Renzi channels Clapton. “Before you accuse me, take a look at yourself”

Let’s start by taking a look at some ten year yield levels, and changes ytd (in red):

12/31/2015 7/9/2016
US 227.5 136.3 91.2
GERMANY 62.9 -18.9 81.8
FRANCE 98.8 10.3 88.5
SPAIN 177.0 114.7 62.3
UK 196.0 73.5 122.5
NETH 79.3 0.0 79.3

This is just representative.  I only included the Netherlands because on Friday, that yield actually joined Hades underworld before closing at zero.  These declines are stunning.  Just for fun, let’s look at sifma’s end of 2015 rate forecast.   When the survey was completed on 12/4/2015 the 10 yr was 2.28%, and median survey forecasts were 2.55% for June 2016 [only off by 100bps] and 2.70% for December 2016.  On the plus side, “The overwhelming majority of respondents expected the Treasury yield curve to flatten by mid-2016 (94%)”

Well, the curve certainly has flattened to crushing new lows.  2/10 treasury spread ended at 75 bps, having started the year at 122.  Red/gold pack spread plunged 5.625 bps on Friday alone to close at 47.25, having started the year at 89.  The latter is just 47 bps away from this century’s low of 0 in 2000 and 37 away from the intervening low of 10 in 2006, essentially following the same path set in 2004 to 2006 when the fed was hiking 25 bps at EVERY meeting.  [Chart of red/gold below]

Of course, not all forecasts were off the mark.  For example from an interview in early 2015, Jeffrey Gundlach “…thinks the 10-year that finished 2014 at 2.17% could potentially take out its modern-era low of 1.38% yield hit in 2012. This would particularly be the case if crude-oil prices keep falling to, say, $40 a barrel from their 2014 year-end level of about $55. This further drop …would only accentuate deflationary forces he sees at work globally that continue to drop long-bond yields.”  He added this, which is still highly appropriate for today:  “And the strengthening dollar, which we think will continue, only makes U.S. bonds all the more attractive, for not only do foreign investors benefit from higher relative rates, but they also win on currency translation profits.”  Speaking of fx translations, note that Serena Williams’ Wimbledon “…prize is worth $2.59 million when converted to U.S. dollars, about $380,000 less than it was worth a few days before the tournament, on the eve of the U.K.’s vote to leave the European Union. “  Doh!

red_gold July 2016

I would add a couple of other bullish factors for bonds.  First, a story on Bloomberg notes “the outstanding amount of treasury notes and bonds split into principal- and interest-only securities jumped to $223.1b in June, the highest level in more than 17 years” due to demand for duration.  By way of comparison, this week’s auctions of 3s, 10s and 30s is $56b.  Second, an article from the Telegraph says the ‘World faces a deflation shock as China devalues at an accelerating pace.’  From Hans Redeker, currency chief at MS, “They seem to be overriding their own model and letting the remnimbi fall to improve competitiveness.  They are in the same sort of deflationary syndrome as Japan in the 1990’s but on a much bigger scale.  The global economy is in no position to absorb this.”  Just to emphasize this point, China’s trade minister Gao Hucheng said at the G20 meeting on Saturday that the global economic recovery remained “complicated and grim”.  “Global trade is dithering, international investment has yet to recover to levels before the financial crisis, the global economy has yet to find the propulsion for strong and sustainable growth.” Gao’s not really one to mince words…  Another G20 downer from BBG, G20 Trade Ministers See Global Investment Falling Up to 15%.

The above points don’t even factor in safe haven demand given the possibility of an unexpected bomb in the European banking system, or any of the myriad of other reasons for a flight into treasuries.   Not to put too fine a point on it, but Italy’s Renzi  threw some shade at DB saying Italy’s bad loan problem is tiny compared to the size of potential derivatives issues.  “If this non-performing loan problem is worth one, the question of derivatives at other banks, at big banks, is worth one hundred. This is the ratio: one to one hundred,” Renzi said.

So let’s say you’re from another planet, and you’ve just taken a job as an underfunded pension manager looking for returns of 7% a year.  What do you do?  Well, you buy US bonds because they have a relatively juicy global yield.  You buy high-yield (HYG and JNK hi-yld etfs made new highs for the year).  You buy US stocks despite the earnings recession.  You sell premium to squeeze out a few additional basis points.  And you do all of this with a dollop of leverage.  Then you go to a casino, order a stiff drink and play craps… realizing in the back of your mind that the Nikkei has not exceeded its bounce from 1996 in the past 20 years.

A few comments about Friday’s astonishing trade.  First, while the headline NFP number showed a nice rebound in jobs, the household survey didn’t, at just 67k.  Second, all Eurodollar one year spreads are making new lows.  While they were mostly around 25 bps throughout April and May, they are now less than half that, with Sept16/Sept17 at just 11 bps and Dec16/17 at 11.5.  On the FF curve, you can buy a hike for the Feb 1 FOMC meeting for nothing… FFF7/FFG7 is -0.5/0.0.  Of course, that’s because the guy selling it to you is buying an EASE for the same price!

BOE meeting this week.  Carney to the rescue?  Also earnings season starts in the US this week.

Tarullo speaks Tuesday, Exploring Shadow Banking; Can the Nation Avoid the Next Crisis?

Policing in other countries:

Trade thoughts

On Friday I looked at just buying TYU 136c which were 16 at the time (133-08), and settled at 20/64 (21d, 47dte).  From the settlement of 133-25.5, the 136 strike is around 25 bps away, or approx. 1.11% yield on the current ten year.   I don’t see much reason why US tens can’t get to the same yield level as, let’s say, Spain.  Also vol was spanked Friday with atm around 5.3 to 5.4, at the lower end of the range.  Note that Sept treasury options expire on August 26, the same day as Yellen is slated to speak at Jackson Hole. The conference is entitled “Designing Resilient Monetary Policy Frameworks for the Future (because we’ve given up on the present)”  Just kidding, I made that last part up, but really, it doesn’t seem so far from the truth.

Posted on July 11, 2016 at 5:36 am by alexmanzara · Permalink
In: Eurodollar Options

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