Feb 24. April Crude over $101, up $3
–Mediocre five year treasury auction yesterday, 7’s today. Eurodollar curve ended a bit steeper, though 2/10 spread flattened by a few bps. Selling once again in eurodollar options. There appeared to be fairly heavy liquidation of EDU and EDZ 9962c. EDZ 9937^ settled 40 from 42.5 the day prior.
–This morning oil is again screaming higher. Saudi king is trying to buy off his populace with a big social aid package. But protests in Greece, and in N Korea, and a bank run in S Korea are indications of growing international turmoil. In the US, the battle between budget conscious states and public worker unions is also heating up.
–Obama admin is proposing that mortgage servicers pay for reduction of principal on underwater loans, without end investors of those securities bearing any loss. (WSJ) The amount is apparently around $20 bln, and banks would also have to reduce second lien mortgages if terms of the first mortgage are modified. Bank stocks didn’t have a bad day yesterday, but I suspect that might change today.
–News today includes Durables expected +3.0%, Job Claims 405k and New Home Sales expected 310k. Existing Home Sales were supported by all cash transactions and other qualified buyers. Probably a good sign as real estate moves into stronger hands.
Feb 23. Libyan revolution. Change at the margin.
–Five year notes are being auctioned today. The yield fell 14 bps from Friday afternoon to yesterday’s close as Libya’s revolution captured the attention of markets, especially oil (+8.5%). Ten year yield fell back below 3.5% (now 3.46%), down 13 bps from Friday close.
–Stocks fell with Nasdaq down nearly 3%, and S&P down around 2%, the latter’s fall cushioned by oil stocks.
–Walmart down 3% due to poor execution. Home prices down over 4% y-o-y but Consumer Confidence is soaring (to 70.4 from 64.8).
–When faced with revolution, it seems that most of the world’s ruling class either flees with all the plunder that can be transported out, or vows to ruthlessly crush the opposition. In the US, politicians flee their jurisdictions when faced with… an uncomfortable vote. I just can’t figure out why the rest of the world has lost respect for the US.
–Rolling crises that have recently transpired seem to be successively more immune to the medicine of monetary/fiscal policy. For example, the subprime crisis (initially thought to be contained), exploded and was eventually mollified with low rates. European sovereign debt crisis, (initially thought contained to Greece) has spread to Ireland and Portugal, with a German monetary firewall hoping to save Spain. But the N African and Mideast revolutions have transcended Wizard of Oz theatrics of western central bankers yet CNBC still advocates “buying the dip”. If I only had a brain.
–The subprime crisis was thought to be manageable because the percentage of those mortgages was small. Greece was thought to be isolated because the size of the economy relative to the EU is small. Libya’s oil production is relatively small compared to all oil produced. Change happens at the margin, in inches. As Al Pacino says on Any Given Sunday:
On this team, we fight for that inch
On this team, we tear ourselves, and everyone around us
to pieces for that inch.
We CLAW with our finger nails for that inch.
Cause we know
when we add up all those inches
that’s going to make the fucking difference
between WINNING and LOSING
between LIVING and DYING.
Feb 20. Revolution tipping point
–Interesting day Friday. US interest rate futures started the day under pressure, following a sell off in euribor on Smaghi comments that the ECB might have to raise rates due to global inflation. However, the front end of the US curve came back to close positive as Mideast tensions dominated the end of week trade. There were several large new option positions entered in size, including buy of 20k EOM 9887/9912c 1×2 for 4.5 and 40k EOZ 9887/9912 c spd for 3.5. Also a buyer of 9k FVM 118c.
–Not surprisingly the curve was steeper, with reds UP 3.25 bps while golds were DOWN 3.125. Inflation concerns are everywhere, so anyone looking for a safe port from international turmoil gravitates to the US front end, not bonds. It’s difficult to follow rapid changes in Mideast events, but the central theme seems to be geographic escalation and growing violence. News footage of demonstrations has caught fire. China has taken steps to quell a “Jasmine Revolution”. And while news reports about demonstrations in Wisconsin describe civility and somewhat jokingly say discussions are cordially taking place over beers (for which the state is famous), the problem with pensions and states finances threatens to spill over like a rapidly drawn draught.
–Monday is a US holiday. Treasury auctions 2’s, 5’s and 7’s starting Tuesday.
–Below is an interesting link about water, rather than oil, as a dominant theme in Mideast.
www.guardian.co.uk/environment/2011/feb/20/arab-nations-water-running-out
(like putting out fire, with gasoline…or something like that)
“In the future the main geopolitical resource in the Middle East will be water rather than oil. The situation is alarming,” said Swiss foreign minister Micheline Calmy-Rey last week, as she launched a Swiss and Swedish government-funded report for the EU.
The Blue Peace report examined long-term prospects for seven countries, including Turkey, Iraq, Jordan, the Palestinian territories and Israel. Five already suffer major structural shortages, it said, and the amount of water being taken from dwindling sources across the region cannot continue much longer.
“Unless there is a technological breakthrough or a miraculous discovery, the Middle East will not escape a serious [water] shortage,” said Sundeep Waslekar, a researcher from the Strategic Foresight Group who wrote the report.
Feb 17.
–PPI was higher than expected at 0.8 with Core 0.5. Interest rate futures weakened but a story about Iranian warships in the Suez Canal and a possible Israeli response prompted a treasury bid which didn’t really fade even as the story did. Generally upbeat FOMC minutes were easily absorbed. Curve flatter with reds/golds -4.5 to 281.
–With protests flaring up through Arab states, it might be convenient for the leaders of those countries to divert the focus of the disenchanted towards an enemy other than themselves. For the sake of simplicity that could be Israel or could be the US. It’s possible there could be additional “provocations” to channel negative energy. Reminds me of a saying: “I didn’t say it was your fault, I said I am blaming you”.
–I have seen several pieces citing food prices as a catalyst for the uprisings…that many of these people use over 40% of their budgets for food. Even in the US, where the weighting of food in CPI is less than 7%, people are somewhat unsettled by rapid jumps in prices. With 42 million people (1 in 7) using food stamps and 20% of personal income from govt transfer payments, the situation (even here) could get more unsettled.
–CPI today expected +0.3 with Core +0.1. Job Claims 400k. LEI +0.2 and Philly Fed 21.0 vs 19.3 last.
— (BBG) The Federal Reserve ordered the 19 largest U.S. banks to test their capital levels against a scenario of renewed recession with unemployment rising above 11 percent, said two people with knowledge of the review.
–French Economy Minister Christine Lagarde was quoted earlier this week describing the global imbalances problem in blunt terms. (in front of weekend’s G20 meeting)
“China exports and saves, Europe consumes and the United States prints money and consumes. Is that a balanced model?” she said.
Feb 16. FOMC minutes this afternoon
Retail sales were a bit weaker than expected yesterday. Today’s news includes Housing starts, expected 540k, PPI +0.7 with +0.2 Core and Industrial Production expected +0.5 with Capacity edging up to 76.3. FOMC minutes released this afternoon.
–Interest rate futures were weak early yesterday but firmed into the close, with greens +4.0 (strongest part of the curve). Probably a bit of downside risk today associated with stronger than expected PPI. Also, Goldman apparently had a note that expressed the possibility of “exit strategy” discussion in FOMC minutes.
–While the economy seems to be improving, there are constant reminders of headwinds going forward. In terms of housing, mortgage rates have risen (mortgage applications down another 9.5% this morning), and I saw a blurb in the WSJ about banks wanting higher downpayments. Fiscal policy in states and municipalities remains contractionary, with CA Gov Brown calling for a hiring freeze for example. I saw a note in my local community about the need for pension reform. Many new fees and taxes are just starting to bite this year. On a personal note my new property tax bill went up 13% on one parcel and 19% on another…even though assessed values were lower. My perception is that federal stimulus is being completely offset elsewhere. (Without even taking higher food prices into account).
Feb 15. All inflation, all the time
Stocks continue to float higher on a sea of liquidity, with light volume. Grains pulled back a bit although copper had a new high closing settlement. There’s a lot of news out: China inflation +4.9%, Obama’s budget ($3.73T) with a huge projected deficit, continued demonstrations in middle eastern nations, and a reminder of european issues with problems at West LB.
–The overriding theme seems to be inflation concerns, which are now constantly in the press, and food costs in particular. (Clothing prices expected to rise 10% due to cotton). Are long treasury rates going to dramatically respond to budget deficits and inflation? So far Japan hasn’t had a crisis, and in fact is slightly upgrading its outlook. Will companies benefit from increased pricing power? FedEx, which just lowered its guidance due to weather challenges and fuel costs, is an example of potential problems. Keeping funding costs at zero (for TBTF banks), actually seems to be adding to risk at this point. In fact there is a story out about adjustable rate mortgages again gaining favor due to the steep yield curve.
–Despite what I perceive to be growing risks, implied vol in interest rates was crushed yesterday. For example midcurve Dec straddle went from 101 to 96.
–Today’s news includes Retail Sales expected +0.5%. TIC data as well.
Feb 14. Food prices rising
Thursday’s rise in yields was erased Friday, with longer maturities leading the way. Whenever red/gold pack spread gets around 300 it tends to fall back, dropping 8.75 bps Friday to 291.5. 2/10 treasury spread fell from 287 to 281.
–Food prices are getting more press. I saw a press piece about cold weather in Mexico and the US southwest causing produce prices to “skyrocket”. There is a note on ZeroHedge about rubber making a new high– just another commodity with a curve now in backwardation (nearer maturities more expensive than deferred, indicating shortages/strong demand). There was a huge jump in restaurant chain stocks last week, led by Panera. Why, it’s a triumph for US capitalism…even Krispy Kreme doughnuts is up 37% in the past three months. I would have imagined that higher input costs would be quite negative for the bottom line of restaurants, but that idea is not working for now. In terms of equities in general, I saw a CNBC piece where the commentator was comparing stock price action with that of 1982 forward. Maybe the price action is similar, but back then long bond rates were around 13% or so, the drop in rates was a HUGE tailwind for stocks. Also, there are comparisons between the fall of the Berlin Wall and Egypt. Germans still spoke the same language, the west was well developed, and East Germany was absorbed. Though it’s absolutely amazing to see the transformation in mideast states, I don’t know that the comparison quite holds.
Feb 11. Housing and QE intertwined
The housing/MBS collapse was the prime factor that reverberated through the economy and caused the financial crisis. Since that time, the gov’t backstops 85-90% of home finance. An administration report outlining ways for the gov’t to pare back its home finance involvement is supposed to be released today. At the same time, a prominent Chinese eonomist is recommending that China dump its GSE holdings ($500 bil) before QE2 ends in June. Even though the FASB relaxed mark-to-market rules it seems to me there still must be a lot of real estate related assets on bank books that will be further impaired if mortgage finance rates rise. And it doesn’t seem likely that the private sector would be willing to lend at the same rates currently available through the GSE’s. If the admin is truly serious about withdrawing support from housing, the Fed has no choice but to continue QE, which seems to artificially support both stocks and commodities (with attendant risks). If the Fed is serious about ending QE, then there is no way the admin can significantly pull back from housing support. I suppose it comes down to the sensitivity of housing to mortgage finance, and if there is continued home price erosion, what the impact will be on the economy in general. The WSJ has a piece today: Rise in Rates Is Headwind for Housing… and that’s just because 30 yr mortgage went over 5%. Like every other article it says rates are still historically low, but the article mentions nothing about credit availability. Though employment is slowly on the mend, it may be housing that again becomes a dominant issue going into the second half of the year.
Feb 9. Treasury yields (and commodities) surge
–Interest rates surged Tuesday, with ten yr note up 8 bps to 3.72%. (10 yr auction today). All near euro$ one-yr calendar spreads made new highs, with the peak now EDZ11/Z12 at 139. Last year in April tens hit 4% which capped the yield rise. At that time the third eurodollar contract traded around 99.10 (in comparison to EDU1 currently 99.39). The 4th contract had a spike low to 98.65. Highest one-yr spd was around 155. Ultimately of course, the Fed stood pat and eurodollars recovered, though it took a few weeks.
–In the current environment the market is convinced that higher yields at the long end won’t create conditions for a FF hike. However, many commodities made new highs with silver up nearly $1. March cotton and copper both posted new high settlements. Corn, wheat, beans, rice all indicating higher prices. It’s almost as if the rate hike in China was a green light to buy commodities. Also (Breitbart) “China is building up strategic reserves of rare earth metals in a move that could give it better control over the resource so indispensable to high tech products, the WSJ reported.”
–In the US, there is a shift against further accommodation, both monetary and fiscal, evidenced by several items yesterday. Lacker and Fisher both indicated opposition to further QE. Budget rhetoric is heating up, with the House possibly voting next week to block funding for Obamacare, and cut other spending. There is a proposal to begin raising the costs associated with FHA backed mortgages in order to reduce federal support of home financing to less than 50% (Reuters). Also from Reuters, ” U.S. cities and counties are getting ready to fight for federal grants they say keep local economies strong and residents employed, after President Barack Obama signaled he is open to cutting them.” While the hand-off from public to private support for the economy is welcome, there are still major headwinds in terms of housing and municipal finance that indicate a slowdown in the second half of the year.
Feb 8. China raises rates by 1/4%
–US interest rate futures closed nearly unchanged Monday after early weakness. However, one year euro$ calendar spreads edged to new highs. The widest one yr calendar is now EDH12/EDH13 which gained 0.5 bp to 135.5.
–Implied vol was weaker, suggesting that the move toward higher rates has abated for now. There was a seller of about 5k midcurve December (EOZ) 9787 straddles from 101.5 to 100.5 (100.0s).
–China raised rates, moving one year lending rate to 6.06% from 5.81 according to Bloomberg. New recent low in India’s SENSEX, off about 15% from Novemeber high. Brazilian stocks are also down about 11% since early November; markets which had completely recovered 2008 highs are now easing back – perhaps a cautionary note for all risk assets.
–Stocks continue to run higher, with the DJIA up over 20% since QE2 was suggested in August. It appears as though economic growth is now self sustaining, though it remains to be seen what happens when QE2 ends in June. We are still in an economy which is dependent on asset prices. After a long period of household deleveraging (much of it forced), December’s Consumer Credit was up over $6B.
–Speeches by Fed officials today include Lacker, Lockhart and Fisher. The treasury auctions 3 yr notes.
