May 5. Stocks unresponsive to lower rates, lower dollar
May 5. Service ISM much weaker than expected at 52.7 vs 57. The economy appears to be losing steam, and treasury yields are falling in response. Tens fell to 3.22% with fives firmly under 2% at 1.93%.
–Employment report tomorrow. Today Jobless Claims expected 410k.
–If the economy IS slowing, and stocks are no longer responsive to a lower dollar and lower rates, there could be serious problems ahead, not the least of which is reaching the debt limit, just around the corner.
–There seems to be a lot of hand wringing about CME raising silver margins aggressively. That is what the futures markets are about… margins are changed to protect the financial interests of the exchange and the clearing houses. Traders who can’t meet margins have their accounts liquidated. Once again I refer you to the Dukes. If margins, which represent a margin of safety, were raised on home lending early on, we might have had a jarring, but short-lived crash. Now it all occurs in slow motion.
–There was a large new trade yesterday in midcurve options, about 50k, bought E2M 9800/9812c spd and sold EOM 9925/9937c spd for 2.5. Expiration is June 11, 38 days. EDM3 currently 9801, so just in the money, while EDM2 is 9917, 8 out of the money. (so EDM2/EDM3 is 116, the highest current one year spread). Slow gind up with falling spread works best….
May 4. Five year note below 2%?
May 4. US yields remain remarkably low and are edging even lower, with the 2 year note at only 59 bps and tens at 3.25%. The backdrop could be the beginning of a leveraged commodity washout, with silver, having neared $50, down almost 20% in a couple of days.
–I marked 2/10 treasury spread at a new recent low of 266 bps, and ten yr treasury to tip at the lower end of recent range at 257 bps. The widest one year eurodollar calendar spread is only 116 bps, (EDM2/EDM3). If the Fed is watching these spreads as indicators of inflation, then they have nothing to worry about. But I know that I spent $1.74 for peanut M&M’s the other day, and that, along with super low treasury rates, makes me feel uneasy about the state of the US economy and markets. To quote Louis Winthorpe III, “Pork bellies! I have a hunch something exciting is going to happen in the pork belly market this morning.” But it’s not just the bellies, it’s the way the whole market structure is hanging together, and it’s not “exciting” in a good way, but more like the way Winthorpe’s life is turned upside down by the Dukes. While it’s been a couple of years since the nadir of the crisis, and things have gotten better with massive gov’t stimulus, it still doesn’t seem that the organic spark of the private sector has quite caught fire, (except for paper assets, and events like gov’t actions against Deutsche Bank may yet derail the fortunes of the financial industry).
May 3. A good day for America
–Obama called the death of Bin Laden a “good day for America” and I agree. Good. That’s all. Commentators were on tv implying this news might give a boost to the US, perhaps even economically. In a world of 15 minute news cycles I would tend to strongly disagree. It’s ten years after the fact, and I would guess Osama’s leadership would have diffused and re-organized by now. If instead it was like the culmination of the Godfather… Moe Greene (bin Laden) shot through the eye, Gaddafi blasted in the elevator (Don Stracci), Kim Il Jong as Don Cuneo caught in the revolving door, with other choices (insert your favorite despot here) for Barzini and Tattaglia, now that would be impressive. And, when rumors swirled that aircraft were massing at an Iraqi airbase for possible action against Iran, it looked like a more concerted effort might be at hand. But the rumors were denied. Stocks gave back early gains.
–India raised repo rate by more than expected 50 bps to 7.25%. Fed’s Sr Loan Officer Survey showed “bank lending standards and terms generally had eased somewhat further during the first quarter of this year, and that the demand for commercial and industrial loans (C&I) and for commercial mortgages increased, while that for residential mortgages continued to decrease.” A pick up in C&I loans could spur an end to accommodation. While residential real estate remains stuck in the mud, a friend informed me that farmland in Iowa and Southern IL had sold for $10k and $11k and acre…double prices from a year ago, to knowledgeable buyers.
–Silver had a wild ride Monday as several houses raised margins beyond CME minimums. Closed down over $2.50 with $6 range.
April 29. Le deluge
Tennessee Williams: Mendacity is a system that we live in. Liquor is one way out and death’s the other.
–I suppose I should write about large euro$ option trades from yesterday, the buy of 100k EDZ 9900/9925/9950p fly for 2.0 or the sale of 100+k EDH2 9937/9950c spd for 8 (new position). And while those trades are sort of interesting, as is the drop in US yields and dollar apres Bernanke, I can’t help thinking about the contrast of pomp surrounding the royal wedding in England with the medacity of US news stories. For example, McDonald’s just hired 62000 people…but they had a MILLION applicants. The US chairman of Walmart says that their customers are running out of money earlier in the month than previously as gasoline prices sap purchasing power– that end of month sales are fading as customers await paychecks or gov’t transfers. Another story mentions that more people have exhausted the 99 weeks of unemployment benefits. It’s a Tale of Two Cities on a global scale. Will Rogers said during the Great Depression that “money was all appropriated for the top in hopes that it would trickle down to the needy.” (Wikipedia) The difference in the current case is that it’s a slower trickle. And it makes me think of a line from Old Farmer’s Advice: “Do not corner something that you know is meaner than you.”
–Dollar is making new lows vs Swiss and Yuan which is now near 6.5. News today includes Personal Income and Spending +0.3 and +0.5. Chicago PMI expected 68 from 70.6 last.
–4 non blondes: And so I wake in the morning and I step outside/And I take a deep breath and I get real high/And I scream from the top of my lungs/What’s goin’ on?
www.youtube.com/watch?v=6NXnxTNIWkc
April 28. Precious metals surge after FOMC
–Two days ago Geithner said the US has a strong dollar policy. At yesterday’s press conference Bernanke said the Fed wants to keep inflation low which should help support the dollar. OJ said he wants to find his wife’s killer.
–The market gave its opinion, suggesting a loss of credibility for official pronouncements, as the dollar fell to new lows and gold and silver surged. Gold was up over $20 to a new record high, while silver (May) ran from 45.25 before the FOMC announcement to 47.50 during the press conf. But the all important equity market also continued to press for a new high, confident that monetary accommodation will continue even as QE2 is slated to end. The only problem is that boosts to the equity market (while houses languish) seems to have less and less effect on spurring consumption and economic growth.
–The curve steepened by a few bps with 2/10 at 306.5. There was a notable seller of TYN (July) 117/121 strangles from 61-57 in size of around 10k…continuous strangle selling by this player as May positions expired and previously sold Junes rot.
–Today’s news includes Q1 advance GDP expected +2.0%. Jobless Claims expected 390k. 7 year auction.
April 27…first FOMC press conference on tap
Looking back at the last FOMC statement from 15 March, the Fed noted generally firmer economic conditions, with weakness in housing, and concern about “a sharp run-up in oil prices”. However, inflation expectations “have remained stable” and the “Committee expects these effects to be transitory….”
The question is whether things have changed much in Bernanke’s mind. After all, even though there have been many Fed speakers recently, it’s Bernanke that will be fielding the questions and setting the tone. My contention is that he will remain dovish, and outline reasons for continuation of accommodation.
In terms of oil, from mid-February to mid-March, oil ran up from around $85-90 to $100-105. In April so far, the first Crude Oil future is averaging around $110. If Bernanke thought the effects were going to be transitory in March, there probably isn’t much reason to change tone now. When considering inflationary expectations, look at attached chart of Ten Yr note yield vs Ten Yr Inflation Index note (TIP…chart below). This spread is up about 15 bps since mid March to around 261, but was as high as 245-250 at the end of 2009. I don’t believe it is high enough to really change Bernanke’s opinion about inflation expectations being contained, especially as core inflation readings remain low. Also, Case-Shiller home prices have declined for the past 7 months. And general economic conditions are probably slightly weakening currently.
The trickier situation will be the future of QE. I think Bernanke will try to leave things open ended as to whether or not there will be expansion of the program. But I believe he will specifically say that coupon payments and maturing issues will be reinvested for the forseeable future. There is such a huge diversity of opinion regarding QE expansion or cessation and the related outcomes, even among well known analysts, that I think Bernanke’s often repeated statement that the Fed has tools and knowledge regarding removal of accommodation rings hollow.
Oil and speculators
Obama is vowing to take ‘speculators’ to task over the increase in oil prices. Over Easter weekend family visits, one of the first topics to come up was the oil market with my sister in law asking me if speculators are indeed to blame for the recent price surge. I said maybe they’re a factor, but so is 1) mideast tension and uncertainty of supplies 2) the relentless decline of the dollar and related price rise of everything priced in dollars (except local real estate) 3) the Japanese disaster and rethinking of nuclear power plants worldwide, 4) the Gulf of Mexico spill and seismic problems with ‘fracking’ (and related tightened regulations) 5) emerging market demand 6) peak oil concerns and the idea that perhaps Saudi reserves aren’t what they were once thought. I’m no expert, but if I were forced to be on one side of the market or the other, I’d have to take the long side (wouldn’t you?)
I also mentioned that higher prices were likely to spur research to make alternatives more economically feasible. In fact, higher prices are probably a more important catalyst for alternative energy investment than any political program.
Attached is a chart of SPX divided by crude oil price (rolling 1st contract). Stocks priced in oil. This ratio had been stable for the past two years, but now is breaking down as oil prices outpace stocks. But seen in this way, it doesn’t look as ominous as the move in 2008, when oil surpassed $140. However, as a portion of median consumer paychecks, oil has become a much bigger factor. From a CNBC article: “With gas prices now standing at about $3.90 a gallon, energy costs have now passed 6 percent of spending—a level that Johnson says is a “tipping point” for consumers. ” http://www.cnbc.com/id/42704213
The idea of punishing speculators has great populist appeal, but every person consumes energy and food, and the idea of stockpiling now because prices might be MUCH higher in the future strikes me as a prudent hedge, even if there is a speculative aspect.
SPX divided by rolling Crude Oil futures contract
April 26. No bond sellers. ‘You can be bearish, just don’t be short’
–Interest rate futures rose Monday on light volume, with new lows in several near eurodollar calendar spreads. For example, EDZ1/EDZ2 fell 5.5 bps to settle at 113.5. There were weekend reports that China intends to dramatically cut its dollar reserves. This news (along with anticipated end of QE2), should have been negative for bonds, and on a light volume day, one could be excused for thinking the downward push might be exaggerated. The important takeaway is that there are NO SELLERS. A shift in the tone of the economy toward renewed weakness seems to hold sway, even though stocks remain strong and commodities signal inflation. For example, silver traded in a $4 range yesterday…ten years ago the PRICE was around $4!
–Today the treasury kicks off auctions with 2 year notes. The five year tomorrow will be pushed up in terms of time, in order to accommodate the first ever Fed press conference after the FOMC announcement.
–From comments to the Dallas Fed regarding its survey (as posted by ZH) there was this note, which makes perfect sense and is a longer term positive for US mfg, though perhaps also somewhat inflationary…
“The recent Japan supply chain disruption has increased concern for diversification in the supply chain to minimize risk. Higher transportation costs along with the need to reduce cycle time favor manufacturing being close to the distribution channel. This increases opportunity for North America manufacturers. Increased manufacturing increases job creation.”
April 21. New highs gold, silver, stocks…
New high gold. New high silver. Crude surged by $3 bbl. New high stocks, new low dollar. Implied vol getting crushed. New low VIX.
–The eurodollar curve edged to new recent high. Red/green pack spread rose 3.375 bps to 118. Still quite low for one year spreads…
–From ZH post, Texas Teachers Pension fund needs 21% annual return to maintain adequate funding. This is just a small example of the enormous institutional bias to boost paper assets. All sorts of public pensions are under water, several have bitten the bullet and actually lowered their assumptions about forward investment returns, but when they do, the bill for the shortfall gets handed to the taxpayers. Which in turn puts more strain on public finances. It becomes a vicious cycle. But if stocks can somehow return 10% or more per year many such problems recede into the background. Wealth managers, pension funds, municipal gov’ts, 401K plans…they all want and all NEED stocks to go higher, so of course the institutional support reaches to the highest levels, i.e. the Fed, as Bernanke has intimated already. However, this same bias has the effect of weakening the dollar, as was seen yesterday. Now, the institutional leaning toward the dollar is ambivalent…your given “wealth manager” says I don’t give a **** …as long as I can show return of 10% and take my fee out. Barely anyone wants a stronger dollar, except perhaps ironically the Chinese (so their dollar assets hold value), and domestic savers. As you know, we are a country of debtors, not savers. So again, the domestic institutional bias is for higher paper assets/lower dollar. The Fed knows that route is fraught with danger, but it’s the lesser of many evils. In the current case, that evil is higher energy bills, which sap the consumer. Nothing has changed…just like the middle of the last decade, the US mistakes paper values for economic health.
(But the real estate market isn’t really buying it).
–In europe, the same ills are faced, with the same temptation to devalue the currency as a way to “solve” problems. But the fight over a weaker currency is more evenly balanced with the Germans standing for a stable currency. Given this framework, logic argues for long gold. I am not saying that the institutional bias will win the game…just that positioning the other way is like being long premium…there tends to be a constant drip of time decay.
April 19. S&P downgrades US outlook on debt concerns
Here’s an explanation for the S&P downgrade of the US outlook: It comes time to review the US, but S&P is short on analysts because the smart ones (anxious to avoid the possibility of incarceration) have flown the coop after the subprime debacle. Being short staff, SVP Smith hands the job to VP Johnson, who in turn gives the US assignment to Bob, the new trainee, chuckling as he thinks, “How hard can it be? It’s the United States– gold plated. I’ll just give him last year’s report to use as a template and rubberstamp the glowing reveiw.” Unexpectedly, Bob does what any new fresh-faced college kid does and goes to the internet…sees deficit spending of 10% GDP, debt of 100% GDP and sees a Huffington Post article that 45% of the populace pays no taxes and the top 400 tax returns paid less than 10% of their income in taxes. And Bob concludes, “Holy crap, this is UNSUSTAINABLE, and I HAVE DISCOVERED IT. It might look gold plated, but it’s tungsten underneath.” Johnson, from force of habit, gives the report his seal of approval without reading it. Of course, it’s only funny until someone loses a few billion $ market cap in stock valuation.
–So Bob has actually written what any idiot already knows. It’s all unsustainable: Greece, Portugal, Ireland, Japan, and yes, the US. But the market lets you know it’s unsustainable at 10% two year yields, (like Portugal). Not at a two-year rate of 65 bps like the US. Note to Bob (and to self), the market will give you the clues, and the drop in the euro is one of them…
