The Macro View

Probability Distributions of EDZ8

[Below is a Trade Thought essay that discusses a real-world application of the options article I wrote for the CME]   This will probably be a multi-part series.  This week, I wanted to discuss the pricing of the front options flies.  Clearly from the FFV8 pricing and lack of movement, the markets just do not think the Fed is going to skip in two months.  We can easily cover the skip scenario by buying FFV8.  We should wait until the August meeting has passed in a few days.  I also don’t think the Fed is going to hike more than once a [...]

Market Reactions

Last week, we had Trump causing waves with this Putin meeting, and ending the week talking about tariffs on ALL of our imports from China.  We had the following weekly reaction from the markets: S&P was unchanged, ED white pack was down 0.6bps, and ED gold pack was down 6.4bps. While the pricing in any given week can be all over the place (especially a low volume summer week), this was curious when Trump noticeably escalated trade tensions with China.  It’s not clear to me if: (1) the markets are underestimating the potential growth tail risks of a full-blown trade [...]

My Tariff Central View

The markets just don’t seem to care about the trade tariffs.  Stock have been chopping around in a tight range, and the front end of the FF curve is pricing in roughly the same amount of hikes.  The argument I hear all the time is that at the end of the day, a 25% tariff on $34B if imports is not going to have much of an effect on a $19 TRILLION economy like the US.  I suppose that’s true.  But you have to factor in that this dispute with China could escalate to $500B, and that we have similar [...]

Inverted Yield Curve

Some of the FOMC members have been saying they don’t want to invert the yield curve, but sections of the ED yield curve have already inverted.  For the past few weeks, EDH0-H1 spread through EDZ0-Z1 has been negative.  I think this will be a permanent feature of the yield curve going forward, barring some miraculous appearance of the term/risk premium.  There are a number of reasons for this: The Fed statement. The Fed took out the forward guidance that implied that they would stay accommodative.  In theory, as long as the Fed stays accommodative, the longer end of the curve [...]

Scenarios

Whenever I have a hard time with macro views because of news uncertainty, I like thinking about scenarios.  Most people think only about the current yield curve, but you can also look at the conditional yield curve - the yield curve implied by the options market.  You can use this conditional yield curve to structure trades such as: if ED6 is at price x by time a, then ED10 should be at y by time b.  Typically, a = b, but this is not necessary.  This may be the topic of a future CA.  For now, I just want to [...]

Game Night and Wages

Every now and then, we’ll have Game Night with some good friends of ours.  One friend works at one of the largest companies in the US, and the other works in a small multinational firm.  Usually we’ll have an hour or so to chew the fat before dinner and occasionally, I’ll ask them how the economy looks from their perspective. This time, I was really curious about wages, so I asked them about how salaries worked at their firms.  It’s been over a decade since I worked for a company, and I was very surprised at how wage increases were [...]

Some Clarity

The outlook for the economy and Fed policy had been a little murky the past few weeks.  A number of things are starting to become clearer, from the Fed, data and news last week: The bar for the Fed being spooked by inflation is higher. The Fed went out of their way to put in “symmetric” TWICE in the FOMC statement.  This also makes an overshoot less likely.  Several Fed members (in particular Dudley and Williams) have come out and said that they are comfortable with inflation being somewhat higher than their 2% target.  I think the symmetric discussion probably [...]

The Next 25bps in US Tens

I was talking to someone at a dinner party and they asked me what I thought of yields, now that we went over 3% in tens last week.  For someone who looks at the yield curve all day, I have no strong conviction on direction.  Whenever this happens, I like listing all the arguments down and seeing which side makes more sense. THE BEARISH CASE We have strong global growth… more or less. The European data has faltered some, but there is no strong reason to think the growth couldn’t just keep chugging along at 2-2.5%, as it has for [...]

High Yields and Equities

I ran across this chart yesterday (a retweeet from 13D Research and Bloomberg), and I thought it was interesting because we had some unusual price action Friday.  Normally, when equities drop almost 1%, you would expect fixed income to rally noticeably (especially after the volatility-driven market nervousness earlier in the year).  But the long end of fixed income actually sold off noticeably!  I suppose the longer end of the yield curve did (over)flatten the prior few months, so perhaps we were due for a correction. Since the volatility scare a couple of months back, it’s felt like fixed income has [...]

Trade Tariffs Potpourri

The markets are difficult to trade directionally with the markets whipping around on trade tariff headlines.  We have no significant competitive advantage in trying to guess the outcome.  There are a lot of people out there with more information than we have – people who actually speak to the inner circles of Trump and Xi.  And even if we knew what the final outcome was going to be, it’s probably going to be a long process and we have no idea if the next major trade headline will move the markets the wrong way before moving the right way. The [...]

The Micro View

Tails and Options Pricing

In a headline dependent market, things can change in a hurry.  We saw some of this last week, as we had surprising progress in trade talks with the EU.  We could get a number of game-changing headlines in the next few weeks: Substantial trade progress (or lack thereof) with any of our key trading partners, Any surprising moves by central banks (in particular the BOJ), Any surprising economic data, Any surprisingly large move in equities, and Any serious frictions with Iran/Russia/China. In addition, we always have the usual terrorism, Trumpidity, etc risks.  Usually, I’ll look at the curve and see [...]

Inverted Yield Curve

Some of the FOMC members have been saying they don’t want to invert the yield curve, but sections of the ED yield curve have already inverted.  For the past few weeks, EDH0-H1 spread through EDZ0-Z1 has been negative.  I think this will be a permanent feature of the yield curve going forward, barring some miraculous appearance of the term/risk premium.  There are a number of reasons for this: The Fed statement. The Fed took out the forward guidance that implied that they would stay accommodative.  In theory, as long as the Fed stays accommodative, the longer end of the curve [...]

Surprising Central Banks and the Curve

After a number of snoozer central bank meetings, we had several surprises from the Fed and ECB.  These surprises have caused a number of minor regime changes on how some local parts of the ED and ER curves should trade.  Here are some of the key things that will affect the yield curves going forward: The Fed removed forward guidance to remain for some time below longer term neutral rates. This was expected at a meeting later in the year, but it was a little surprising it occurred so soon.  The Fed was not going to hit “neutral” for a [...]

Fed Meeting Thoughts

Next week’s Fed meeting could be important to gauge their thinking in the midst of various uncertainties – trade (tariffs) and the effect of the recent tax stimulus.  Here are some things I’ll be looking for from the Fed, and some trades I am considering implementing. The statement should be a snoozer, with a hawkish bias from the better economic data. I think a hawkish tilt will be the baseline expected from the markets in the economic conditions section.  I don’t expect a major change in the rest of the statement.  The reason is because of the uncertainties around trade [...]

Fed Comprehension Fail

I was amazed that FFV8 sold off as much as it did, but I am equally amazed that it rallied 8bps last week off of the Fed minutes.  I had been telling clients for weeks that the Fed Funds were too cheap – both from an additional-FFER-move perspective and a Fed hike probability perspective.  I gave reasons to think there were tail risks of the FFER coming in lower from what the markets were pricing in – including the Fed managing the FFER as it got closer to the upper end of the target range.  The Fed minutes did have [...]

Planet of the Apes

You’ve heard me talk about Kong (the EDZ8-Z9 buyer) for most of the year.  I’m not sure if I’ve seen too many of the Planet of the Apes movies, but I seem to be seeing signs of large market participants all over the place. I was telling some people that I thought I was strange that tens broke the key 3.05% rate and we didn’t take off.  It will be interesting to see what happens the next week or two before the next wave of key data. There are clearly large players in the market that have the size to [...]

Backing Out Fed Funds

Have you ever seen that online ad, where they show you a bunch of fruit in a series of math problems, and you have to figure out what the value of each fruit is?  That’s exactly what I thought of when I looked at the Fed Fund futures.  The market price of the FF future would be the numbers on the right and you have to figure out what the factors being priced are (the fruit).  You use the values of the fruit from one level to work on the next. I had been trying to figure out why some [...]

Longer Term Fed Funds Are Back!

For many years post-recession, the Fed Funds curve was dead.  Then as whispers of Fed policy normalization came around, the Fed Funds within 6 months started to come alive.  Then the Fed Funds within one year were trading actively.  I was surprised to see that the volumes even past one year are finally showing signs of life.  On the right are the open interests in Fed Funds futures from this time the past three years.  There are a number of things to note: The open interest has steadily increased the past few years. The FFF9 OI of 309K is fairly [...]

The Fed’s Overshoot

One of my former colleagues at JPM was a rocket scientist – literally.  We once discussed how for some corrective system models, you can have a situation where you overshoot before eventually settling to the equilibrium.  That conversation was what I thought about when I saw the Fed’s dots last week. The way the Fed models tend to work is that there is a bit of an overshoot on rates, because Fed policy generally takes a number of months to take effect.  So if the Fed had the foresight of a bat, they would keep hiking as they saw inflation [...]

Fed Meeting Thoughts

There are so many wacky things going on with Eurodollar futures, from libor blowing out to Kong buying EDZ8-Z9 in unprecedented sizes, that it’s hard to get a good handle on what is going on with short end interest rates just from looking at the EDs.  I haven’t seen the ED curve this messed up since the Libor crisis a decade ago.  But this time around, the economy is perfectly fine!  EDs are insane!!! Fortunately, we have Fed Funds, which gives us a cleaner look.  But even that has a little noise in it from the markets pricing in a [...]

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