Shades of 1997/1998



7/31/2015 8/7/2015 chg
UST 2Y 67.2 72.1 4.9
UST 5Y 154.7 158.2 3.5
UST 10Y 220.5 217.3 -3.2
UST 30Y 292.9 282.8 -10.1
GERM 2Y -23.2 -26.2 -3.0
GERM 10Y 64.4 66.1 1.7
EURO$ Z5/Z6 ** 76.5 79.0 2.5
EURO$ Z6/Z7 61.0 59.0 -2.0
** peak one-yr spd
EUR 109.84 109.67 -0.17
CRUDE (1st cont) 47.12 43.87 -3.25
SPX 2103.84 2077.57 -26.27
VIX 12.12 13.39 1.27


Review of last week: The employment report was termed “solid but unremarkable” by the Washington Post, an apt description. The odds for a rate hike in September therefore increased, not too much of a surprise there. What is surprising is the aggressive flattening that occurred in the wake of the jobs data. On the other hand, we had a taste of that reaction when the Atlanta Fed’s Lockhart on Tuesday said “I think there is high bar right now to not acting” and 5/30 instantly fell 5 bps from 133 to 128. By the way, Lockhart speaks again Monday.

On the week, 2/30 spread fell 15 bps as the thirty year yield sank 10 to just 283. According to a post on ZH, that was the biggest weekly flattening since April 2013. And 5/30 fell 13.6 to 124.6, the biggest weekly flattening since Sept 2011. Back month Eurodollar calendar spreads all made new recent lows. For example, red/green Eurodollar pack spread on a rolling basis (2nd to 3rd year), closed at a new monthly low Friday of just 56.5 bps. The range this calendar year has been about ¼% from 51 to 73, and we are obviously near the lower end of that range despite what is generally referred to as a moderately growing economy with the Fed poised to raise rates. The deflating curve is starting to cause some pain.

In terms of outright yield levels, the ten year is at the 38% retrace of this year’s low in January to high in June (38% is 216.3, at the futures close I marked tens at 217.3). The thirty year bond is just below the 38% retrace which is 285, vs 282.8 close. These are important support areas. The 50% retrace levels are 206.3 and 273. I personally expect 281 to hold in the bond…why? Because, on May 20 I made a bet with a client (for a cold beer) that we’d see 325 before we reached 280. We did get to 324, but never closed above 325. I think perhaps we single-handedly defined the rest of the year’s range.

There are a myriad of reasons that treasury yields are falling. While economic growth has been good, it hasn’t been accompanied by inflation and strongly higher wages. In fact, the CRB index actually made a new low this week falling below 200…lower than the plunge in 2009, when oil got down to $35. Chart of CRB:

CRB new low 2015




Additionally, there is lower global growth. Brazil is in recession; according to Markit, the 7th largest economy in the world “faces a bleak outlook.” Similarly, because China has decided to peg its currency to the dollar, it is encountering deteriorating trade conditions. Reuters: “[China’s] Exports to the European Union fell 12.3 percent in July while those to the United States dropped 1.3 percent. Demand from Japan, another big trading partner, slid 13 percent…Analysts say Beijing has been keeping its yuan strong to wean its economy off low-end export manufacturing. A strong yuan policy also supports domestic buying power, helps Chinese firms to borrow and invest abroad, and encourages foreign firms and governments to increase their use of the currency.”

I showed earlier this week that Brazil’s ten year dollar denominated bond yield had broken out to the upside. In other indications of increased credit risk, high yield ETF’s in the US, HYG and JNK closed at new lows for the year. Berkshire Hathaway’s net income “…fell to $4.01 billion, or $2,442 per share, from $6.4 billion, or $3,889 per share, a year earlier – a stunning 37% plunge.” ZH. I don’t know exactly what BRK holds besides Geico and railroads and Dairy Queen, but I do think it’s sort of a slice of Americana that is indicating a slowdown. On another anecdotal note, Fannie Mae’s National Housing Survey for July was also negative. From Fannie’s website: “The dip comes as more consumers reported a negative outlook regarding personal finances and the direction of the economy. The share of consumers saying the economy is on the wrong track rose by 3 percentage points to 54 percent in July.”

This is a fairly slow news week, although on Tuesday the Nat’l Federation of Independent Business Optimism survey is released, expected to bounce to 95 for July. The last report plunged 4.2 to 94.1. I suppose one negative print doesn’t necessarily change a trend, but here’s some commentary from the site’s economist: June terminated a promising string of improvements in owner optimism during the first months of the year. While it is not a disaster or a signal of a looming recession, it is a disappointing sign that economic growth on Main Street is not set for a strong second half of growth. The weakness was substantial across the board, showing no signs of a growth spurt in the near future.So Tuesday’s release might bear just a bit more scrutiny. Retail Sales on Thursday.


Let me just circle back for a minute to the emerging market problems.   I already mentioned China and Brazil. I have thought for some time that the current environment of weak EM currencies and industrial commodities bears some real similarities to 1997/1998. The chart below doesn’t prove anything, but in my research I did think it was an astounding how charts from different periods can trace out such similar patterns over identical time frames.

ibov shcomp 1997 to 2015

(It might be a little difficult to see the text, but the green line is Bovespa from Sept 1996 to July 1997, it rallied 2.12x (peak is in July 1997). The red line is the Shanghai Composite which rallied 2.35x from August 2014 to June 2015. Both then traded lower, of course there has been significant and overt support by the Chinese authorities. What isn’t shown on this chart is that within another year, Bovespa had plunged well below the starting point of 6500, to 5000. Commonly known as a crash. Warning to China bulls?

At the end of 1997, many people recall that the emerging market currencies were under severe pressure, including the Indonesian Rupiah, the Thai Baht and the Mexican Peso. It is a similar circumstance now, and we can of course, throw the Brazilian Real, Turkish Lira, SA Rand, etc into the mix. Capital is fleeing these countries. What many people might not recall is that crude oil was tracing out a pretty similar pattern at that time to the current situation as well. Here’s a chart:

crude 1997 vs 2015


Where does this leave us in terms of treasury yields and monetary policy? Well, the first important lesson, in my opinion, is that not all the moves were simultaneous.

Thai baht bottomed in January of 1998, both the rupiah and crude oil bottomed in June 1998, SPX in September with a revisit in October, and MXN peso in Sept. It was July to September that SPX fell 20%. [20% from the high of this year would be 1700, SPX currently 2077]. From the end of July to the beginning of October the ten year yield went from 550 to 420, 130 bps. The FF target was 5.5% during this time period. The first cut came on Sept 29, 1998, 25 bps to 5.25, then again in mid-October and mid-November to bring the target to 4.75.

It was only after the Fed cut that both stocks and bond yields stabilized.   By March 1999 the ten year yield was back up to 540. It doesn’t appear as though the Fed reacted to the emerging mkt crisis of 1997/98, until US equities started to plummet and ten year yield dropped simultaneously.

In the present case, we are seeing modest pressure on both long end yields and stocks. Almost certainly not enough at this point to forestall tightening. The FOMC is still 5 ½ weeks away. By the trend of economic data, I wouldn’t be surprised to see more signs of a stall, though with the quarterly refunding this week perhaps there will be a small yield concession. Again, tens and bonds are at support levels.

From a trading perspective, I think the odds this week favor a pretty quiet range in tens with a slight bias towards higher yields, though any back up toward 225 should be bought. The risks of course are that recent trends accelerate in oil and EM, spilling into US equities, which would cause support yields to give way, perhaps dramatically.

The other big factor to watch is China. Trade data indicate that by holding the peg to the USD, China has ceded export share to other Asian countries, and Germany. Any indications of depreciation in the yuan would unleash a new global disinflationary wave.

Posted on August 10, 2015 at 4:54 am by alexmanzara · Permalink
In: Eurodollar Options

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