire today.
–I was skimming an article on Reuters about Jefferson County, AL declaring bankruptcy on debt related to sewer bonds of $3.14 Bln.  http://www.reuters.com/article/2011/11/11/usa-alabama-jeffersoncounty-idUSN1E7A920B20111111  You might think that a county in Alabama is a long way from Italy, but there are likely some parallels.  In any event, I started to think, how can a sewer system in a county with population of 660,000 have over $3B is sewer debt?  That’s $4750 per person! (where per capita income is $20892).  The article went on to say that JPM worked feverishly (the article didn’t really say “feverishly”, I just thought that word captured the essence of JP’s efforts) to avoid bankruptcy, WAIVING $647 MILLION IN FEES!  That’s nearly $1000 per capita!!  “Tell ya what JP, you can have the sewer and everything in it, and we’ll call it square.”  Now I don’t mean to say that I really have all the details on this story, and I know there was fraud and corruption and jail time for public officials, but REALLY?  Almost makes the missing $600 million to $1 billion thus far associated with MF look quaint.
–Now back to Italy.  Italy/Germany ten year spread declined from over 550 to just above 500. (Maybe yesterday was the final blowout of MF’s Italy position and the market just wanted to extract a small fee for providing “liquidity”).   But the fact is that Italian banks are stuck with Italian debt, which is more or less being funded by the ECB.  Which is to say that the ECB, or Germany and France, own the Italian banks (and the Greek banks, etc).  And the small political gesture of Bini Smaghi’s resignation to allow for France to name a replacement at the ECB doesn’t change things.  I guess that’s why a triple A rated country like France can urge a lesser credit like the USA to help out. 
–The tide has rolled out, in Alabama, at MF, in Greece, and in Italy.  The erosion begins at the margin, both financially and in the trust of financial institutions, and then in all institutional architecture.  Roll Tide.

Nov 8

Yesterday’s market moves are being completely erased this morning as sentiment shifts to a decidedly “risk-off” posture.  Italian yields have surged in spite of Berlusconi’s vow to resign; higher funding rates are simply untenable in a structurally stagnant economy.  SPZ, having rallied yesterday, is now below Monday’s close.  EURUSD is below 137 and at the lower end of the last seven days’ range.  The removal of leaders in North Africa and the MidEast (a trend that has now swept around the Mediterranean) seems to have produced little so far in the form of positive economic reforms.
–This morning new lows are being set in red euro$ to deferred spreads.  EDZ12/Z15 is down over 10 bps, and the ever popular Blue Dec EDZ14 (in terms of midcurve options) is nearing new highs, trading around 9858. Ten yr treasury looks to spend some time below 2%. (10 yr auction today).
–While markets swing widely, the underlying news related to the primary problem, which is too much debt, continues to show erosion.  For example, Fannie Mae needs $7.8 billion more due to Q3 loss of $5.1 B.  HSBC cites bad US loans and slowing growth in Hong Kong for disappointing results. The real economy or Main St economic data isn’t that bad, it’s just that it’s linked to gov’t largesse/liquidity to the point of dependence.
–Bernanke speaks at 8:30 Chicago time to Small Business group.

• 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.