Jan 11. Portugal accepting aid package?
Interest rate futures continued to firm, with ten year note dropping another 2 bps to 3.30%. New low in EDH11/EDH12 at 57.5 bps, down 4 on the day. There was early selling of midcurve puts which appear to be exits, EOM 9750/9775 and EOU 9750/9800p spd all sold in size of 10k. There was a buyer of 25k EOM 9900/9925c 1×2 (new) and 50k EOH 9912/9925c spd for 5.5, which looks like a roll up of a short from 91 c to 92 c.
–Portugal’s situation continues to worsen; now expected to take an aid package. Japan is pledging to support the euro. Kind of like California pledging to help Illinois. However, India is offering to pay Iran in gold in order to assure continued supply of oil (and avoid sanctions on Iran)…this from a zerohedge piece.
–From today’s Telegraph a nice summation of the euro issue: ‘…the bail-outs themselves – done in the in the name of “saving the euro” – are causing the crisis to spread ever wider by contaminating stronger states instead of separating the balance sheets of good from bad, as would be normal in a debt clean-up operation.’
–Treasury auctions this week. Because of continued european turmoil they should be well received. 3 yr auction today followed by tens tomorrow. Today’s Fed purchase of $7-9 billion of notes maturing in 2016-17. The schedule for additional Fed purchases of treasuries is to be released tomorrow.
Jan 10. Rising energy, state taxes counteract Fed stimulus
A backdrop of unsettling news continues, with European sovereign debt problems, US state debt problems (Illinois as poster child/NYT article), currency and trade war tensions, rising gasoline prices (up 9 cents to 3.09 in past 2 weeks, Chicago highest in nation), inconsistent employment growth, more mortgage/robo-signing issues for banks, and now the shooting of US Congressman Giffords. IL wants to raise state income tax from 3% to 5.25%. Rising energy prices and state fee/tax increases are counteracting federal stimulus. I didn’t double check this but heard that the JOC index of industrial materials made a new high.
–One year euro$ calendar spreads sank after employment report. For example, EDU11/EDU12 fell 10 bps to 93. Only a few one year spreads are clinging to levels over 100 bps. The idea of Fed rate hikes keeps being pushed into the future.
–There are treasury auctions this week, but also continued Fed buybacks (POMO’s) which commence today, $7-9 billion of treasuries maturing 2018-2020.
–The ten year note yield closed around 3.32% Friday, and seems to have rejected 3.5% for now. Though many believe treasury prices are in an unsustainable bubble, I think 3.10 to 3.20 is likely to be the next stop, as a flight to relative safety dominates trade.
Jan 7, 2011. Emp situation. Europe debt problems threaten to overshadow
Employment report today. NFP expected 140k to 200k, though some estimates are higher after big jump in ADP. Some huge euro$ options trades. Buyer of 60k EDM1 9900p 6.5 (exit). Seller of 30k EDU 9937^, adding to short. Buyer of 30k EOM 9800p 18.5/19, adding to long puts; short the market.
–While the data is likely to support views of a US job market on the mend, it may be overshadowed by the global theme of a revolt against government support of financial firms at the expense of the general public. It started small with Iceland and Greece, went to Ireland, and now the EU is trying to tackle the issue, releasing a proposal with the suggestion that senior bondholders take haircuts for failing banks. From the Telegraph, ‘There would be a strict ranking of creditors. “Equity should be wiped out before any debt is written down, and subbordinated debt should be written down completely before senior debt holders bear any losses,” said the document.’ Severe budget problems aren’t going away, and creeping austerity measures are meeting resistance. The government safety net for senior bondholders is fraying.
–The US market responded with selling pressure on front eurodollar contracts, and a bid in treasuries and the dollar. The dollar index is breaking out to the upside. A stronger dollar along with CFTC’s proposals to consider position limits could negatively impact commodities that have become darlings of the ETF crowd.
Jan 6, 2011. Huge jump in ADP payroll growth
ADP number showed large unexpected increase of 297k vs expected 100k. Interest rates jumped on the report, sending the 10 year yield up 13 bps to 3.48%. Red eurodollars sank 19 bps. There was huge buying of EOM 9800p from 18 to 19. This put traded 100k yesterday, though about 40k of that was related to a buy of 20k EOM 9850/9800/9750p fly. There was an outright buyer of the puts in size of around 50k. Open interest was up 63k. In fact all midcurve puts had significant rises in open interest. Sustained improvement in the labor market is supposed to be one of the last necessary conditions before the Fed can snug. Friday’s NFP expected 140k. Today’s Jobless Claims expected 412k from 388k.
–One year calendar spreads from fronts to reds made new highs, with EDM11/M12 up a whopping 14 bps to 94.5.
–The yen was crushed vs dollar, with futures dropping 2 big figures. Nikkei is rallying due to yen weakness. However, US equities haven’t been dented by renewed strength in the dollar index.
–Two WSJ headlines this morning: Global Food Prices Hit Record High, and Health Spending Eats Up Record Chunk of GDP (17.6%). From Tuesday’s Fin Times: Rising oil price threatens fragile recovery. It’s not inflation, it’s a rise in the share of spending devoted to needs, a cautionary signal going forward.
Jan 5, 2011. Start of a slide in commodities?
Jan 5. Big slides in gold and silver yesterday, which may portend a more general commodity pullback and dollar strength. Red/green euro$ pack spread had been making new highs over past several sessions; it also came under profit taking pressure, with red pack -3 bps and greens +3.5.
–There’s a note on ZeroHedge about the CFTC taking a renewed look at position limits. Per Reuters: “Under the system, if a trader’s holdings in a commodity reaches a certain threshold, it triggers a new level of heightened regulatory scrutiny by the CFTC where commissioners could vote to require the trader to reduce their positions.” This may be the story of 2011. The aftermath of oil’s moonshot to $140 in 2007 was ugly, and now ETFs are prevalent in just about every commodity. I know it’s against the free market mantra, but I think position limits have a place in basic commodities. I also recall crazy moves associated with “corners”, like the Hunts in silver and Ferruzzi Grain in soybeans in 1989. There’s a passage in Reminiscences of a Stock Operator where Livermore says government actions can always be a wildcard in trading positions. China with rare earths is perhaps the best current example. The entire economy is a wildcard currently…
–Saw a piece cited on Drudge that says real estate investors now have to fill out many more tax forms and maintain onerous record keeping, sending 1099’s to anyone that does work. That ought to help the housing market.
http://washingtonexaminer.com/blogs/beltway-confidential/2011/01/new-law-creates-big-tax-headache-rental-property-owners
—-ADP and Non-mfg ISM today, expected 56 from 55.
Jan 4, 2011.
Jan 4, 2011. US interest rate futures rallied back from steep losses to close nearly unchanged. Selling pressure was evident just prior to ISM, which was strong at 57.0, though after the actual data was released buyers took over, one of which was the NY Fed with a large Permanent Open Mkt Op. The next two days feature smaller POMO’s, with $1-2 bill in TIPS today and $1.5 to 2.5 bill of 18 to 20 year maturities tomorrow.
–Copper set a new high. Gold and silver were strong in the morning but silver especially had a large reversal and is lower yet this morning. However, stocks held on to gains. Over a longer timeframe, stocks have only gone sideways when priced in gold since lows in 2008. (See chart).
–Red/green pack spread notched another new high at 112.5 bps. Been a strong trend higher, as in late November this spread was 64 bps. Red/green/blue butterfly has rallied from around -15 to +15. I think this fly has gotten a bit ahead of itself.
–Reuters “Roughly 1.53 million consumer bankruptcy petitions were filed in 2010, up 9 percent from 1.41 million in 2009…” Highest in five years. This is an example of consumer “deleveraging”, not intentional, but forced. On the other hand, losses are marked and it allows for a fresh start.
Dec 29. Rates jump on weak 5 year auction
Dec 29. What a difference an auction makes. On Monday interest rate futures rallied after a strong 2 year note auction. Yesterday prices slid after a weak 5 year auction. Ten year note is again near 3.5%. Copper made a new high, gold soared over $20/oz and silver gained over $1 as China again moved to limit the export of rare earth metals.
–Near euro$ one year calendar spreads made new highs with EDU1/EDU2 finally breaking 100…up 6 bps to 104. Red/gold pack spread gained over 8.5 bps to 278.
–A small Michigan city (Hamtramck) is trying to file for bankruptcy, but the state of MI is trying to block the move…because its concerned the floodgates will open. I’ll take the ‘over’ on Meredith Whitney’s prediction.
–From the AP: “Home prices are dropping in the nation’s largest cities and are expected to fall through next year, as fewer people purchase homes and millions of foreclosures come on to the market. The Standard & Poor’s /Case-Shiller 20-city home price index released Tuesday fell 1.3 percent in October from September.” Keep in mind that in Oct, mortgage rates were a lot lower than they are now.
–Gasoline continues to rise. On a rolling contract basis crude oil is now around halfway back from the 2007 high around $140, and the ’08 low.
–7 year note today.
Dec 28. US States’ fiscal woes threaten to blunt Fed stimulus
As an example of fiscal woes plaguing state and local governments, consider the state of Illinois. State and local governments comprise about 13% of GDP, so the crunch in this sector is likely to blunt the effects of federal stimulus measures that were recently enacted. All sorts of fees and taxes have been rising, but in the case of Illinois, proposals to raise the income tax have so far floundered, with Governor Pat Quinn aiming for an increase of 1%, from 3% to 4%. In other words, tax increases and budget cuts are yet to come in many states, and the end of the Build America Bond program is another headwind for state budgets in 2011. In June of 2010, Moody’s downgraded IL debt from Aa3 to A1, saying the state lacks the political will to deal with fiscal problems.
As of the end of 2008, IL was the 5th largest state as a contributor to US GDP at 4.5%, in an amount of $634B. The larger states are CA, TX, NY and FL, with CA at around 13% of US GDP. Besides TX, all of the above states are in bad fiscal shape, for many of the same reasons: falling tax revenues accentuated by the drop in real estate values, and unpaid pensions.
In IL, one issue that has begun to garner increasing (negative) publicity is the pile of unpaid bills owed to vendors of all types. These liabilities are apparently in the staggering amount of between $6 and $8 B. In 2008 the unpaid bill backlog was $512 million. The Chicago Tribune reports today (Dec 28, 2010) http://www.chicagotribune.com/news/local/ct-met-governor-quinn-20101227,0,6073116.story that Gov Pat Quinn is looking at floating a $15B bond issue to cover unpaid bills. From the article, “Those the state owes now get 1 to 2 percent in interest for each month payments are late after the first 60 days.” My understanding is that 2% is only in special circumstances, but at 1% the state is losing $60 million per month in extra interest and penalties at a minimum. If the bond float passes, I would guess the state could save at least $30 million per month in cheaper interest.
Another (much less publicized) step the state has taken to deal with unpaid bills was noted in the Huffington Post http://www.huffingtonpost.com/david-ormsby/governor-pat-quinn-is-mov_b_798455.html and on the website Illinoisisbroke.com http://www.illinoisisbroke.com/newsitem.aspx?id=673 as reported November 15, 2010. The idea (which was done in small size in a pilot program) “allowed a handful of vendors to sell financial institutions the rights to their overdue payments.” It is basically a collection agency arrangement made with the blessing of the state. The structure of the deal is that the “investor” or buyer of the rights, immediately pays the vendor 90% of the amounts owed, with 10% held in escrow. The investor receives the accruing penalty interest payments directly from the state (eventually), and then the other 10% is released to the vendor. So the vendors forfeit the extra interest in order to get immediate cash flow for survival. From the HuffPost article: “I applaud Governor Quinn’s clever initiative to pay overdue bills owed to human service providers and other state vendors without adding to the state’s debt,” said State Rep. Sara Feigenholtz (D-Chicago), the Chair of the House Human Services Appropriations Committee. “This program will rescue many social service providers operating on the edge of financial extinction.”
The previous quote, while true in terms of possibly saving vendors that are swirling the toilet bowl because they can’t cover their costs without cash flow, shows willful ignorance by asserting the state is not adding to debt. The state already HAS the debt, and is paying PUNITIVE interest rates. If that’s “clever” then I would hate to find out what Ms Feigenholtz considers “stupid”. The questions that naturally arise might be 1) if we pass the bond issue can we tie it to a proposal to pay all unpaid bills IMMEDIATELY with NO INTEREST or PENALTIES? Why can’t the state negotiate those terms directly with vendors? 2) if investors are willing to accept lower interest payments on Illinois bonds, can the state negotiate lower payments than 1% per month directly with those investors who assume the unpaid bill debt? In my opinion, the state of Illinois is guilty of gross financial misconduct, but I suppose that shouldn’t be a surprise, since several former governors have been sent to jail.
The other huge issue facing IL and other states concerns unfunded pension liabilities. According to an article by Mish Shedlock http://globaleconomicanalysis.blogspot.com/2010/04/interactive-map-of-public-pension-plans.html IL unfunded pensions are at least $209 billion. At least two plans, for the Universities and the Teachers Retirement System are less than 30% funded. That’s a pretty large chunk of money relative to GDP of $634 billion. I’m not sure if the two numbers are exactly current, but I would safely guess that IL GDP isn’t significantly higher than it was in 2008.
The point is that several large US states are facing fiscal problems similar to european countries, and the crunch of budget cuts and increased taxes/fees will occur in 2011 as a direct and opposite force to federal stimulus.
In: Eurodollar Options
Dec 21. Spanish ten year at new low, EURCHF new low
After the Fed finished both POMO operations Monday the bond market slid back to close lower on the day. Stocks were firm.
–According to an item on CBS News the latest terrorist threat has to do with poisoning food at restaurants. The report specifically cited salad bars and buffets. Whew! That means I’ll be safe with the double cheeseburger, but just in case, hold the pickle.
–EURCHF broke to new lows. A piece by ICAP on zerohedge noted that this move likely portends renewed sovereign debt fears.
–In the US the fears concern city and state finances. For example, the State of Illinois is months behind on accounts payable, which is creating hardship on vendors to the state. Apparently, the state pays a penalty of 1% per month on these late balances to the vendors. Seems crazy, because the interest rate the state collects on unpaid income taxes is 4%. In any case, the state is shifting these payables to investors, who, as I understand it, will pay the vendors the amount due, and collect the 1% per month from the state. This apparently circumvents the political process that would require legislative action to issue bonds at a more beneficial rate (for taxpayers). One could almost conclude that Illinois couldn’t raise money from the “market” at a rate below 12%….
Dec 17. Moody’s downgrades Ireland
Heavy selling pressure on bonds seems to have abated for now. The only economic news today is Leading Indicators, though Moody’s downgrade of Ireland could negatively impact front end over funding concerns. After the huge move down it’s not surprising to see a bounce; five year note moved from 1.03% to 2.12% in a month and a half, and ended yesterday around 2.06. Possible weekend bid over terrorism concerns?
–Huge buying yesterday in E2H 9825/9850/9912c fly with extra 9912c, 2.0 paid for 60k. The top call strike was cover. There was also a notable buyer of 7k JYH 112p and 1k JYM 110p (notable in the fact that CME fx options aren’t typically very active). Could it be that the small increase in JGB yields causes a tipping point for Japan’s budget deficit? Or due to impending China tightening?
–Visa and Mastercard were crushed yesterday as the Fed proposed to limit transaction fees for debit cards. (-14.5 and -11.5%). Stock market in general is still firm, though given QE2 and tax stimulus reaction, it appears to be somewhat tired.
