Weekly summary; Is the Strong USD Tightening for the Fed?



7/10/2015 7/17/2015 chg
UST 2Y 64.9 66.5 1.6
UST 5Y 167.3 166.8 -0.5
UST 10Y 241.4 234.7 -6.7
UST 30Y 320.7 308.0 -12.7
GERM 2Y -21.0 -22.0 -1.0
GERM 10Y 89.8 78.8 -11.0
EURO$ Z5/Z6 83.5 82.5 -1.0
EURO$ Z6/Z7 69.0 66.5 -2.5
EUR 111.56 108.31 -3.25
CRUDE (1st cont) 53.22 51.21 -2.01
SPX 2076.62 2126.64 50.02
VIX 16.87 11.95 -4.92



The US curve flattened hard this week as Yellen continued to stay the course regarding the prospect for a rate hike for this year. 2/30 yield spread fell 14.3 bps as twos edged to a slightly higher yield (66.5) while bonds plunged 12.7 to 308. The ten year yield fell 6.7 bps to 234.7, gravitating once again to the 50% area (233.5) of the high at the end of 2013, 303, to the low of 164 earlier this year.

The idea of a rate hike also strengthened the dollar with the euro down 3% this week to a new recent low of 108.31. Of course, the IMF calling Greece’s debt unsustainable was another factor for euro weakness, further exposing political cracks. The low in late May was 108.18; year’s low was March 13 at 104.63. As the uncertainty of Greece leaving the euro faded, implied vol was crushed across assets. As an example, consider Green and Blue Sept midcurve straddles. One week ago Friday, 2EU 9812 straddle settled at 32.5 (ref 9810). This week it finished at 26.5 (ref 9812). Same story with the Blue Sept 9762 straddle… from 35.5 to 29.0. I marked the atm USU straddle at 5’32 last week (ref 149-03) or 14% vol. On Friday I marked it at 4’14 (ref 152-03) 11.6%. VIX had the lowest close of the year at 11.95, having been as high as 20 last Thursday.

Crude oil fell $2 bbl to 51.21 (CLU5). For this particular contract, the low of the year was set on March 18 at 49.69, so it’s still about $1.50 away, but the front contract at that time (in March) had a low settle of 44.66. However, I would note that the oil curve was much more contango in March, with the near contract vs one year forward at about a $10 discount, compared to now only 4.60 (CLU5/CLU6). In other words, when oil was first breaking in the beginning of the year, there was a huge incentive to buy the front and sell forward contracts if one had access to storage. Not so much now… Even though there are clear benefits from lower oil, it’s hard not to conclude that soft prices are a reflection of global economic weakness, even if the Iran deal is a contributing factor.

CAD hit a new high 129.75 (a decline in the loonie of over 11% since the beginning of the year) and MXN at a new high 15.93 (peso down around 8%). The Brazilian Real, though not quite at a new low, is down 20% this year. And the dollar index has gone from 90 to 97.90 (up about 8.75%). A research piece from the NY Fed was circulating Friday that said “…a 10% appreciation [of the USD] in one quarter shaves 0.5% off GDP growth over one year and an additional 0.2% in the following year if the strength of the dollar persists.”


Regarding Canada specifically, it’s worth mention that the Bank of Canada cut rates to 0.5%, the second of the year after a surprise cut in January. From late 2010 to 2014 the rate was 1%. It had been raised from the rock bottom level of 0.25% which was in place for about a year starting in April 2009. Governor Stephen Poloz cited a disappointing global economy, as earlier forecasts for growth proved over optimistic.

Some say the move is meant to drive down the Canadian dollar to generate more export demand. However, household debt is at nosebleed levels already, with a McKinsey report from earlier in the year noting “Canada’s household debt-to-income ratio rose more than any other country outside of Greece between 2007 and mid-2014…. It hit a record high of 163 per cent in the third quarter of last year. Canada is one of a few countries in the Western world where household debt burdens are higher than they were in the United States at the peak of the global credit bubble…” Note that US household debt to GDP was 98% in 2009, but has declined since then to the current 80%.

Bank of Canada’s Poloz himself expressed concerns about how his latest decision would affect household debt, which is already at very high levels, and the housing market, which many believe is dangerously overheated. “And we must acknowledge that today’s action could exacerbate these vulnerabilities…” http://www.thestar.com/business/2015/07/15/bank-of-canada-cuts-interest-rate.html

Besides Canada, excessive debt is also a huge problem in China: “Corporate China’s debts, at 160 percent of GDP, are twice that of the United States, having sharply deteriorated in the past five years, a Thomson Reuters study of over 1,400 companies shows.” http://www.reuters.com/article/2015/07/19/us-china-debt-companies-idUSKCN0PT00H20150719


The points here are 1) that if there’s any doubt about currency wars, this should quell that idea. 2) Canada is only about 1/10th the size of the US economy at 1.786T in USD, according to Trading Economics, but it could still have negative ramifications for the US. 3) Because of an election in the fall, there are political overtones, something the US Fed may have to contend with next year.

Canada’s TSX is off about 5% from its high in April, and around where it started the year. In the US, the SPX roared back this week to close near a new high; Nasdaq made a new high. Google alone added about $70 billion in market cap on Friday. The three largest cap stocks in the US are AAPL $746 billion, GOOG $477 and MSFT $378…with FB in the top ten at $267b. Those four tech stocks, with a combined market cap of 1.867T, are valued over 10% of the GDP of the US.

The stronger dollar is disinflationary. It also causes a push into dollar based assets, and may contribute to a reach for yield/ income inequality. Canada had to retreat from its earlier modest hikes.   The Fed wants to lean against financial speculation, and also wants ammo for the inevitable next crisis, but the rest of the world is pursuing easy policies, which makes the US relatively tight. Does Yellen bite the bullet and jack up rates to spur the dislocations that will get the US back to a more normal economic posture? It takes a strong backbone…

volcker“It may be difficult to imagine, but Paul Volcker used to testify before Senate while smoking a large cigar. His physical size – all 6 feet 7 inches – dwarfed the desk he sat behind. He looked as if he was sitting behind a grade school desk! In many cases, the hearings became extremely confrontational, but the giant in the room never backed down, not even for a minute.”



Posted on July 19, 2015 at 3:12 pm by alexmanzara · Permalink
In: Eurodollar Options

Leave a Reply