Round trip back to 2016

August 11, 2016

Weekly Comment

There were many important lows made in 2016 across markets, just before the US election of Donald Trump.  For example, pictured below is the Copper/Gold ratio, which I will return to.  It bottomed in June 2016, which, by the way was just below the 2009 crisis low. (For a better longer term chart see link at bottom).  The US ten year note hit 1.36% and the 30 year 2.10% in June/July 2016. I had thought those levels would never be seen again.  However, this week the 30y came within 5 bps of that level though it ended Friday at 2.25%.  The STOXX Europe Bank Index (SX7P) index is back at the low of 2016.  The ratio of Russell 2000 small caps to SPX is back at the low of 2016.  So are the Aussie dollar and British pound. 

At the December 14, 2016, FOMC announcement, the Fed raised the target FF rate to 0.5% to 0.75%.  It was the second move in the hiking cycle which had begun in Dec 2015.  The statement noted (like a broken record) “Inflation has increased since earlier this year but is still below the Committee’s 2% long-run objective…” “Inflation is expected to rise to 2% over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.”  That was a reasonable call at the time I suppose.  WTI Crude had plunged below $30 by January of 2016, but by December it was back over $50.  On Friday, the front contract settled $54.50.  The one-year forward contract, CLU20, settled 51.69. In the interim, it traded just north of 70, as everything levitated with the signing of the US tax package in late 2017.  In Dec 2016, SPX was around 2250 vs 2918 now.   

While the current FF target is 2.00-2.25%, forward rates are trading back to levels more consistent with 2016.  In mid July of this year, Elizabeth Warren warned “I see a precarious economy that is built on debt – both household debt and corporate debt – and is vulnerable to shocks on the horizon that could cause our economy’s shaky foundation to crumble.”  I don’t know how much that warning resonates with the electorate, but it’s likely to become more of a talking point.  In any case, rate markets globally have bought into the ‘shocks on horizon’ thesis.  Will markets generally be able to hold 2016 lows?  I don’t know how much it has to do with the election cycle and how much it has to do with Fed and global central bank policies, but rate cuts have been more aggressively priced and it’s likely the Fed acquiesces, not to Trump, but to market signals. If anything, Trump’s strident tweets will slow the process (hence the recent bias toward flattening).  I doubt that the Kansas City Fed’s Jackson Hole conference, which starts August 22, will do much to shore up confidence.

Yields took a dive this week as the currency war escalated with the yuan piercing the 7 level.  On Monday SPX fell 3%, but staged a powerful rally through Thursday, before easing back on Friday, closing nearly unchanged on the week, even as Trump warned that September’s planned talks with China could be cancelled.  The ten year yield plunged and remained lower, closing -12.4 on the week at 1.733%.  The red and green eurodollar packs rose 13.875 and 14.625 on the week to end at 98.63875 and 98.6375.  The red pack starts in September 2020.  So, over this two year forward period, the market is currently projecting a short term yield level of around 1.36%, which is more consistent with a FF target of 1-1.25%.     

Of course, it’s not just the US.  Below is a chart of 10 year yields in Japan and Germany, with the latter having seriously out-Japaned the former.  In Q2 the bund yield decisively plunged below the JBG and never looked back; the gap has opened up to 36 bps (JGB -22 bps and Bund -58 bps).

The ten year yield in Greece began 2019 around 440 bps and is now just 2.12% having briefly dipped below the US yield (now 1.73%).  The US ten year yield is correlated to the copper/gold ratio (Gundlach indicator) with copper prices projecting manufacturing strength and confidence while gold acts as safe-haven.  This ratio indicates more downside in US yields.

With a larger percentage of global yields sliding into negative territory, and gold breaking out to new highs in many currencies, and bitcoin closing the week strong around 12000, larger questions about what constitutes a stable store of value are likely to dominate the investment landscape.  It’s really the Trump era that has seen the surge in bitcoin, and certainly the relationship between currencies is in flux at this time.  As prophesied in the 4th Turning by Strauss and Howe (1997), in the Unraveling, “…people will come to the jarring realization that they have grown helplessly dependent on a teetering edifice of anonymous transactions  and paper guarantees…The era will have left the financial world arbitraged and tentacled.”  I don’t know how close we are to an “Unraveling” but the idea of 14-15 trillion in negative yielding global debt is certainly a jarring fact that rests on the idea of financial engineering as a transmission vehicle to the ‘real economy’.  Can we be confident in that?   


The current Fed Effective has been around 2.13%, right in the middle of the Fed’s target range.  October FF settled 98.19 or 32 bps lower (covers Sept FOMC).  The Oct/Nov FF spread settled -16.5, indicating better than 50/50 odds of an ease at the Oct 30 meeting.  April 2020 FF settled 98.65, or 78 bps lower in yield than the currect EFFR.  The April contract covers 5 FOMC meetings.

From last week. “Dec Gold settled 1457.50.  Buy pullbacks close to 1440 with stop below 1414 and an objective of 1500 to 1550.”  With a high of 1522 last week this hit the objective much faster than I would have guessed, but still looks constructive. 

In 1986 the Chernobyl radiation accident occurred.   Grain prices rallied as Ukraine’s crops were threatened with contamination.  The latest Russian nuclear accident is much further north in the Arkhanglelsk region.  However, grains are a much better buy than sale. 

8/2/2019 8/9/2019 chg
UST 2Y 171.8 162.6 -9.2
UST 5Y 167.0 156.0 -11.0
UST 10Y 185.7 173.3 -12.4
UST 30Y 240.2 224.6 -15.6
GERM 2Y -78.8 -86.3 -7.5
GERM 10Y -49.5 -57.6 -8.1
JPN 30Y 32.1 21.3 -10.8
EURO$ Z9/Z0 -43.5 -45.5 -2.0
EURO$ Z0/Z1 -1.5 -2.5 -1.0
EUR 111.09 112.01 0.92
CRUDE (1st cont) 55.66 54.50 -1.16
SPX 2932.05 2918.65 -13.40
VIX 17.61 17.90 0.29

Posted on August 11, 2019 at 8:21 am by alexmanzara · Permalink
In: Eurodollar Options

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