Year end butterflies
Sept 7, 2019 – Weekly
Short note this weekend as I am out of town.
Commentary below isn’t really macro, but rather concerns some specifics on the Euro$ curve, notably weakness in all December contracts. Below, I have simply taken last prices from Bloomberg during the day Friday and created 3-month butterfly prices. i.e. +1 /-2 /+1 for consecutive contracts. I have highlighted in red the three month flies where the middle leg is the DECEMBER contract. What is instantly apparent is that these flies are the only ones with POSITIVE values. Sept/Dec calendars are much higher than Dec/March calendars. Specifically, EDU9/Z9 -21 and EDZ9/H0 -33.5. EDU0/Z0 -1.5 and EDZ0/H1 -9.0. EDU1/Z1 +3.0, and EDZ1/H2 0.0. EDU2/Z2 2.5 and EDZ2/H3 1.0.
| PX_LAST | 3 MO FLIES | |||
| ED1 CME Comdty | U9 | 97.9000 | 0.125 | |
| ED2 CME Comdty | Z9 | 98.1100 | -0.185 | |
| ED3 CME Comdty | H0 | 98.4450 | -0.055 | |
| ED4 CME Comdty | M0 | 98.5950 | -0.080 | |
| ED5 CME Comdty | U0 | 98.6900 | 0.075 | |
| ED6 CME Comdty | Z0 | 98.7050 | -0.075 | |
| ED7 CME Comdty | H1 | 98.7950 | -0.010 | |
| ED8 CME Comdty | M1 | 98.8100 | -0.035 | |
| ED9 CME Comdty | U1 | 98.8150 | 0.030 | |
| ED10 CME Comdty | Z1 | 98.7850 | -0.020 | |
| ED11 CME Comdty | H2 | 98.7850 | 0.005 | |
| ED12 CME Comdty | M2 | 98.7650 | -0.010 | |
| ED13 CME Comdty | U2 | 98.7500 | 0.015 | |
| ED14 CME Comdty | Z2 | 98.7250 | -0.005 | |
| ED15 CME Comdty | H3 | 98.7150 | -0.005 | |
| ED16 CME Comdty | M3 | 98.7000 |
Before the turn of the century and Y2K, trading the “turn” was a pretty big deal. Funding issues could arise going into year end, and money desks actively hedged this risk. In futures markets, this pressure was manifested by relative weakness in December euro$ contracts, as they cover the three month period from mid-December to mid-March. When Y2K occurred, the fear was that code that had only used the last two digits of the century would foul banking, transportation, and all sorts of other services, with no distinction between 1901 and 2001 for example. Imagine if you called UBER and instead a horse drawn carriage arrived. [There’s a good book with that premise, Time and Again, by Jack Finney].
In any case, the Fed stepped in and guaranteed year-end liquidity to quell impending signs of panic. Since then, the kink with December contracts abated. Until the last couple of years. In the old days, a standard trade was to sell Dec/March three month spreads or sell the Dec LED, which was selling the one-month Dec ‘libor’ contract (no longer in existence) and buy the Dec 3-month contract, because the turn was more concentrated in the one-month period. Now these pressures are apparent again, and I have to believe it is due to possible funding issues for dollar-based loans globally.
The other aspect of December contracts which may draw extra appeal for hedges/specs is the Fed’s infamous ‘dot-plot’ which forecasts end of year rates. In any case, open interest in December contracts exceeds that of other contracts by a healthy margin. For example, as of close Thursday, EDU9 had OI of 1.355m and EDZ9 1.915m. In the reds, EDU0 1.107m and EDZ0 1.184m. Does it really matter? Well, clearly some participants shy away from strategies that are long December contracts. By extension, perhaps vols should be a bit higher on December contracts than otherwise.
In a broader sense, does this weakness in December contracts reflect – to just a small extent – a feeling that funding could ‘get away’ from the central bank? Clearly, the Fed can always provide dollar liquidity. But in a global financial world where the US seems to be turning a bit more isolationist, will the Fed be as willing? Just a thought.
The other parallel thought concerns WeWork, whose potential IPO came under heavy scrutiny this week as its value was more than halved from $47 billion at its last funding round, to $20 billion in the prospective IPO. Like the banking system, this company is based on a ‘borrow short, lend long’ model, where the company takes long-term commercial leases, carves them up, and sub-leases short term. Vulnerable to ‘funding crises’.
OTHER MARKET/TRADE THOUGHTS
With just a week and a half until the FOMC. The market is comfortably pricing a cut of 25 bps. Oct Fed Funds settled 9813.5. On a cut of 25, FFV9 should ultimately settle at 9812-12.5. With three month libor setting in the area of 2.11 to 2.13%, EDU9 should expire around 9788, and Friday’s settle was 9790.75. Forward spreads indicate the Fed will guide to lower future rates (or will be dragged along for the ride).
| 8/30/2019 | 9/6/2019 | chg | |
| UST 2Y | 150.2 | 152.6 | 2.4 |
| UST 5Y | 138.5 | 141.8 | 3.3 |
| UST 10Y | 150.3 | 155.0 | 4.7 |
| UST 30Y | 196.8 | 202.1 | 5.3 |
| GERM 2Y | -92.7 | -87.0 | 5.7 |
| GERM 10Y | -70.0 | -63.8 | 6.2 |
| JPN 30Y | 14.6 | 20.9 | 6.3 |
| EURO$ Z9/Z0 | -60.0 | -59.0 | 1.0 |
| EURO$ Z0/Z1 | -9.5 | -8.0 | 1.5 |
| EUR | 109.91 | 110.31 | 0.40 |
| CRUDE (1st cont) | 55.10 | 56.52 | 1.42 |
| SPX | 2926.46 | 2978.71 | 52.25 |
| VIX | 18.98 | 15.00 | -3.98 |
