160717 6mo spdsIt took an extra week, but we are back in the green box, as predicted!  So it took: (1) solid payrolls, (2) firm China data and (3) solid retail sales.  Hmm… Based on what happened, I would have thought we sold off a little more, even post Brexit.  I continue to expect the spreads at the back of the green box to be lower and the front of the green box to be higher.  The potential for more QE could cause the long end spreads to be lower.  The US being stronger should keep the front end spreads somewhat supported.  So how do I explain the current shape of the curve?  To state the obvious, either:

 

1) There is some risk out there that I am underestimating on the front end.  I wrote what I thought were all of the main risk factors last week.  You can get some bizarre event risk like the Turkey pseudo-coup.  While every random event can’t be accounted for, I suppose the possibility always exists for a “crisis” event, and the market always seems primed for a short squeeze.  But again, I am not getting any confirmation of risk from other markets.  For example, the VIX is near all-time lows.  So equities are laughing at a potential crisis from Brexit.

 

160717 Fed probs2) We may have to sell off more on the front end.  I suppose you have to weigh how much Brexit is worth vs how much the recent stronger data is worth on the ED curve.  Which would you say was a larger factor for the US?  I was looking for some relevant markers.  I thought I would just compare where we settled Friday to where we were pre-Brexit.  It’s interesting that EDZ6 settled right where we were pre-Brexit.  Part of it is just the libor-FF spread being a little wider.  The big thing that has changed since June 23rd is that the long end has rallied a ton.  The yield grab with the specter of more European stimulus has been fierce.  I don’t expect this to abate with the elephant.

 

I personally lean towards #2 – that we have to sell off more, because I never thought Brexit was a big deal.  The markets have wanted to blow anything out of proportion the last few years – Greece, PIGS, China, Brazil, Russia, etc.  So while the front year spreads are < 25 (one hike per year), I think there is value in good risk/reward bearish positions still.  And I continue to think the long end could rally relatively on both a rally and a selloff.