March 30. Sentiment towards bonds falling as fast as consumer confidence
–There has been a tremendous amount of put buying in the past few days. Yesterday the Green April E2J 9725/9700p spd (on EDM13) bought in size of 40k for 4. Midcurve June (on EDM12) puts rose 52k in open interest. There is a lot of weight on the market, and the down trade in bonds doesn’t feel like it’s over even though tens should have a bit of support around 3.5% yield. There was also notable put buying in tens, though a seller of 10k TYM 117/122 strangles down to 53. Of course, if this is a big bond fund now devoid of treasuries, he may be considering the trade like my old friend Andy Totman: would you like to own tens at 117 with an extra 53/64s? Just take delivery if it goes through you.
–ADP report and 7 year auction today, along with several Fed speakers.
–I’m not sure if this move is more representative of economic growth, or inflation concerns, or if it is more insidiously associated with lack of confidence in sovereign bonds. I saw a news item that said Irish “stress tests” may lead to government control over banks. Perhaps the wording should be changed, because it appears to me that the gov’t is held hostage by the banks, the taxpayers are on the hook already.
–I don’t know much about the situation in Japan, but the word plutonium seems to be popping up a lot more. After the tremendous repatriation, yen is right back at pre-tsunami level. EUR/JPY at new high. Perhaps the concerted intervention was the best timed I have ever seen.
Correlations.
The above chart overlays AAPL stock and May Copper. One is a tech company with some of the coolest consumer gadgets in the world…producing huge innovations, one after another, i-phones, i-pads, etc. The other is a base metal, used in industrial applications. (Apps, we like to call them). With all the pontificating and effort expended on CNBC to determine which company is going to blaze a trail to higher profits, it’s somewhat surprising that a base metal runs neck and neck with the stock that every portfolio manager owns. Or….maybe it’s just a “risk on” trade. Surprisingly enough, the upward trajectory for both came as the Fed was hinting about the beginning of QE2. So I guess the question is, what happens in June when QE supposedly ends?
March 29.
–Interest rates still edging higher. Ten year note closed nearly unchanged yesterday at 3.45% but came close to 3.5% early in the day. The curve is flattening modestly.
–Five year auction today along with Consumer Confidence expected 64 from 70.4. Bullard also speaks (in his Seven Faces of the Peril paper he had argued for raising the funds rate while increasing QE, different from Plosser who wants to raise funds while unwinding QE).
–Stocks had a late sell off, oil and other commodities were weaker.
–Just a couple of sideline notes that bear on state finances. A headline in the FT today: US muni bond demand slips into big freeze. From the AP, Arkansas has proposed borrowing $346 million it owes to the federal govt for payments to unemployed workers, comparing the 2% rate it can borrow at in the market to the 4% it would have to pay the Feds. In Illinois, Caterpillar sent a note to the governor as an “olive branch” suggesting it might move from the state because of higher taxes. The themes are 1) borrowing to pay regular bills, and 2) large companies (probably) getting special incentives at the expense of smaller firms. CAT’s CEO said he had been wooed by several other states. Seems like many of the same problems faced by the PIIGS.
March 28. Bonds are showing cracks…
–Huge amount of treasury put buying Friday, about 25k TYJ 119p associated with April option expiration, but more notably, new position buys in TYK 117p …total 80K trade. The sell off, (red euro$ pack -9.125) was mostly a result of Plosser’s comments outlining a plan for an exit strategy combining asset sales with a rise in the funds rate to 2.5%. However, the big picture is also unfriendly to bonds, as every day brings us closer to the end of QE2, inflation in basic living goods as energy continues to rise, and sovereign bonds the world over are thought to require higher rates to compensate for risks inherent in austerity versus tax increases related to servicing public debt.
–In the UK, an anti-austerity march had some rioting mixed in. In Ireland, haircuts to senior bondholders was proposed. In Germany, Merkel’s party lost a state election in Baden-Wuerttemberg, at least partially as a protest against nuclear power. The situation in europe generally seems to be fraying at the edges, and the IMF is taking steps to increase its footprint. (More liquidity helps stocks).
–The Japanese situation is also getting worse, or at least does not seem to be contained. The Middle East upheaval jumps from country to country, with Obama slated to explain US involvement on the heels of Sec’y Gates saying Libya was not “a vital interest for the US.” This last is taken somewhat out of context, but still reflects uncertainty. Large cap US stocks have become the safe haven.
Mar 22. Swans
–Getting to the point where people are asking “Does anyone remember what a WHITE swan looks like?”
–Irish yields soared yesterday…2yr 9.26%, 10 yr 9.48%. Portugal’s gov’t set to fall over opposition to austerity measures (as every gov’t is that imposes austerity). I saw a news clip that said “US treasuries dip as fears over Japan recede.” It could just as easily be that UST’s fall because Japan will no longer be a major buyer. In the meantime Fukushima Reactor 1 Core is reportedly rising in temperature, over 400 celsius, and drinking water is contaminated. Oil is back over $105 as the ‘coalition’ can’t seem to agree on goals in Libya. Yemen is tense, though Saleh is apparently stepping down at the end of the year as his generals defect.
–So…implied volatility fell everywhere. I heard it was down heavily in oil yesterday, and of course it fell in US rates. The ten year atm straddle settled 2-53 yesterday, compared to previous 2-63. VIX had a low of around 15.5 in early Feb, shot up to 30 last week, and is now back to 20.
–In dollars there was notable front put buying. Fimat +25k EDJ 9925/9950ps for 0.75 (new). EDM 9925p bought for 1.25, EDU 9950p also bought.
–Curve slightly flatter as greens were weakest dollar pack. 2/10 declined 3 bps to 268.
Mar 22, 2011. Update on Europe yields
With Japan and the Mideast capturing the attention of the world, don’t forget that Europe’s financial crisis is still lurking in the background. Ireland’s yields surged to a new high as rumors surfaced that AIB had missed an interest payment. Here is a snapshot of 2Yr and 10Yr yields in the floolowing countries: Portugal, 6.126, 7.26. Ireland 9.266, 9.48. Italy 2.356, 4.76. Greece 14.193, 12.26. Spain 2.816, 5.164. Ireland looks like it has a chance to join Greece with an inverted curve.
March 21. No-fly zone operation commences in Libya
–Military action to create a no-fly zone in Libya commenced. However, it’s unclear whether this action will create more certainty regarding oil supplies and mideast stability. US rates moved higher Friday as worst case fears about Japan eased slightly. Even so, my personal bias is that the market is not fully pricing dislocations related to Japan, and that treasury rates will move lower, as will equities.
–The humanitarian crises in both Japan and the Mideast have highlighted the collision between energy and environment. My guess for the foreseeable future is that all energy sources will become more expensive. Plans for nuclear power plant expansion are being reviewed the world over. Mideast oil supplies may become targets in protracted conflicts. There are reports of another huge oil slick in the Gulf of Mexico. And the process of “fracking” to release oil and natgas from shale is being halted due to concerns about increased earthquake risks (mostly in southern US). Higher energy prices are going to make people revisit the idea of a “double dip” recession.
–From BBG: “The mounting debt burden of the world’s most developed nations, set for a post-World War II record this year, is unsustainable and risks a future fiscal crisis, the International Monetary Fund’s John Lipsky said.”
–From Huffington Post: “A study by Cardhub.com of Federal Reserve data found that last year, while banks wrote off a total of $75 billion in credit card debt, the level of the debt only declined by around $67 billion. This, according to Cardhub, suggests that the “entire decrease [in overall debt] is the direct result of Americans defaulting on their debt.”
Fracking links
http://en.wikipedia.org/wiki/Hydraulic_fracturing
http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=439×654531
http://www.huffingtonpost.com/2011/03/18/arkansas-fracking-earthquakes_n_837485.html
March 17. Japan worsening
–Japan’s situation deteriorating further, with Germany’s Merkel calling it “apocalyptic”, though yen is staging a huge run up, apparently the result of carry trades being unwound.
–US interest rates plunged. Eurodollar calendar spreads narrowed further. Last week EDZ11/EDZ12 was 132.5 at its high, yesterday settled 101. Implied vol has exploded. At the money June Five Yr straddle was below 2 points last week, settled yesterday at 2-14. Ten year note could revisit 3%, now around 3 3/16%.
–The very front end of the curve closed slightly lower, with EDM1 -2.0 at 99.61, portending funding pressure.
–Though the catastrophe in Japan’s nuclear plants dominates all else, there is quite a bit of news in the US today. CPI headline expected +0.4 with +0.1 Core. Job Claims 385k, Ind Prod +0.6, Philly Fed 32.
–Market dislocations are met, as always, with central bank liquidity measures. This is a particularly sensitive time, as energy sources and food supplies are no longer taken for granted. Inflation expectations could easily rachet higher. I can also see the possibility of government price controls on foods, and elimination of all food based ETFs.
— From BBG: ‘Biblical Exodus’ From Africa Feeds Anti-Immigrant Rhetoric. This article concerns North African refugees going to Italy, but the idea of “biblical” events shaking the world’s confidence is looming.
March 16. A move towards a larger margin of safety
Mar 16. The epic disaster in Japan overshadows all else, though it has barely registered a blip in US markets. If anything, the situation in Japan appears to be getting worse and the humanitarian ramifications will grow for the globe. Adding to the mix of uncertainty was a downgrade of Portugal and increased tension in Bahrain with the arrival of Saudi troops.
–In terms of markets, the factors that were in place prior to Japan- uncertainty about energy supplies, the prospect of liquidity removal by the Fed, worsening conditions in european financial markets- are still pretty much in place. The Fed meeting acknowledged commodity price pressures, but termed inflation pressures “temporary”. The Bank of Japan has of course pumped out a huge amount of liquidity to try to stabilize financial markets, and the Nikkei rebounded today from it’s plunge.
–The reaction in US rates has been a flatter curve, and of course increased vol. The ten year note is now around 3.30%, but I think it’s likely to move towards 3%, even though there are inflation pressures, and even though the Fed is the only buyer. My view is that all financial markets will become further unsettled, and everyone is going to demand a larger margin of safety, be it more collateral for loans, more margin for trading, less financial speculation.
March 11. US stock market “day of rage”?
–Moody’s downgrade of Spain was the opening catalyst for a move to higher bonds and lower stocks, but late news that Saudis had opened fire on protesters sparked an immediate 5 bp rally in green euro$ pack. Ten year yield fell another 8 bps on the day to 3.39%. Five year note is approaching 2%. One year euro$ calendars fell further, with EDZ11/Z12 down 6 to 120.5, down 12 in 2 days. There was a buyer of about 8k TY2H 119.5c for 7 early…nice trade as the contract blew through the strike. (weekly treasury options). SPM fell through 55 day moving avg.
–The market is clearly worried about the prospect of spreading Mideast unrest, with treasuries acting as the immediate safe haven. There are protests occurring in Saudi Arabia today…whether the outcome is peaceful or not, the ten year note will likely maintain a bid into the weekend.
–Another terrible earthquake, this time in Japan, which caused a tsunami. In the 1980’s whenever there was a large US natural disaster bonds would immediately sell off as insurance companies were thought to have to sell bonds to pay claims. In this case I suppose the Japanese govt is the ultimate insurer, with an already large overhang of outstanding bonds.
–Household net worth jumped over $2 T according to Fed’s flow of funds report, nearly all due to stocks. At the same time, the household sector continued to deleverage…good news, but it does seem to reflect an inordinate dependency on equities, which are mostly held by a small % of the population, and underlines the fact that the US hasn’t really changed from a paper asset economy in spite of the (last) crisis. The latest reaction to oil price increases similarly shows that the US hasn’t changed much regarding preferences for SUV’s, and the thought that cheap energy is a right. It’s going to take a lot more paper stocks to buy that oil going forward.
–Retail Sales today expected +1.0% and +0.7% excluding the Chevy Volt.
