We could see extremely interesting price action this quarter. There are a number of catalysts we had been anticipating in Q2. Let’s look for opportunities in the next week or two in the following areas:
- Equities. We had been looking forward to this next set of earnings for months now. We should see the effects of the lower corporate tax rate and investment incentives. We will also get the announcements on what will happen with the repatriated earnings. I would think one of the reasons people have liked buying equities on dips is because of the anticipation of these pieces of good news. Most of this should be priced in. So barring an even larger positive surprise than expected, that we could see some selling pressure in equities after the rumors are confirmed and we get the “news.”
- Libor. The #1 reason mentioned for the rise in Libor has been the Treasury issuance ahead of tax receipts. The tax deadline is approaching in just two short weeks. The Treasury is expected to decrease its T-Bill issuance next week, and we would expect this trend to continue through tax season. The question is, where will the medium term Libor-FF spread settle at? My contention has been that short term Libor-FF will start narrowing (“normalizing” at narrower levels), OR the longer term ED-FF will start widening (“normalizing” at higher levels), OR both. This is one of the reasons I have liked the steepener in the ED-FF curve. We should get the answers this quarter.
- Kong. The EDZ8-Z9 and EDZ9-Z0 buyers should be scratching their heads as to how the 2018, 2019 and 2020 dots could have increased and yet the curve has flattened. I mentioned in an email last week that Kong does not seem to be adding (EDZ9 OI declined 51K on the week, and EDZ0 OI declined 63K on the week). Kong had elevated the EDZ8-Z9 year spread to such a point relative to the rest of the curve, that just not adding would have caused the EDZ8-Z9 to underperform, and that is what we have seen. I think a related larger story is the relative performance of the longer end yields…
- Longer end yields. The most important set of dots from the FOMC meeting were the longer term FF rate dots. Those increased a tepid 9bps. Having a longer term FF rate of 2.87% while the 30 year Treasury noticeably over 3% seemed excessive. The 30 year Treasury is currently 2.97, which seems more reasonable. After all the talk of BOJ and ECB policy normalization in Q1, ten year JGBs are yielding only 5bps and ten year Bunds are yielding only 50bps. I could see the next 25bps in the 30 year US Treasury go either way – rally on any economic weakness story, or sell off on any Treasury supply or growth story. I don’t have a strong view on direction… I just think we could an interesting move this quarter.
Now that the move catalysts have been identified, let’s look for some good trading opportunities next week.