Weak Housing, Lower Rates

April 21, 2019 – Weekly

On the week, prices didn’t change all that much.  The US ten year yield barely budged, ending Friday at 2.556%, even though the Fed is working hard to communicate a new plan to allow inflation to overshoot in order to catch up with previous shortfalls. While yields have generally been increasing throughout the month of April, Thursday’s price action was somewhat interesting, in that rate futures rallied in spite of stronger than expected retail sales data and jobless claims that have fallen to their lowest level since 1969. Of course, on Saturday morning’s WSJ site there’s this headline:

Fed Officials Contemplate Thresholds For Rate Cuts

As can be seen on the chart below, TLT, an etf which tracks the market-weighted index of US Treasury debt with remaining maturities over 20 years, traded huge volume on Thursday, three to four times normal, causing a modest bounce in price.  Why the demand for the long end?  Perhaps it’s simply an anomaly, as treasury futures volumes weren’t particularly high.  Or maybe the market is sniffing out the possibility of rate cuts and more QE around the corner.  Near term cut odds have been trimmed recently, with January 2020 Fed Funds at 9772.5 or 2.27%, essentially projecting a 50/50 chance for an ease by the end of this year.  But flows still favor the Fed’s next move as easing.

TLT – long bond etf- heavy volume Thursday

It’s worth noting that the US dollar index continues to exhibit strength near a two year high, and that stocks are also seeing solid demand.  It’s pretty amazing to see VIX languishing just above 12 when the upcoming week features earnings reports from over 1/3rd of the SP500.  Large companies reporting include AMZN, FB, MSFT and XOM. (Just those 4 companies have a combined market cap of $2.7tr).  

On Friday, housing data was released and showed surprising weakness of -0.3% month over month, with February revised to -12%!  YOY housing starts have fallen to -14.2%.  The chart below indicates the turn, even as the long bond remains below 3%.

Interestingly, the NY Fed released a note on housing on 15-April, titled ‘Is the Recent Tax Reform Playing a Role in the Decline of Home Sales’.  In short, the answer is yes.  The paper compares three recent periods of similar mortgage rate increases, noting that from Q4 2017 thru Q3 2018, the 30-yr fixed rose about 70 bps.  “During this same period, there was a broad-based slowing in housing market activity with sales of new single-family homes declining by 7.6% while sales of existing single-family homes fell by 4.6%. Interestingly these sales were larger than in the two previous episodes when mortgage interest rates rose by a comparable amount.”  The paper notes that the largest declines were in the highest priced homes. 

Here are a couple of other excerpts:

In the next section we present analysis of the recent period focusing on high-priced homes in areas with higher tax rates. We assume property taxes are 2.5 percent of the home value, which is typical for a high-tax jurisdiction, and that the amount borrowed to purchase the home exceeds the cap of $750,000, which is often the case for homes in higher price ranges. This means that the mortgage interest is no longer deductible at the margin, raising the effective mortgage rate by 2.2 percentage points. Under these assumptions, the cost of capital appears to increase from around 1 percent to 5 percent for these homes. 

While certainly not conclusive, the evidence presented above is consistent with the view that changes in federal tax laws enacted in December of 2017 have contributed to the slowing of housing market activity that occurred over the course of 2018. Specifically, this slowdown stems from a higher user cost of capital caused by lower marginal tax rates, the $10,000 cap on the deductibility of state and local taxes, and the lower limit for the amount of mortgage debt on which interest payments are deductible.

On a broader scale, much of the economic discourse following the passage of the tax act concerned the idea of a ‘sugar high’.  Inventory build to beat tariffs also played a role.  While the labor market remains extremely strong, other data indicates deceleration, a sign of dissipation from the tax package (even ignoring the negative effects on high-end housing).  Obviously, the Eurodollar curve is already projecting a further slowdown with the first seven one-year Eurodollar calendar spreads being inverted.  The lowest is still EDZ9/EDZ0 which closed the week at -26.0.


May treasury options expire Friday.  Thursday’s settlement was 123-045, and the previous Friday was, 123-03.  The May 123 straddle went from 38 on Friday to 29/64s on Thursday.  On April 12, the previous Friday, there was a new buyer of 75k TYK 123 call, and this is still the strike with the second largest amount of open interest at 130k while the peak 124c has 142.6k open.  On the put side, TYK 123p has the most open interest at 110k.  I’m going to go out on a limb and say TYM by Friday will be between 123 and 124.   Friday’s settles: 123c 19 and 123p 10, with TYK 123.5c 6 and 122.5p 2. 

Skew leans heavily toward calls.  For example, consider EDH0 which settled Thursday at 9756.5, up 2.5 on the day.  With futures almost exactly between strikes, the 9762.5 straddle settled 36.0, while the 9750 straddle settled 33.0.  Even more illustrative, EDZ9 was essentially unch’d on the week at 9746 from 9745.5 the previous Friday.  The 9700p settled 0.5 while the 9800c settled 2.75 even though further out of the money. 

4/12/2019  4/18/2019
UST 2Y 239.3 238.2 -1.1
UST 5Y 237.5 236.8 -0.7
UST 10Y 255.8 255.6 -0.2
UST 30Y 297.2 295.9 -1.3
GERM 2Y -55.9 -57.4 -1.5
GERM 10Y 5.5 2.5 -3.0
JPN 30Y 51.6 55.5 3.9
EURO$ Z9/Z0 -25.0 -26.0 -1.0
EURO$ Z0/Z1 -2.5 -0.5 2.0
EUR 113.01 112.34 -0.67
CRUDE (1st cont) 64.02 64.07 0.05
SPX 2907.41 2905.03 -2.38
VIX 12.01 12.09 0.08
Posted on April 21, 2019 at 6:59 am by alexmanzara · Permalink
In: Eurodollar Options

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