May 30. Treasury rates remain low on European fears
–Once again US interest rate contracts closed firm. EDZ1/EDZ2 spread (Dec/Dec) has closed at a new low for seven straight sessions, ending Friday -1 at 74.5. It started the month around 102.
–The situation in Greece is again front and center, but going into the next few weeks there are high profile US events as well: QE2 is scheduled to end and the fight over raising the US debt limit will heat up.
–All over the world gov’ts have substituted government debt (backed by taxpayers) for private bank debt. And neither taxpayers nor those receiving gov’t transfers care for the implications of getting less. But what started as uneasiness is boiling over as the reality of austerity bites.
–Dec corn closed at a new high Friday. There was an interesting piece late last week that China is going to release water from the Three Gorges Dam to replenish the Yangtze river, mostly for agricultural reasons. However this action will also detract from hydro-electric generation, thereby increasing demand for oil imports.
–Caroline Baum from Bloomberg wrote an opinion piece saying that yield curve steepness makes recession extremely unlikely, using FF vs ten yr treasury yield as her measure, “…one rate is artificially pegged by the central bank while the other is determined by the market. Their relationship encapsulates the stance of monetary policy. When the yield curve is steep, as it is now, it’s an inducement for banks to expand their balance sheets — borrow short, lend long — and increase the money supply.” http://www.bloomberg.com/news/2011-05-26/recession-forecasts-yield-curve-says-no-way-commentary-by-caroline-baum.html
My only problem with this argument is that it’s wrong. Both rates are being artificially pegged, and in spite of the curve banks are not lending into the market, but to the government. Velocity remains stagnant, having plunged over the past three years. I’m not saying recession is likely, but I would be wary of using the curve as my only indicator in a zero rate environment.
May 25. Front eurodollar contracts look vulnerable to downside
–Little net change in US rate futures after a weaker opening. Continued erosion in implied vol and in one-year eurodollar calendar spreads, with EDZ1/Z2 spread in 2 bps to a new low of 85. (Selling of TYU 121.5^ from 3-00 to 2-62)
–There are a few good pieces of news. Late credit card payments fell to the lowest level in 15 years, “..the rate of payments 90 days or more past due on bank-issued cards dropped to 0.74 percent in the first quarter, down from 1.11 percent a year ago.” (HuffPost) The same article says balance continue to drop, haven’t been this low since 2000. It’s sort of surprising at first glance that households would pay unsecured debt in a more timely fashion than collateralized (mortgage) debt, but that’s the state of view regarding the value of said collateral. Also, Chrysler paid off gov’t loans early and an AIG stake was sold for $5.8 B for a small profit to the US gov’t.
–While USD libor settings continue to drip lower, near eurodollar contracts are under some selling pressure. There have been several buyers in good size recently of puts on EDU1 and Z1. This is NOT the time to try to squeeze a few bps out of the front end of the curve looking for convergence to LIBOR settings. If anything bad happens to US stocks, it will be reds and greens that perform, the front end is vulnerable to higher rates. (And recent performance of China, India and Brazil stocks are evidence of what can happen when liquidity perceptions change).
–News from Japan is bad, with yoy exports -12.5%. Although there were some who thought rebuilding after the tsunami would boost Japan’s economy, it looks the opposite, and the tipping point regarding gov’t finances, demographics and pension payout obligations may be here.
–News today includes Durables expected -3.0% and US 5yr note auction.
May 24. Concerns about europe’s debt problems dominate trade…
— US interest rate futures settled mixed Monday, as a stronger open faded. The main feature was a flatter curve with red/gold pack spread down 4 bps to around 104. Trading flows supported a flattening theme. Large buyer of EDN 9962/9937p spread for 2.5. Notable buying in green midcurve calls. For example, E2N (July expiry with EDU13 underlying) 9850c were bought for 3 bps in good size. E2U 9900c were bought for 1 in size of at least 40k on the day…appears to be a trade which caps off risk on existing long 9837/9862c 1×2’s.
–Today’s news features New Home Sales, 2 year note auction, and several Fed speakers. However, an undercurrent of unease related to european debt issues is unlikely to be assuaged by officials of the US Fed.
–Each passing day brings us closer to the end of QE2, (and some would say nearer to the beginning of QEnth). Stocks are reflecting a degree of uncertainty as the dollar rallies, removing an underpinning of US equity strength. The old adage of “sell in May” seems to be right on target this year.
–EDM1/EDU1 spread edged to a new high of 6.75. June/Sept/Dec butterfly is -0.25, while Sept/Dec/March is -4.5. EDU1 is the weak contract and appears to be most closely linked to the possibility of bank funding concerns.
May 23. New lows in treasury yields (the day after my calls expired)
–Going into the last week of the month US treasury rates are pretty much right near their lows. Tens fell a couple of bps to 3.15% Friday. A few of the one-year eurodollar calendar spreads made new lows, for example, EDZ1/EDZ2 down 2.5 bps to 88.
–There’s really nothing particularly new going on. The situation in europe continues to slowly deteriorate, with Greece circling the debt toilet, Spain the subject of widespread protests echoing those in the mideast, and Italy’s debt rating cut.
–New protests are also re-emerging in Egypt. A military base in Pakistan was stormed by militants. Yemen’s Saleh says he won’t step down.
–The good news is that the world didn’t end on Saturday, though another Icelandic volcanic eruption is a reminder that natural disasters seem to be increasing both in frequency and ferocity.
–Now back to the financial landscape. There is simply not enough capital at ANY global financial institution to withstand marking down assets to their actual tradable levels. So, the central banks must convince everyone to allow these assets to be marked near par. It’s accomplished by printing up as much paper as necessary. In the case of Greece, where tax collections aren’t even going to cover interest payments at some time in the near future, the scam is obvious. But the charade continues…
May 20. If these guys don’t get us, the Mayans will
Interest futures clawed back from early losses to close mostly higher, as housing data and Philly Fed were both lower than expected, adding to a list of economic data that has disappointed.
–No data today, though NY Fed’s Dudley speaks. (Summary: there is no inflation and we may need more QE).
–June treasury options expire today. As I write TYM is 122-21. I have a hunch the close is around the 123 strike. Open interest levels are 118k in 122c, 30475 in 122.5c and 37411 in 123c.
–LinkedIn IPO soared on the first day of trading. Somehow I don’t think ‘social networking’ can be the great new US industry to win the future.
–There’s an interesting note on zerohedge about General Collateral/Interest on Reserves collapse; the implication is that holding shorts in treasuries is very expensive with repo rates around zero to negative. The article indicates a Fed hand in this situation, though changes in FDIC insurance charges to banks appears to be the main factor. In my mind, the further implication is that the roll of the eurodollar curve, where EDM1/2/3 futures fly is -64.5 and EDU1/2/3 fly is -40.5 and Dec behind is -16 can continue to be exploited, e.g. sell the Dec fly and let it roll more negative.
May 18. Ten year yield has fallen to 3.12%…slower growth ahead
–New lows again in euro$ one-year calendar spreads. EDM12/EDM13 down another 3 bps to 105. Red/green pack spread at new low of 102 bps. Stocks broke down early but fought back…economic data yesterday was disappointing.
–Meredith Whitney is again warning about public finances, this time noting the problems with states’ budgets. She has repeatedly warned about municipal finance, an issue on overt display in Chicago. Facing a budget problem of some $560 million, Chgo’s new mayor identified $75 million in cuts on his first day on the job. The new public transit appointee, Forrest Claypool, said the agency is in crisis and needs more federal money. Not more efficiencies, more gov’t cash. It might not be forthcoming in the current environment. Whitney points out contractionary impact of tighter state (and fed’l spending).
–Slower growth also on display in the public sector. Both Walmart and Home Depot reported year over year comp stores sales declines of 1.1% for WMT and 0.6% for HD. The interest rate market appears to be foreshadowing a lower growth profile going forward with ten year yield down to 3.12%. Though I agree with the idea of slowing growth, I still bought EDZ2/EDZ3 for myself yesterday at average 102…I just feel as if the move is extended.
–FOMC minutes this afternoon.
May 17. Portugal bailout package approved
–The rally in interest rate futures continued as stocks sold off and crude oil slid (down $2.60 bbl late). I marked ten year treasury to tip spread at a new recent low of 240 bps (though the Fed was buying TIPs yesterday as part of POMO). Eurodollar one year calendar spreads pressed to new lows, the highest is still EDM12/EDM13, down another 2.5 bps to 108. EDM1/EDM2 is only 48 bps, less than 1/2%.
–Overall volume was quiet on Monday. There is still a buyer of Green midcurve call spreads (+30k E2U 9825/9862c 1×2’s, settled 6.5) and a seller of TYU 121 straddles down to 310.
–Today’s news includes Ind production expected +0.4% and Capacity 77.6.
–There was an article on zerohedge about Chinese bill auctions being undersubscribed as a result of the PBoC having raised reserve requirements repeatedly recently. Not sure how much this has to do with US stock sell off but the Shanghai Composite looks vulnerable, and tightened liquidity conditions are felt globally in this environment.
–A Japanese official suggested that bondholders write off some of the loans made to Tepco before the disaster, in order to minimize taxpayers’ burden. Banks bristled at the suggestion. In the rest of the world, the disaster was bad lending on housing, but the final analysis is similar. How much should private bondholders be impaired when an imploded company/system creates a burden on taxpayers as if it was nationalized? And how much will lending be restrained as a result in the future?
–Now a bit of local news. Rahm Emanuel was sworn in as mayor of Chicago yesterday, with VP Joe Biden at his side. Ever since news got out that the VP wasn’t considered a terrorism target by the Taliban, he’s been in great demand as an extra security measure in public appearances.
May 16. Debt ceiling talk heats up
–The issue of the debt ceiling is becoming the subject of increasingly dire warnings by Geithner and Obama…US would lose credibility, small businesses would find it more difficult to get credit, confidence would evaporate. With the world awash in real possibilities of default, (Greece first and foremost), the positive aspect of the US debt situation is that perhaps structural problems will be confronted.
–Currently markets aren’t exacting a price to resolve the issues. Some analysts call for much higher treasury rates at the end of QE2, some for much lower stock prices, and some for hyperinflation as bank reserves have gone parabolic.
–From an article about the Irish debt problem (cited in Mauldin): “The ECB can then learn the basic economic truth that if you lend €160 billion to insolvent banks backed by an insolvent state, you are no longer a creditor: you are the owner. At some stage the ECB can take out an eraser and, where “Emergency Loan” is written in the accounts of Irish banks, write “Capital” instead. When it chooses to do so is its problem, not ours.” This is the classic rule of banking, if the borrower is large enough, the borrower’s problem simply shifts to the lender. In the current case the borrowing collateral is real estate.
www.irishtimes.com/newspaper/opinion/2011/0507/1224296372123_pf.html
–New lows in some of the one year euro$ calendars. Highest is now only 110.5 bps, still EDM12/EDM13.
May 12. Commodity washout continues
–Once again commodities plunged with silver down over $3 and crude oil down over $5 to 98.90 (late in day). Renewed volatility after last week’s gyrations is forcing a change in perceptions; moves like this might become more likely and risk reduction is the new reality, in some cases forced through margin changes. Structural problems are not being solved, just papered over until they flare up again, like Greek riots. Yesterday it was reported the government was scaling back plans for AIG share sales as the stock slid from 50 to 30 this year, and this morning I saw that the idea might be shelved for now. GM, another gov’t sponsored project, has gone from a high of about 39 to current level around 31. Things are fine globally as long as the backstop of gov’t (and central bank) largesse is there, but there is the potential for unravelling when support is withdrawn. Sort of raises the stakes for the end of QE2. Even the stock market is reflecting nervousness. (Cisco’s continued warnings don’t help).
–Curve was a bit flatter yesterday. There was a large seller of EOU and EOZ 9925/9937c spreads vs buying E2U and E2Z 9800/9812c spreads, about 40-50k, representing a bet toward further flattening with a grinding move upside.
May 6. Good morning, this is the margin department….
–The great speculative margin call has begun. Staggering sell offs in silver (SIN at 35.20, -4.18), oil (CLM at 98.63, -10.61), gold (GCM at 1465, down $50) and euro (ECM 145.20 down 3.14). [I marked these around 2:00pm close in interest rates yesterday]
–The day started with a large unexpected jump in Jobless Claims to 473k, with previous week revised higher. Also, Trichet lost some of his vigilance as the ECB held rates steady, sending the euro tumbling. US interest rates continued lower, with ten year note -5 bps to 3.17%. The curve flattened, with nearly all one-year eurodollar calendars making new lows, the highest still being EDM12/EDM13, -4 to 112. 2/10 fell to 259. Red/green pack spread fell 4 bps to 104.5. There was a large seller of red packs on screen (20k), appeared to be someone taking profit or perhaps selling reds and buying longer treasuries. (total euro$ open int down 17k).
–Unemployment report today with NFP expected 185k and Private Payrolls expected 200k. Rate expected to remain at 8.8% but I wouldn’t be surprised to see 9%.
–Not that I would know from personal experience, but when one gets a margin call, (and there must be some doozies this morning), they sell WHAT THEY CAN to raise funds. Think stocks. I would bet that in some cases the margin depts are the ones exiting the positions, and they don’t “work” orders. They hit the bids, and usually there is more behind. Perhaps the bulk of the washout has already occurred, but it seems to me that indicators like the VIX are still relatively low in this environment.
