Curve Advisor Bulletin
The two most interesting news items yesterday were:
• Trump’s Ukraine envoy implying there was a quid quo pro. Even with the China tariffs, equities could easily find a less-friendly President (i.e. Warren). Considering equities have historically had some catastrophic months in October, and more recently, we saw Q4 weakness last year, the markets could be more jittery the rest of the year.
• Richmond Fed (normally ignored) popped to +8 from a -7 expected. As mentioned, a cease fire with China could show up quickly in the forward-looking survey data. But let’s see if it continues in tomorrow’s Markit data.
Note that Brexit did not make the list.
Two weeks ago, I mentioned that selling EDZ9 because a China trade deal made more than 1 hike being priced into Q4 seem too high. The gorilla is fierce! Good China rhetoric and a potential Brexit deal and the Nov meeting became even more priced! In any event, I think if we are going to play for a skip in Oct, that 2-2.5x EDX9 98.00 put vs EDZ9 98.00 put for a credit makes better sense, so I like stopping out of EDZ9 and converting to the EDX9-EDZ9 put structure.
Meh. I was hoping we got some kind of Brexit selloff to put on some kind of conditional call trade, but we rallied instead. I'll keep looking.
At the risk of sounding like a broken record, my favorite trade now is to sell the FFK0 or FFN0 3mo fly and buy 25% of the EDU0 6mo fly. If you don’t want the bullish bias, you can buy 25% of the EDH0 6mo fly instead. The reason I am suggesting the EDU0 6mo fly is that it looks at least 1bp lower on a smoothed fly curve.

I think the reason these FF flies are zero or positive is because of:
• The extreme pressure from EDZ0-FF year-end turn trades (lots of FFF0 and FFG0 buying). If you are concerned about further year-end pressures, you can buy some EDU0 3mo fly. However if …
• You think the Fed will have to ease after the elections (say Warren wins and equities collapse). In this case buying EDH0 6mo fly as a hedge is better. But Trump is still almost a coinflip to win and a centrist could emerge from the Democrats. There was a Bloomberg piece that suggested equities will be fine with Warren, so the post-election ease is not a central scenario.
In terms of timing of any actual Phase 1 deal, it looks like it will be at the APEC meeting (Nov 16-17). The EDX9 and 0EX0 options settle the Friday before the meeting. So if you want to make an trade deal play, you may want to consider Z options.
The manufacturing surveys the next few weeks could be interesting. We had the “trade deal” 1.5 weeks ago, so I am curious to see if there is any early flow-through. AOTBE, depending on the timing of the surveys, we could see less of a downside tail if this deal alleviates some of the manufacturing concerns.
But with the 2.5:1 EDX9:Z9 trade, you could be in short gamma hell if the Fed eases in Nov and skips in Dec. So you have to have a strong view that the Fed could skip, or have a book that can accept a short EDZ9 80 put. Otherwise, do 2:1 and try to buy back the EDZ9 put before the Dec meeting.
In terms of trades, I have the following (preliminary) trade thoughts:
• I had previously mentioned buying EDX9 80-81 put spread vs 82-83 call spread. I like taking profit on that before the Fed meeting, as it is less than a bp ITM and I don’t like the risk/reward for an Oct skip. Libor-FF seems to be narrowing/stabilizing with the Fed intervening in the front-end so I'm not sure where a large EDZ9 selloff will come from, unless the Fed skips.
• Instead, I am thinking about something like buying 2-3x EDX9 98.00 put vs selling 1x EDZ9 98.00 put for around 0. 2.5:1 is currently offered for 0 (as a 5x2). The logic would be we could get a 20bp selloff on EDZ9 on a skip. But if the Fed doesn’t skip, it will be hard for EDZ9 to sell off much past the 98.00 strike, unless Libor-FF widens noticeably.
• I think if the Fed skips next week, the markets will price in eases further out the curve (2020). There could be some headwinds to the reds selling off aggressively (previously mentioned). I want to think some more about put 1x2s in 0EX0, or some kind of call trade in midcurves.
I’m finally back in the office!
• We seem to be making progress on both the trade deal and Brexit. I do think Trump has “changed approach” (i.e. I don’t think he is planning to keep putting on more China tariffs through the elections) so something (very) thin will probably be signed next month.
• The gorilla still is pricing in 80+% of a Nov ease. I am certain nowhere near “80+%” of the FOMC do not agree with the ease, had the “markets” not priced it in. This makes trading the front-end every tricky.
• I’m looking at EDZ9-Z0 spread at 33.5, and if that is turn-adjusted, that is probably pricing in about 26bps of ease (a little over one ease) for next year. That could be a 100% chance of one ease or a 1 in 7 chance of going to zero.
• I’m not sure where the next major leg of the selloff is going to come from, unless: (1) the Fed skips hiking in Nov, as 31bps are priced in for 2019, (2) the markets think 1 ease is too much for 2020, despite the EU being next in the tariff war and many people thinking we get a recession next year, (3) we just keep reflating the curve from the long end (like today), despite negative rates globally (possible) and/or (4) we start pricing in hikes, which is hard to see with no inflation.
I suppose a major headline could change any of the above.
We seem to be in headline limbo while we await progress on Brexit and the details of the “settled” China trade talks. I didn’t have anything interesting yesterday. Here are the things that stand out today:
• We seem to be having funding issues again, as seen by the elevated repos, SOFR fixing and FFER fixing. I think the Fed will be aggressive in dealing with this issue at the next meeting.
• For the past week, we seem to be having a strange battle between Asia/London and the US, where we rally strangely hard overnight and sell off strangely hard during US hours. The weak Retail Sales somewhat broke that run today, but let’s see how we trade overnight. If this is some kind of regular pattern, you may be able to use whatever directional bias you have to flip flies. For example, if you are bullish fixed income, you can sell flies (like EDH0 6mo fly) during NY hours and buy it back overnight. If you are bearish fixed income, you can buy flies (like EDH0 or EDU0 6mo fly) overnight and sell it back during NY hours. Of course, Murphy’s Law of trading says the pattern will break now that it has been pointed out, but if you have a bias regardless, you could try and pick up some flipping P&L.
• The FF flies seem to not want to go lower. You can hedge on rallies by buying 25% as many ED 6mo flies behind and flipping the ED flies. I think the FF flies are high because FFX9 and FFF0 are too high (causing the other FFs to be too low). I’m not sure the gorilla will keep this up indefinitely, so I like sticking to the good value… the economy is not out of the woods. And positioning tends to correct round year-end.
We had a large move overnight on perceived bullish headlines, but Mnuchin’s clarifications settled the curve back down. I don’t think it should be a surprise to the markets that the two sides will keep having to meet and negotiate though next year. The main things I find interesting today are:
• We are continuing to see large volume in EDZ9, FFX9 and FFF0. EDZ9 has been declining in OI while FFs have been increasing. I keep thinking that these front contracts are too rich, and am looking for a way to play for EDZ9 downside, as that contract settles after the Dec Fed meeting.
• EDZ9-Z0 spread is at -36.5. About 6-7bps of this is just the EDZ9 turn being higher than the EDZ0 turn. So we are looking at roughly 30bps turn-adjusted. I think if this were to get closer to 25bps t.a. (aka “one ease for 2020”), this could be an interesting sell as a bullish trade, or could provide some value in an EDZ9 put vs 0EZ0 put (or put spread) trade - especially if we sit here and EDZ9 vol gets crushed.
• EDX9-FF is now pricing in Libor-FF to NARROW 1bp. This is probably the Fed adding liquidity to the front of the curve. But part of me thinks that we could start widening back out some time between now and the end of the month (after the Fed meeting). So this makes downside on EDZ9 fractionally more attractive.
• The FF flies are curiously high, but I continue to like the value of these – either outright, or vs ED flies. An interesting variation is to sell some EDZ9 (or buy an EDZ9 put structure) against the short FF flies, but only if you think two eases this quarter is unlikely (or have crisis protection). The trade deal is weak, and we could have them seemingly fall apart on one headline.
ANNOUNCEMENT: I’ll be out of town the week of October 14. Commentary may be sporadic.
As for the markets, the two things I believe in are:
• I don’t think the Fed is going to hike more than once next quarter. The Fed is already split as it is, and the rationale given (weak trade outlook) is now mostly gone. Even though we may not have a great deal, we no longer have China trade headwinds. I’m not sure why the Fed needs to ease. The main argument are the weak ISMs. However, that sentiment disappear quickly. We will get the first indication in the Beige Book. So I like some short exposure in the next 2-3 Fed meetings (either directly or via puts).
• However, I realize that this deal is probably lame. It won’t take long to get something for Trump and Xi to sign. But it could take a while for other aspects to be completed in a reasonable manner. And there is always the risk that the rest of the negotiations fall apart, or Trump now focuses his attention to Europe. I think some chance of recession should be in the curve. With no inflation, I don’t see the Fed hiking any time soon.
After listening to Trump, it sounds like we got the “lame” trade deal. Trump tried to make it sound comprehensive, but I’m pretty sure there will be a whole bunch of enforcement holes. I think the markets have to be relieved that there won’t be escalation, and it seems like the has enough things held back (Dec 15 deadline, Huawei, currency manipulator, etc) to keep China moving along. The biggest factor that I underestimated was that Trump seems to have changed recently. It started with Bolton, then Syria then this China deal. As we approach the elections, I am guessing he is trying to check off all his campaign promises. Whether it is the deal with Japan or China, it seems like he is settling for the quick gains rather than the longer-term solutions. An election in 13 months will do that.
I can’t remember which contracts they were (probably in the back whites or front reds), but a while back, there were some large flows of risk reversals (buying calls). So we would get a larger selloff than would otherwise be “fair”.

The gorilla seems to be very active, with the EDU9, FFX9 and FFF0 volumes being noticeably higher than the surrounding contracts. I’m not sure if just the ISMs will be enough to get a divided Fed to ease… especially more than once.
Looks like we may be close to a "cease fire" deal. As mentioned earlier, I'm not sure this is going to have any teeth, but in the short term, the 27bps of eases priced into Q4 seems too high. Assuming this deal is confirmed, I think being short EDZ9 (since there is not much more priced into year-end turn) makes sense. As for the rest of the curve, I was always dubious that would couldn't get a recession anyway, so the longer-end rally is not too surprising.
The news is going to be choppy, but in case we get a lame deal:
• A lame deal agreed today (unlikely): The Fed may not ease in November, as they may want to see what happens with trade – especially if equities pop to new highs (as I would expect).
• A lame deal by the Asean meeting (likely): The almost full ease (24bps) at the Dec and Jan meetings could be questionable. The gorilla may try to keep the Q4 meetings bid, but that could give an opportunity to buy some front-end puts.
• After a fixed selloff after a lame deal, I like looking for an ease in Q2-Q3 2020 after the euphoria wears off. We may have to wait for a decent ISM print.
But at this point, there are so many scenarios that I’ll send trades I like once we know how the negotiations go.
Now that the merchant (Trump) dragged the old woman (Liu) back, it seems like Trump wants the deal. He’s fickle, but he seems amicable. Maybe he knows when he is beat. I’m wondering how Trump is planning to sell any lame deal he negotiates, where the Chinese get everything and the US gets nothing the Chinese didn’t want to give us anyway. Since Trump is a real estate guy, I’m guessing he’s going to pass it off as “rent” – get $XX billion for a 3 month deferral of tariffs. And if he feels like he needs to get a bigger deal, I guess he could be really lax on enforcement, so that to the Chinese it would be as if there were no core provisions. This way the headline looks good, but the caveats are buried in the details.
Apparently, Liu He *IS* an old woman at the bazaar! That’s why I said I needed to see him get on the plane! He pretended to leave early to try and get some leverage from weaker stocks and some possible concessions from the US. The US took the bait and came back with a few (and to stabilize stocks). At this point, I still think we could see some “difficulty” in the negotiations today, but the US position does seem to have softened (increasing chances of something eventually getting done). Note that I am not saying what the odds are – just that it is higher than before.
Liu He is supposed to leave early tomorrow. Part of me is wondering if he is pulling the ol’ “old woman walking away from a haggle at a street bazaar.” I’m thinking the US would really need to have a change of heart for negotiations to continue. In any event, I actually want to see him get on the plane. Then I will unleash the list of good “recession trades,” because unless the Chinese are holding back on some core issues until Xi meets Trump, they are not going to offer the US anything else. THEY walked away from the alter in the spring and have been making the same ag/energy peace offer repeatedly. After Trump-Xi, I doubt they will be back with much more.
Yesterday, Powell unofficially announced a “QE” at the next meeting. Keep in mind that in the past, after QE was implemented, the curve steepened for some time afterwards (see Chart). The thick lines are the start and the thin lines the end of the various QEs. The algos probably think that QE caused curve steepening – that’s what the data shows! But I think it’s the markets anticipating QE and unwinding afterwards. I’m wondering if we could get a similar effect.

The main caveats though, are that:
• it’s not a real QE this time, so we could get a different result.
• the Fed may buy bills instead of the long end. I’m not sure if the markets are pricing this in, and whether this means we will get a flattening or a steepening.
But just be cognizant that we could get a large steepener (or flattener) that may trade out of the recent ranges.

That last FFX9 vs put trade moved away. FFER continues to print low. The Fed will probably put enough measures in place so that the short-term rates will be better behaved. It’s would be absurd if the Fed didn’t prevent a liquidity issue in jittery markets if it could be avoided. I think there is a chance that the Fed could be overly accommodative for funding. It’s possible the FFER could print lower than 1.82. So I like looking for structures that get long the front FFs.

Another impact of more liquidity could be the impact on the quarterly FFs. We had seen the quarterly FFs (i.e. FFZ9) be as much as 4+bps theoretically (not including bad days) too cheap relative to FFX9 and FFF0. That FFX9-Z9-F0 -0.5:1.5:-1 weighted fly got above 7 at one point, and it is now 4.5. This could continue to drift lower, so I continue to see the quarterly FF contracts as fractionally better longs than shorts, relatively.
Wow… The Chinese are still coming to see if they can buy ag (something they need) in exchange for no new tariffs (something they want). Shocker! They are also bringing a large contingent because they are so eager to negotiate a bigger deal. Bah ha ha. #redherring

Trump wants a deal and the Chinese are showing up with a handful of beans. So it shouldn’t be a surprise Trump is pulling out other sanctions. If this was earlier in the year, I’d say there was a negligible chance of tariffs not being placed next week. But a number of things have changed: (1) the US economy is showing cracks, (2) the overwhelming narrative is that tariffs are ineffective (I think they are very effective if you look at the bigger picture – like how Fitbit is moving production outside of China), (3) Trump may not want to jack up prices ahead of the holidays, (4) Trump’s impeachment woes are going to prevent him from getting anything passed, and (5) he seems to be having a change of heart on a number of other policies (Bolton, Syria, etc). Time keeps working against him in the negotiation ahead of the election. I’m not sure how desperate Trump feels (if at all).

But the only cards Trump has are new tariffs/sanctions and a denial, so even if he was defanged, it seems like he should play whatever cards he has for now, unless he is truly desperate.
I was looking at the Fed calendar, and the Nov 2020 meeting is AFTER Election day. Usually the fall non-quarterly meeting is before Election Day. We should keep that in mind, in case we need to play for a Warren collapse.
After a good night’s sleep, I’m staring at the 18.5/19bps priced into the Dec meeting, and thinking that seems too high. On the one hand, if trade talks break off, that could be okay, but if we get a trade deal by the Asean meeting, I’m not sure the Dec ease is that sure a thing. Let’s look at that, once we confirm that the trade war isn’t escalating.
Well, I was going to suggest the following trade, but the China visa headline came out and FFX9 jumped higher. However, FFX9 does tend to be jumpy, so the following looks reasonable on a dip – especially if you are short flies or double flies in the back whites. It encapsulates the two themes we discussed – being long FFX9 (as long as we think the Fed eases), and we have some puts (0EX9P 98.625) that should kick in on a rally. Note that this trade is DV01 weighted (60 FF vs 100 options).
• If the Fed eases 50+ in Oct (maybe because a China deal fell apart and equities sold off a ton), it’s a home-run.
• If the Fed eases 25, you make 60-75% of the option price on FFX9, and you may make another 1+bps on the FFER being more well-behaved, and the puts should still have some value. So you may scratch.
• If the Fed skips, you lose 20bps on FFX9, but EDZ0 should similarly sell off 20bps, but something bearish must’ve happened (like a trade deal), which could cause EDZ0 to sell off more than the additional 18bps to break even (from the 60+bps of easing that are priced in after October). This scenario is a little iffy (so this trade may lose money), but vol should stay bid after the Oct FOMC, and going into the Asean meeting.
• BONUS 1: The Fed eases 25 and sound hawkish. Then there is a trade deal at the Asean meeting, so you make money on both sides of the trade.
• BONUS 2: The gorilla starts pricing in a chance of a 50 before the Oct FOMC meeting, so you get a “free” midcurve put (that you have the option of unwinding).
I was looking at this trade at a structure price of 98.435, but it looks closer to 98.45 now. Let’s watch the developments and see if we can get this package closer to 98.435. As long as tariffs aren’t lifted (or prospects don’t look great), this seems like a reasonable play.

As of now, I’m hoping tariffs stay in place and we rally, so that we can look at some put trades for the Asean meeting:
• We currently have 55bps priced through Q1 (30bps not including Nov). If we get a deal, I think that figure could almost get halved, which is why I like puts.
• If tariffs are imposed, I’m looking at the weak ISMs and the weak wages and PPI (CPI tomorrow), and I’m thinking the gorilla will force the Fed to ease in November. The Fed meets before Trump-Xi, so there would be little clarity (unless a deal signing ends up being scheduled). So any put trade could incorporate a FFX9 long (depending on tone of news).
The above are obviously subject to change.
Thus far, we’ve had a lot of posturing. I’m looking at some goalposts:
• In the near-term, the first “positive” sign would be if the Chinese trade delegation doesn’t leave early (as threatened) and stays the two days (high probability). It’s even possible the Chinese could stay longer!
• After the talks, the markets will look at whether or not additional tariffs scheduled for October 15 are suspended. I think a suspension of tariffs is low probability, as it’s Trump’s way of weaseling some more concessions when he sees Xi. So Trump deciding to suspend tariffs would be a really strong signal for an interim deal.
The rest of the week, we are so headline-dependent, that I think the markets will be difficult to trade.
Yep… things are going according to the script… “Any time they say, “we don’t want to give you what you want”, you would have to think that the odds of tariffs being slapped and tensions escalating are higher.” With the Chinese delegation suggesting they may leave early, it seems unlikely anything gets done this week.

I like buying put structures after any bad news this week comes to pass. The BFFs meet in three weeks, so talks aren’t dead. Watching the Japan trade agreement signing, Trump seemed rather subdued. On the topic of China, I thought he would go into this rant about taking in billions of dollars in tariffs, but we got nothing… just that he would prefer a bigger deal. It seems like he could accept an interim deal – especially since he was turning that interim trade deal with Japan as some kind of monumental deal. Could be foreshadowing. Maybe.

RANDOM THOUGHT: I was thinking about with the whole Hong Kong / NBA / South Park situation. I think if the Chinese are going to play Great Brain and any kind of deal doesn’t look possible, Trump should just say he would lift some tariffs if the Chinese “free” Hong Kong and the Uighurs. The Chinese would never agree, but if you are going to show up empty-handed ahead of the elections, you might as well make it for a great democratic cause.
Here are the “obvious” probabilities regarding the trade deal and the “murky” implications:
• The odds of getting *ANY* trade deal have increased, as many thought the full deal was unlikely. This may be why fixed income is selling off today. There could be the thought that ANY deal would be enough to get growth going again. I think a soft deal should decrease recession odds, but this probably won’t cause that large regime-changing growth driver. I’m a little unclear as to how much a soft deal would improve business uncertainty and investment, as the future will still be unclear (especially with elections next year) and we have seen Trump flip-flip many times in the past.
• The odds of trade tariffs being enacted next week have increased, since the Chinese won’t be stringing us along. Any time they say, “we don’t want to give you what you want”, you would have to think that the odds of tariffs being slapped and tensions escalating are higher. However, the increase in tariffs could be short-lived as we could get the lifting of some tariffs at the Asean meeting. My main uncertainty with this view is that Trump seems a bit defanged lately, with impeachment, pulling out of Syria, getting rebuffed by N Korea, etc. The best realistic scenario for equities (and the US economy) would be if Trump is willing go along with the interim deal (eventually) and somehow try to spin that as a win. I’m wondering how he could do that and save face. I suppose he can do what he usually does and just keep tweeting what a great accomplishment it was – “If you keep saying it, it will be true.” But maybe he can do something “tough” this weekend before he acquiesces to a deal. Maybe.