Curve Advisor Bulletin
Market
I was watching an interview with Howard Marks (on Realvision) over the weekend, and something he said resonated with me – that he only has a strong conviction view ONCE A DECADE. When I step back and look at the current environment, this does not strike me as a great time to have large positions in anything. I’m not saying there isn’t some value on the curve – there usually is. It’s just that the narrative could easily change on a single headline. It’s great if you have a strong conviction on something going on now – by all means load the boat. I would want to be constructive on the economy on a China trade deal, but I think that may already be priced, as equities are lofty. My crystal ball right now is really fuzzy.

“It's not like, well you find a bunch of investments and sometimes you decide to go heavy and sometimes you decide to go light. What it is is that sometimes you find a lot of great investments and they tell you that this is the time to lead up the load up the boat. And sometimes you can't find any bargains and they tell you this is the time to be defensive. So it's not an independent decision, you see.

Now a lot of people make that decision top-down. They look at the macro, they look at-- whatever the number-- technical, and all the trading numbers, and all those things. And I look at the mood of the environment, I look at how people are acting and thinking and talking, and that tells me also whether I should be aggressive or defensive as I described in '06, 6. But it also comes through in the investments. You find things that you say well that's I think that's half what it should be. I'm going to load up the boat. So you turn aggressive. But for the most part, you don't get many of those opportunities when the market is galloping along and everybody's optimistic and risk aversion has gone out the window. So it's all of a piece. But I do think that it's desirable at the extremes to alter your behavior.

Now I was working on the book and I gave some chapters to my son to read who works on our family investments. And I told him I think my market calls have been about right. And he said, yeah dad, that's because you did it five times in 50 years. The point is, and I didn't even stop to think about it that much, but of course I thought about it in the later days. But when you are at an extreme high or an extreme low, the logic is compelling and the probability of being right is high. But when you do it in between, the market's 5% overvalued, 2% undervalued, 10% overvalued. The logic is not compelling. And the probability that you're right is modest at best. So five times in 50 years, once a decade. And that's what we tend to get. We get tend to get one of these and one of these a decade. But these are not always extreme. And so you can't make a career out of playing the extremes of the cycle. But they can inform what you do. And you can modify your behavior in between, but you shouldn't count on being right.”
Trade
Reducing/eliminating any white ED positions vs FF makes sense – in particular getting out of the ED flatteners vs FF steepeners. This is because EDH9 vs FF only has 2bps of narrowing priced in. And “Kong” is keeping EDZ9-FF wide. So any further narrowing of Libor-FF could cause even more steepening. We are also starting to get close to last summer’s 17bp narrows in Libor-OIS, so that does not leave us much room for flattening. If you had told me last year that the LONDON Interbank Offered Rate would narrow heading into the Brexit deadline (and US tax time, where we should get a shortfall), I would have said you don’t understand tail risk. But I suppose if equities and credit spreads are going to be at these “risk-on” levels, the markets and I disagree on tail risk.
Market
Libor dropped a whopping 3.9bps "again." While analysts will try to explain this as CP transactions affecting how the Libor waterfall is calculated. I’m inclined to think these massive moves in Libor in quiet markets have a manipulation component. This makes trading the front end of the ED curve very dicey. As a result, staying away from anything in the very front end of the curve is prudent, unless you have a very strong view.
Market
Today was a day of unusual moves. We had that suspicious gap up on the SPX open – that seemed really “manipulated.” We had more terrible hard data (IP), but the soft data was better than expected. We also had weaker inflation (consumer expectations, import/export prices). On the rates curve, we are seeing a reduction of the eases priced (presumably on good China news and equities), but a negligible amount of additional hikes. I think a lot of people are in steepeners further out the curve, and this EDM1-M2 spread could be an unwind. What I have to figure out is how much any recession story will take a back seat to a China deal getting closer, as that will determine the shape of the curve going forward. Enjoy the holiday weekend.
Trade
The EDM1-M2 spread has traded over 9K times today. One trade thought I had is to play for a recession around after the 2020 elections. So selling the EDZ0 6mo fly vs buying the EDZ1 6mo fly (aka selling EDZ0-Z2 vs buying 2x EDM1-M2 spread) @ -2.5 (or even -3) could be a reasonable trade. I think the recession folks will be around for a while, so claiming some territory around areas we like makes sense. Also, the Z0 year-end turn has been regularly priced 2+bps higher than the Z2 turn, so if this remains the case, this structure will be 2bps or so lower than prior to December. We have also had a much more dovish Fed. We should be long some of the turns further out the curve (like EDM3 6mo fly), so if all turns go higher, we will be protected. Kong’s not easily giving up the front turn any time soon.

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Market
The most important piece of data today for US rates is that the 5 year consumer inflation expectations matched a 10 year low (last see two years ago). The Fed is not going to hike with contained inflation expectations.
Market
China's goal is to keep pushing things back, and to sign a "fluff" agreement. So regardless of how much or little has been done, they will talk up progress. We have seen Trump play “good cop” while his minions play “bad cop.” I think it's a little more important that Mnuchin thought they were making progress. Lighthizer will probably be tight lipped (because it would be moronic to say things are going well in the middle of a negotiation), so if he sounded positive, that would really be news.
Market
As mentioned yesterday, I think people are expecting some downside to the data today. So we could see outsized reactions to favorable data, like today’s Empire Manufacturing. But the big ones (IP and consumer sentiment) are coming up.
Market
I was looking at the EDU9 6mo double double fly (aka EDU9 6mo double fly vs EDH0 6mo double fly, or EDU9 12mo fly vs 4x EDH0 6mo fly) as an indicator of relative curvature, and I thought it was curious that we had the following movement (see chart). It’s highly unusual for rates to be mostly choppy this year, and have a fly structure move in such an unnatural way. The structure drops precipitously and steadily and then rises sharply and consistently. I would have said it looked like someone bought a lot of EDU0 since early January, but this does not show up in the OI. We are short this position, so let’s see if the slow and steady march continues downward (again).

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Trade
Since you may be looking for reasonable bullish trades, my four favorites bullish trades right now are: (1) Selling EDU9 3mo fly. I know I said Kong was out there. But this seems lofty considering the markets are thinking the Fed eases in Q4. See chart below. (2) Buying the long end of the US. The curve *might* bull-steepen. But it *might not*. I’m not a big believer of eases, but I think the central banks may be on hold, so earning carry can’t be terrible. Trump kicking the can 2 months down the road on China trade removes some short term tail risk, but not what I consider a “great” result. (3) Buying FFJ9 @ 97.60. I just don’t see the Fed hiking at all next month. While it’s unlikely they ease, all it takes is a 10% equity correction to get a few bps priced in. (4) If you have some bearish trades and need some ease protection, I like the idea of selling Canadian BA spreads in the reds. The reason is that I can’t see the Fed easing, and the BOC not following suit (maybe 3 months later). This trade thought is going to take a little research, but I thought I would put it out there. I’m not sure I like the BA flattener as an outright trade – it just looks strange, relative to the ease priced into the US curve.

I still like being short equities against bearish positions, but equities seem to not want to sell off. I’m not sure if there’s a buy the rumor, sell the fact going on with respect to the great Wall and China, and that we’ll get selling after the good news.

The best bearish trades really depend on your view. I am still sticking to the low FF flies and put flies (especially on the red midcurves playing for “no move”).

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Market
The OI for EDZ9 increased 29K yesterday, after a bit of a lull. This brings the February OI increase to over 105K Since Feb 1. Nothing huge, but it has been the largest OI mover on the curve. This may be one of the reasons why the flies centered around the reds are low(er). We have seen Kong both capitulate, and be stubborn. So the back whites bears watching – 105K is not that large a position for Kong.
Market
That was a shocking Retail Sales number. The only silver lining is that the print today was for December. We get the January number in two weeks. That having been said, the markets will probably think there is some additional downside to the sentiment and IP data tomorrow. I think we may hear some “stagflation” talk in the weekend economist write-ups this weekend.
Market
Looking ahead, assuming we get a China deal done, it seems to me that the next thing the US will do is to go after the EU (and Japan) on trade. This is not going to help either of these economies. At the same time, that Oliver Robbins story (where he allegedly said that May’s strategy was to wait until the last minute), makes me think the hard exit probabilities should be low(er). I also think we could see a surge in UK activity after the uncertainty clears. I want to start looking at some sort of “bearish UK rates” trade (relatively, possibly against something in the EU?). Let me see what looks interesting on the curve in the next few days. Hopefully, we get some “bad” negotiating news to put on our view.
Trade
We will probably see increased curvature from the mid whites to front reds on a continued bear flattening. As a result, you should adjust your entry and exit levels on various front fly trades. In particular, you should take profit (or scratch at worst) on short fly trades like FFN9 3mo fly and FFV9X9F0 (unless you really need the crisis protection). You can also consider adding to some of the FF fly trades we previously mentioned (like FFQ9V9X9 fly, FFV9 3mo fly and FFX9F0-G0J0 condor) if you want a bearish trade that has not moved much. I still like scaling out of EDH0 6mo fly trades (unless you are really bearish), as an early inflation hike could cause more ease to be priced in later.
Market
Inflation is going to be the main catalyst that could get the Fed off their "patience" rhetoric. While this CPI and earnings data are just 1 month, people are not going to be as comfortable thinking that the Fed is going to be on the sidelines. This also changes the math on "net hikes", as previously, the odds of an early hike were "zero", so net eases were priced into the front of the curve. But the math changes when "zero" becomes "nonzero".
Trade
The EDH0 6mo fly traded -7.5s. Unless you are really bearish, I would take profit on EDH0 6mo fly-based structures (vs EDU9 1yr fly, vs S&P and outrights) by -6.5. You can start scaling now and get out by -6.5. We still have a lot of uncertainty and taking P&L off the table makes sense.

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Market
Today’s market move is a bit of a head-scratcher. I can understand a strong rally in equities, on the back of a shutdown deal being reached and a positive tone in the China trade talks. I’m a little confused that the markets don’t seem to want to more aggressively take back eases (and we are bear steepening, and not bear-flattening). Perhaps the longer end selloff was the JPM client survey showing extreme bullishness in the long end (most in 2+ years). But to be fair, there was no reason to be bullish the long end the past two years. I would have thought on the news today, we would have taken back more ease (and put in some hikes). Part of the selloff in the whites was just a rise in Libor, so there was even less selloff than shown by EDs. The disconnect between recession on the curve and the equity markets continues. I suppose this could explain why equities seem to have blowoff tops right before a recession. Let’s look for good opportunities if the divergence continues.
Market
There’s been a lot of recession talk over the weekend. The graph of the NY Fed’s Probability of recession was making the rounds, as was Krugman’s recession call. I was surprised the recession indicator got this high, but apparently the NY Fed model is primarily a 3mo vs 10yr spread, which probably doesn’t account for the Age of QE (flatter curves). I lean towards thinking the very long end could flatten barring massive easing being priced, so it’s not clear if the markets will continue to think a flatter curve means recession. While I do think there will be “tough talk” prior to any deal, there seems to be a difference in what the interest rate and equity markets have priced in. The markets like owning shorter term fixed income (which is pricing in an ease), so they are looking more at the “journey” of negotiations (“tough talk” ahead). Equities appear to be pricing in more of the “destination”, where deals “should” eventually be reached. But I don’t think recession priced in fixed income and relatively lofty equities can stay diverged. It’ll be interesting to see what will give by next month.

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Market
This should be an interesting week, with China trade talks resuming, and the government shutdown deadline at the end of the week. It helps Trump with China negotiations to be firm on the Wall. Any perceived give-in on the Wall could be shown to signal weakness on the much bigger issue of trade. As a result, I do think Trump “should” bend much. As per most negotiations, I would also think that we get some additional “tough talk” before any deal (China or shutdown) is reached.
Market
The Libor-FF spread narrowed 0.9bps today. But since there was a decent amount of narrowing priced in, the front EDs did not rally much. While there has been much written about how the move in Libor was related to lower commercial paper rates, I'm a little surprised Libor is not staying wider ahead of Brexit. EDG9 is pricing in for Liblor-FF to narrow 2.3bps in 1 week (which does not seem excessive considering the recent moves). And EDH9-ff is pricing in a further 3.4bps of narrowing.
Market
I think the curve will flatten on a selloff. But it feels like there’s a battle between people who think the curve should flatten and steepen in the long end on a rally. The longer end spreads have had a hard time deciding what it wants to do. For example, EDM2-M3 spread has just been sitting suspiciously around 12bps for over a month, despite the wide trading range in EDs over the time period. Typically, if you thought the Fed was going to ease, we would expect to see the EDM2M3 spread steepen. However, we are in the age of QE with no inflation. Barring a massive easing cycle priced (more than 1 ease), it’s not clear the long end couldn’t lead a rally. In any event, I would be surprised if we were still here next month. It looks like we are consolidating for a breakout. I’m just not sure in which direction.

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Market
EDZ9 OI increased a meager 10K contracts. But that is a small amount every day. EDZ9-FF looks a little wide compared to the ED-FF curve. It's not clear how much of this is "year-end turn" and how much of it is "Kong accumulating".
Trade
There seems to be decent buying interest in FFV9X9 spread @ -0.5. If the markets look unfavorable and you need some ease protection, look at selling this spread @ -0.5, or selling a fly like FFV9-X9-F0 fly @ 4 (Nov vs Dec meetings).
Trade
If you need some crisis (ease) protection, take a look at selling FFN9 3mo fly (4s are trading small). If eases continue to be priced into the whites, this could go negative, while it's not clear if this will go much higher than 5 in the current environment. The only caveat is that I wouldn’t want to be short this fly from 4 if a trade deal is about to be announced, but with the deadline still 3 weeks away, we may get some bad news before good news.

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Trade
Fading the EDH0 6mo fly move could get hairy, as that has dropped like a stone. But I think taking a stab near the lows could be good risk/reward. The main way I would like to play for a “less ease” view is to Buy 4x the EDH0 6mo fly vs Sell EDU0 1 yr fly. The reason for this is that if things get really bad, a majority of the eases will start getting priced into late 2019 and early 2020. And if things look great, this structure could revert toward the highs of last month (-2.5), which is 18+bps higher. I would definitely leave room to add.

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Trade
I suppose you could do Sell S&P equity vs buy EDH0 6mo fly trade, as I could easily see equities lower without EDH0 6mo fly going lower. Whereas if equities recover, I think the fly should recover. I’m thinking something like Sell 5 ES vs Buy 400 of the EDH0 6mo fly. The weighing is just a wild guess – this could be anywhere. You need to put a stop on the ES portion. But heading into a Friday and people coming off the Chinese New Year holiday, it’s not too hard to picture horror scenarios.
Market

Market
The news today has been very bullish for fixed income (China trade talks, ECB lowering expectations, dovish BOE). A lot of this is just uncertainty ahead of events that will be eventually resolved. Both the China trade talks and Brexit are negotiations. And as we know, negotiations always look the worst as you approach the deadline. There seems to be a lot of deferred eased being priced in. For example, someone pointed out that the EDH0 6mo fly is near its lows, while equities are still lofty.
Trade
The unusually large unpredictability of Libor makes trades like being short the EDH9 call vs EDJ9 calls very unattractive. But I still like ED spread flatteners vs FF spread steepeners (like EDM9-U9 vs FF N9-V9), as that is a little further out the curve.
Market
I don't want to sound like sour grapes, but Libor manipulation is alive and well! That was a shockingly low Libor print (down over 4bps). I should have stuck to my New Year's resolution to stay away from LIbor directional calls. While this was a 3 day fixing, it's a real outlier to see such a large move when rates have not moved much. We did see very large EDH9 buying a couple days ago, so perhaps that could have been a warning sign. It's not clear if this fixing was related to the BOE meeting today. In the long term, this makes trading the very short term EDs unattractive.