March 10. Spain downgraded; peripheral bond yields rising

–US Ten year note fell below 3.5% to 3.47 even as news circulated that Pimco’s Total Return Fund had been purged of all treasuries.  New lows set in many one year eurodollar calendar spreads, for example EDZ11/EDZ12 fell 6 bps to 126.5. EDM1/EDM2 fell to 81 bps as the market lessens the odds of rate hikes any time soon. Big trade of the day was a seller of about 18k EDH12 99.375 straddles at 52 to 51. (Settled 51.0, -2.5 on day).  Same player as above also sold EDH12 9912^ in size of 6k.  Both are opening positions…deja vu for the option pit as EDU1 9937^’s were pasted in size a few months ago, starting at 45 bps.
–Spain was downgraded by Moody’s as it is set to reveal capital needs of the savings banks (cajas) of around 20b.  Peripheral bond yields keep rising, putting a circular strain on sovereign finances.
–China reported a trade deficit of $7.3b with exports up only 2.4%.  Perhaps that’s why Baltic Dry Freight rates remain low? Also, from Calculated Risk blog:  The Ceridian-UCLA Pulse of Commerce Index™ (PCI), issued Wednesday by the UCLA Anderson School of Management and Ceridian Corporation fell 1.5% on a seasonally and workday adjusted basis in February, after falling 0.3% in January.
–Transportation is the lifeblood of the economy…if prices and volumes are lackluster, then weaker economic data is likely going forward.
–ZeroHedge reports US naval resources are massing near Tripoli as the prospect of a no-fly zone draws closer.

Mar 9. Baltic Freight Indices reflect weak global trade

Uneventful session in US interest rates.  There was some selling pressure prior to the 3 yr as stocks recovered, but the auction was well received and eurodollars ended with only modest losses.
–Ten year auction today.  Ten year note to tip spread is edging a bit higher, now around 257.
–From a WSJ article yesterday: “Goldman Sachs has accused Saudi Arabia, the world’s most important oil supplier, of misleading the world about its oil production since late last year.
If true, this allegation would mean that the Organization of Petroleum Exporting Countries has far less spare production capacity to make up for the disruption of Libyan supplies than it claims, leaving oil markets in a much more perilous situation than anybody realizes.”
–Silver up another 55 cents this morning.  From the low of late January it’s up about 30%, slightly outpacing the gain in crude oil over the same time frame.
–The Baltic Dry Freight Index has been steadily moving lower, and is now at its lowest since Q3 2009.  The Cape Index (most volatile) was $35044 one year ago and $6548 yesterday. BSI Supramax was 26682 one year ago and 15486 yesterday.  I’m no shipping expert, but that doesn’t seem to be a reflection of robust global trade.
www.dryships.com/pages/report.asp

 

March 8. Worldwide risks remain elevated

–Net change in interest rates was negligible Monday even though there were large swings in other markets.  Crude was up over $2 early in the day before easing off.  Copper was down a whopping 14 cents (potential head and shoulders top setting up). Stocks fell. While markets took some solace from the idea of a negotiated departure of Gaddafi, tensions (and oil prices) are likely to remain elevated.  The spread between CLM1 and CLM2 (crude one year spread) has gone positive, with the near contract at a premium.  The bid “for storage” that was characterized by much cheaper near contracts and tankers full of oil idling outside of ports, has evaporated almost overnight.
–Outside of the Mideast, Greece was downgraded, Portugal ten year yields hit new highs, and Spain may take nationalization steps in cajas that don’t meet new requirements by Thursday’s deadline: (Breitbart) “Under the new rules, savings banks must raise the proportion of core capital they hold to 8.0 percent of total assets from the current six percent, or 10.0 percent if they are unlisted.”
–February US budget deficit was $233 billion.  I recall when a $400 bln ANNUAL deficit raised eyebrows.
–3 year auction today.

March 7. Ten year yield falls back below 3.5%

–Interest rate futures rallied after the employment data, which came in around published expectations at 192k and 8.9%.  However, the market was leaning towards even stronger data, and there were disappointments in hourly earnings, workweek, and the labor participation rate.  The ten year note fell back below 3.5% at 3.49.
–The upcoming week is light on US economic news, and trade will likely be driven by events in the Middle East, which seem to be worsening.  According to S&P website, energy is now around 13% of total market cap.  I seem to recall seeing that it was over 20% in the late 70’s and 80’s.  In any event, I am seeing more about peak oil, and about speculation concerning Saudi reserves.  Interestingly, while Geithner mentioned that the US could tap its strategic oil reserve, there was a piece last week in the Financial Times saying that the Philippines is ordering oil companies there to maintain increased reserves.  “…developing countries across Asia are taking evasive action, shoring up their strategic petroleum reserves against the risk of a prolonged supply shock.”  China is building strategic reserves currently.  Seems like a “no-brainer” for China to offload hot-potato dollars to the Mideast for oil, and let those countries in turn recycle their dollars for good old US manufactured weapons.
–Treasury auctions, (and Fed will buy) 3’s, 10’s and bonds this week.

–Just a few other thoughts.  I have a friend who assured me when stocks were near their lows and the economy looked awful, that ‘the Fed’s rate cuts and increased liquidity will work, just like it always does.’  Every time I think of that I slap my forehead with my palm, because of course, he was right and I thought….well, I was just wrong.  Well it seems to me that we are now running into the reverse situation…a lessening of liquidity.  Not only is the Fed supposedly going to end QE in June, but the oil price increase also drains liquidity.  And governments at all levels are moving towards fiscal austerity.  Back in the beginning of Clinton’s presidency, Greenspan supposedly made a deal to lower rates if the administration reined in the budget.  That was around the time the Clinton (quaintly) said something like “do you mean my economic program is dependent on a bunch of f’ing bond traders?”  I say “quaintly” because the US bond market has the Fed as its bond daddy now.  But Portugal is fighting a ten year rate of 7 3/8% while Spain is right around 5 3/8%, which is the rate at which Ireland is struggling with in the ECB deal.  In any case, Bernanke has no such carrot to dangle in front of the current administration…everyone knows the path is unsustainable.  We’ll almost surely have more QE beginning in Q3.

–The eurodollar option pit is rumored to have lost something like $200 million over the past month.  There really only seems to be about 4 big customers, and there is a lot of “disguised” market maker to market maker trading going on.  This might be a stretch…(well it is a stretch but I’m going to go with it anyway), but it makes me think about all the “social networking” and concepts like Groupon and Open Table.  The connection that I make is that these sites are a lot like local trades in the pit in that the “pie” isn’t getting bigger, the DISCOUNTS are.  Sort of like one advertiser picking the pocket of another.  While it feels like growth, just as Nasdaq in the late 1990’s did, only a few winners are likely to shake out…barriers to entry just don’t seem particularly high.  Is this another area that is simple driven by liquidity?

BELOW from Prudent Bear, citing Financial Times:

March 2 – Financial Times (Leslie Hook):  “As oil prices spiral higher amid turmoil in Libya, developing countries across Asia are taking evasive action, shoring up their strategic petroleum reserves against the risk of a prolonged supply shock. Their actions could propel crude even higher. The Philippines… announced… that it would require oil companies in the country to maintain 15 days of reserves, and refineries to keep enough oil to last for 30 days.  Manila’s move is the most visible sign yet of how Asian countries are seeking to improve their oil security… Analysts believe the political upheaval in the Middle East and north Africa is likely to encourage both China and India to accelerate their purchases of crude for strategic reserves… Unlike industrialised countries… China only recently began its strategic reserve programme, starting to fill reserves in 2006 and completing a 102m barrel build-out in ‘Phase One’ two years later.  The second phase of the programme will build a further 168m barrels… by the beginning of next year. When China finishes filling its reserve, which it is expected to do by 2020, it will hold about 500m barrels, equal to roughly three months of imports… China’s strategic stockpiling ‘is likely to be a feature of the global oil market not only this year but this decade’,

March 4. Watch out for a BIG payroll number

Employment situation today with NFP expected +180-200k.  However the market appears to be leaning towards a much higher number, perhaps more like 350k.
–Trichet said the ECB might have to raise rates to combat inflationary pressures, and an April hike is possible. Trichet’s comments, along with a sharp drop in Jobless Claims pushed the US ten yr yield up 11 to 3.57.  Also, Atlanta Fed’s Lockhart said he wouldn’t favor ending the QE program before June… “The economic situation makes the subject of whether to cut it short probably more debatable than whether to extend it,”  The curve was only slightly flatter as a near term rate hike in the US is unlikely.
–My own view is that a significant yield back up, if it should occur in reaction to a big payroll number, would provide a buying opportunity.  This feels to me somewhat like late 2007, when oil was screaming higher and stocks began to trade with more volatility before succumbing to the subprime debacle and financial crisis.
–A couple of other minor notes: Geithner said the US could tap its strategic oil reserve if supplies are disrupted.  Also, I saw somewhere that GM is again offering 0 % financing.  The US is addicted to cheap oil and cheap money…can’t always have both.  There was also an interesting piece in the NYT yesterday by Simon Johnson saying that the NY Fed is arguing against increased capital requirements for banks, creating a rift within the Fed and other institutions that find increased capital prudent.  The implication is that the Fed is doing the bidding of TBTF banks…another instance of demand for cheap financing without pain.

March 3. ECB leaves rates UNCH’d

Interest rate futures gave up early gains after the Beige Book, where the gen’l theme seems to be that companies are trying to pass on higher input costs. Comments attributed to purchasing mgrs in the last ISM report note higher costs and longer lead times for acquiring inputs. When concerned about both cost and supply, the natural reaction is to stockpile inventory. If the Fed had only price stability as a mandate, then rates would already be rising, and the oil price shock (up another $2 yest) would only support the case for rate hikes.  This morning’s ECB meeting is expected to lean that way; it’s expected the inflation estimate will be increased to 2%. 
–However, the Fed has repeatedly said the recovery can’t be complete without improvement in the labor markets (Job Claims expected 395k). And geopolitical tensions are spreading, threatening the economic outlook. For example, in Pakistan a Christian politician was assassinated, in Saudi Arabia a man who had tried to organize a “Day of Rage” was killed, and Libya continues to boil.

www.reuters.com/article/2011/03/03/us-pakistan-assassination-idUSTRE72216Z20110303
(Reuters) – Pakistan is being swept toward violent chaos by a growing wave of Islamist extremism, newspapers said on Thursday, a day after Taliban militants killed the country’s only Christian government minister.

http://www.monstersandcritics.com/news/middleeast/news/article_1623088.php/Report-Saudi-Facebook-activist-planning-protest-shot-dead
Riyadh/Cairo – Saudi activists alleged Wednesday that state security shot dead a leading online activist, who was calling for a ‘Day of Rage’ on March 11 in the oil-rich kingdom.

–While these forces would previously have caused a flight to the treasuries and the dollar, they now support gold.  And the PBoC is moving toward making the yuan more of a reserve currency with cross border transactions. 
Reuters provides a simple translation and summary of the announcement: “China hopes to allow all exporters and importers to settle their cross-border trades in the yuan by this year, the central bank said on Wednesday, as part of plans to grow the currency’s international role. In a statement on its website www.pbc.gov.cn, the central bank said it would respond to overseas demand for the yuan to be used as a reserve currency. (ZeroHedge)

–Pimco’s Bill Gross released a new investment outlook today with this line: Many critics, though, including yours truly, would wonder whether Quantitative Easing policies actually heal, as opposed to cover up, symptoms of an unhealthy economy. They might at the same time ask simplistically whether it is possible to cure a debt crisis with more debt.  Also,

March 2. Oil up $3 as Libyan situation escalates

Mar 2. Stocks slid as crude oil rose over $3 on Libyan tensions.  Gold and Silver both made new highs.  In his semi-annual comments Bernanke said there could be a short term inflation effect from rising commodity prices, and said the Fed was closely monitoring inflation expectations (10yr note/tip spread at new high of 244 bps yest).  He also said high oil prices represent a risk to the economy.  And while he noted that GDP reached pre-recession levels last quarter, he also highlighted weakness in labor and housing.  My conclusion is that thus far official actions have benefited capital as opposed to labor.
–Though eurodollars rallied, option plays were mostly bearish.  Midcurve March 9900p traded 85k, open int in the strike was up 67k.  Mostly buying of 9900/9887p spreads and EOH 9900p outright (2.5 and 3.0), though there was also a buyer of 9912/9900/9887 fly.  Fimat liquidated about 20k EDU1 9962c. Looking for a huge non-farm payroll number??  ADP today.  NFP Friday expected ~200k.
–While private sector news was pretty good yesterday, (ISM 61.4 and auto sales up 27% in Feb), the public sector situation is still shaky. From Reuters: States’ revenue forecasts increasingly off-base.  From WSJ: ‘A consulting firm is predicting close to $100 billion of municipal-bond defaults over the next five years as state and local government-debt problems “dampen” the U.S. economic recovery.’

March 1. Post Bernanke comments…

Stocks are selling off (ESH from 1330 to 1320) and fixed income is rallying (TYM from 118-16 to 118-24) in the wake of Bernanke’s comments.  Overall not much new, but the increased emphasis on inflation expectations, the mention of an exit from QE, (and that markets perceive a lessening of QE) all had the effect of weighing on stocks, which in turn supports bonds.  The treasury market was leaning short going into the testimony. 

–Bernanke also cited weak employment and housing, but noted that GDP last quarter hit pre-recession level.  Somewhat interesting coincidence that GDP recovered without labor improvement, while stocks rallied.  It’s a jump to assume cause and effect, although it does seem that official governmental actions thus far have accrued to capital, not to labor.

–I also find this comment interesting regarding QE: “All of these developments are what one would expect to see when monetary policy becomes more accommodative, whether through conventional or less conventional means. Interestingly, these market responses [higher rates, firmer equities] are almost identical to those that occurred during the earlier episode of policy easing, notably in the months following our March 2009 announcement. In addition, as I already noted, most forecasters see the economic outlook as having improved since our actions in August; downside risks to the recovery have receded, and the risk of deflation has become negligible. Of course, it is too early to make any firm judgment about how much of the recent improvement in the outlook can be attributed to monetary policy, but these developments are consistent with it having had a beneficial effect.”     I would note that in 2009 subsequent to March the ten year yield neared 4% in June, then fell back as the economy faltered.  Also in 2010 the ten year yield hit 4% in March…and then fell back as the recovery faltered.  And this year in Feb the ten year yield peaked at just above 3.75%….might we again get a relapse into economic stagnation as oil rises??

March 1. Could Mideast type unrest happen here

–Vol fell as shorter dated notes rallied, in part due to Fed POMO of $6.6 bln.  Implied vol softer.  
–Today Bernanke is before Congress for semi-annual testimony.  ISM expected 60.5 from 60.8.  
–This doesn’t have anything to do with the markets (for now), but…”Nation of Islam leader Minister Louis Farrakhan predicted on Sunday that America faces imminent uprisings that mirror those in the Middle East.
“What you are looking at in Tunisia, in Egypt … Libya, in Bahrain … what you see happening there … you’d better prepare because it will be coming to your door,” Farrakhan said in a booming voice, thousands of followers cheering in his wake.
Farrakhan also called on President Barack Obama to allow protesters to march, urging the president not to attack innocent people when they do. (from Chicago Tribune).  Farrakhan made these remarks in Chicago. http://www.chicagobreakingnews.com/news/local/chibrknews-farrakhan-mideast-uprisings-will-come-to-us-20110227,0,1665375.story
–While only 7.8% of white people in the city are unemployed, Latinos face a 13.3% unemployment rate, and African Americans a staggering 21.4%. This is the highest unemployment rate for African Americans in the ten largest cities in the country.  http://povertytoopportunity.blogspot.com/2011/02/race-matters-disparities-in-chicago.html
–Chicago’s black population fell the most, nearly 17 percent. Today, blacks make up 33 percent of the city’s population, down from 36 percent 10 years ago.
Hispanic population grew 3.3 percent in Chicago during the decade. But that’s less than the birth rate, meaning it’s likely that Hispanics also are leaving the city for the suburbs. Non-Hispanic whites now comprise 32 percent of the city’s population, while Hispanics of all races make up 29 percent.  http://southtownstar.suntimes.com/news/3845041-418/chicagos-population-drops-6.9

Feb 28. US interest rate implied vol going lower

–With only small change in US market this morning vol likely to be hit again.  New lows in near 3 month calendar spreads with EDH1/EDM1 at 5.5 and EDM1/EDU1 at 8.5. 

–Big picture features remain the same.  Mideast turmoil, high energy prices, growing US internal dynamics pitting states against the federal govt.  This doesn’t just have to do with Wisconsin’s fight against public unions, I also saw a piece about 11 states trying to pare back medicare obligations.  In terms of oil pricing the question is whether a move to relative stability will bring down prices.  The articles I have seen suggest the Saudis are still the swing factor, and I would think they would keep prices high for the short term 1) to remind the rest of the world’s leaders that stability in SA’s regime can benefit them through energy stability and 2) to provide a transfer tax from the rest of the world to pay for social improvements in Saudi Arabia.  
–Besides the drag on consumers from high oil, there is another issue in the US, that tax refunds to date are $20 bln below comparable level in 2010 and $14b below 2009 (zerohedge).  Might affect consumption…
–Today’s news: Personal Income and Spending both expected +0.4%. Chicago PMI expected 68 from 68.8.  Dudley and Rosengren speak.

• 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.