Curve Advisor Bulletin
I mentioned that the markets are probably expecting downside on this Retail Sales number. If we get an in-line print, or something that is only 0.1 off, I like buying EDZ9 puts (maybe around the 97.875 strike) vs selling some 0EZ9 put structure at zero cost. I think a non-dovish Fed will take out the near-term hikes, and move them to 2020. I suppose you could do some now, as a very weak Retail sales will just cause us to rally, but you will take a small MTM loss. I like this structure because we get a cheap look at Libor-FF widening. Even if the Fed does an insurance ease, Libor-FF widening could cause the EDZ9 puts to be ITM.
There are two parts of the curve that seem very sticky…
• FFG0 3mo fly (trading some @ -0.5). This seems insane, when every 3mo fly in front and behind are lower, and we are bull steepening. If you want a curvature-neutral structure, you can buy a 3mo of 25% of a 6mo fly behind and convert to selling a positive double fly on a very attractive part of the curve. But I think this makes sense as a stand-alone trade.
• EDH1 6mo fly. This seems strangely high @ -0.5. Since the contracts roll Monday, It’s possible the pressure could ease later this month. I would expect this to perform better on a bear flattening than a bull steepening, so I like being long a fly against this for the latter scenario.
Those are the two areas I like focusing on for value. It’s not clear when they will release, but I think those two parts of the curve offers the most positive expected value aotbe.
FFQ9 3mo fly has also preformed very well. I would take all profit between now and Retail Sales. The "bearish trade" I'm thinking about is to buy EDZ9 puts and selling 0EZ0 puts (or put spreads), for about zero cost, in small size. I think a non-dovish Fed could cause the front whites to go screaming lower. I also like the idea of having a short exposure to EDZ9 in case Libor-FF blows out like last year.
My directional radar seems to be broken. I am still shocked that we couldn’t sell off more after the Mexico trade deal. Since then, the data has been constructive, but the markets in the hands of the bulls are taking an overly bullish interpretation or recent events. We get Retail Sales tomorrow, which I would imagine has some downside risk (and the bulls may be in control approaching the data aotbe). Assuming the data comes in-line, I think the risk is that the markets may be in for a rude awakening at the FOMC.

It’s kind of insane to think that the unemployment rate is at multi-decade lows, equities are near all-time highs, key FOMC members think we are at “neutral” and the Fed is going to cut. I’m not saying the economy couldn’t devolve, but this was mostly caused by negotiating rhetoric, and rhetoric could quickly flip the situation.

FFQ9 is pricing in 24bps of an ease. Barring an equity or retail sales collapse, there is a very tiny chance that the Fed eases next week. Let’s call this “zero.” My odds for July are very roughly: 50% nothing, 25% 25bp ease, 25% 50bp ease. That gets us to 19bps but I think there’s downside if: (1) FOMC remains “data dependent” (no more dovish than “monitoring closely”) and (2) we get any kind of Trump-Xi warmth (high probability).

I like the idea of waiting for an “inline” (or not too weak) Retail Sales, and look at bearish trades (put structures). Or I guess you can get a head start, if you think the data will hold up.
The two pieces of additional information we got today were:
• CPI, which nudged down. FWIW, Cleveland trimmed mean CPI also nudged down, but at an elevated level.
• Hong Kong protests. I’m not sure to what extent this could cause a crisis bid. I could see the argument for this helping or hurting the negotiations.

In any event, the ease story is not going away. If you are in need of an ease trade, consider selling the FFQ9 3mo fly @ -3 (if you think a Sept/Nov ease is possible). Note that there is a chance the Fed may skip if they do an insurance ease of 50 in August. But there is a lot of time between now and then. If you think an early 2020 ease is possible, consider selling FFG0 3mo fly @ -1.5 or -1, or the FFJ0 3mo fly @ -1 or -0.5.
EDH0 6mo double fly traded -2.5. You should take most/all profit around there. I think it could go lower, but we could see some potentially volatile curve moves in the next week, and remaining light makes sense. So now we have two sister trades, one old and one new:
• Sell EDH1 6mo double fly. This shockingly traded +1s. I still like this trade – especially if the year flies around EDU1 are down on the day (and on a down trend). Maybe this is here because of put buying (or call selling) in the green midcurve options? In any event, we have not seen the flies be able to get noticeably positive, so selling this 6mo double fly @ +1 makes sense.
• Buy EDU0 6mo double fly @ -8. This is my new favorite curve trade now. The reason is that it carries well, and if the fly curve does go positive, this trade should go higher, as it is further out the curve. On such a flat curve, it’s hard to see this double fly this low. Turn-adjusted, this is by far the lowest 6mo double fly… by about 3bps.

I thought I heard that 100K EDU9 97.75-97.625 put 1x2 traded, but I don’t see this in the OI. I see the “no move” ED level around 97.43. You would need Libor-FF to narrow, or a sizable amount of ease priced into the Sept and Nov meetings, two days before the Fed meeting (the EDU9 options settle 2 days before the Fed meeting) for those strikes to work. There is a certain amount of “using the force” to try and guess where Libor will be. The market has a tendency to 95+% price in the binary outcome before Fed meetings, so if you are going to pick strikes that are not close to the boundary, you may want to choose structures in EDN9 or EDQ9 options.
I am laughing at the new Trump “threats” regarding meeting Xi at the G-20. It is becoming clear that after leaving us at the altar last month, the Chinese are not returning our calls. I think the sequence of events went something like this:
Trump: Xi and I will meet at the G-20
Chinese: <crickets>
Trump: Xi and I will meet at the G-20
Chinese: Umm… President Xi may not go to the G-20?
Trump Tweet yesterday: If he doesn’t show up, then it’s instant tariffs!
Chinese: <crickets>
The reason for the laughter is when I was a kid, there was a joke:
Q: “How do you keep a moron in suspense?”
A: “I’ll tell you tomorrow.”
As mentioned previously, the Chinese are not the Mexicans. The Chinese will keep Trump waiting, because one of the three principles listed in their white paper is respect. They will wait until they get some. If they don’t get any, they will still show up. If your biggest customer is an a*s, you are still going to talk to them to see what they want. The Chinese have already decided they don’t need our business, so they might as well see if respect is given.
I’m surprised the markets only sold off 4bps today. I think they will be really disappointed by the Fed next week. Assuming the Mexico tariffs don’t reappear, I don’t see why the Fed would ease, or give a stronger indication than “monitoring closely”. The 75K payrolls was weak, but economists have been saying for YEARS that 75K a month is standard as you get closer to full employment. So 75K is not horrible – you can’t expect to grow 175K a month forever. I suppose more economists are jumping on the July/Sept ease bandwagon. I’m just not sure the Fed is going to act after a positive G-20, unless you thought the data really falls off. The last two major pieces of data before the Fed meeting are CPI and Retail Sales.

In looking at the OI, FFN9 OI increased 52K, while the EDM9 through EDZ9 OI declined 95K. It’s not clear if these are related. I suspect some of the EDU9 longs got out on Friday. Let's see if the FFN9 buyer is looking to dump his position later this week (when the bid/ask sizes are larger).
This could just be an Illiquid overnight session, but the following don’t make sense to me:
• EDH0 6mo double fly is around 0. I fail to see how this could get much more positive in the current environment, as any eases will be earlier, and any hikes will be later. This is probably my favorite curve trade right now.
• Sell FFQ9 3mo fly being around -3.5. If you look at FFN9 3mo fly around -13 and FFV9 3mo fly around -12, this is a bit of a head-scratcher. It comes down to the Nov meeting relatively unpopular. FFV9-X9 is around -8.2 while the August meeting is -19 and the Jan meeting -6.7. It could be worthwhile to play for rolldown in the Nov meeting absolutely (selling FFV9-X9 if you are bullish) or relatively (selling FFV9-X9 vs buying FFF0-G0 or just selling the FFQ9 3mo fly).
The Trump agriculture comments (and the Mexicans knowing nothing about it) may decrease the conviction in this deal that was announced over the weekend. USDMXN only retraced 75% of the tariff move, so trade accordingly.
Apparently both Trump and Mexico were eager to make the deal. I’m guessing Trump was feeling the heat from Republicans, businesses and his staff – he was really under no time pressure. I was wondering where the markets were before the Trump Mexico tariff tweet. Here are the levels on May 30 and the changes since then, for select contracts:
• FFQ9 97.68 +20bps
• EDU9 97.64 +28bps
• EDZ9 97.765 +28bps
• EDZ0 98.165 +15bps
• EDZ1 98.12 + 12bps
• EDZ2 98.005 +10bps
• EDZ3 97.875 +8.5bps
Factoring in that the economic data has been fractionally weaker, I would think that “fair value” would probably be to retrace 75% of the move. But I think after seeing how crazy the markets get in the near-term contracts on a rally (could have been stops, which may no longer be there), I would think the markets may only take back about half of the move, with some additional comments:
• The moves in FFN9 and FFQ9 have been insane. It is unlikely the Fed will ease or signal an ease (but they will signal data/news dependency) at the next meeting. Let’s see what the OI changes are on Monday. If the FFN and FFQ trades are large new positions, they may be wanting to get out and jamming the bids. I can’t tell if these were stops, or if someone really thought a “no deal” weekend was that relevant (I previously indicated that the Monday deadline was not particularly relevant).
• Curiously, in June (1 day after the Mexico tariff announcement), EDU9 has rallied 17bps, while EDU0 has only rally 0.5bps! That’s kind of insane as well. It’s not clear if this was just because of the bull steepening unwinds, or this is some option-expiry-related shenanigans on (large player trying to pin the 0EM0 strike).
In any event, I would expect:
• Less eases priced in the next two meetings.
• More eases priced into Q4 this year and Q1 of next year.
• More flattening further out the curve.
This move in FFQ9 is very surprising, as is the strange curve move in the reds. I suppose I did warn of the bull steepeners getting stopped out... and we may be seeing a continuation of that in reds-gold spread. But what seems to be going on is that the markets want to price in an insurance ease in the next two meetings and then a Fed pause. I think this may be getting a little too cute: (1) there is no reason why we wouldn't get the insurance ease later in the year, (2) the Fed may need additional eases afterwards, and (3) the insurance ease may only be 25bps. But I suppose the Fed could ease 50, so it's a matter of when the knife stops falling. Set an appropriate stop for the FFQ9 vs EDN9 risk reversal trade. I think a safer play is to fade the June meeting (FFN9) vs a EDN9 call structure. And look for tactical ways to play for further eases later (selling high flies) - I think if the Fed eases, it won't be until later in the year.
That payroll data wasn't great, but I didn't think it was 10+bps poor. I would still consider the data constructive. What I find interesting is that I feel more confident of a no-move in June post-payrolls than I was before payrolls. Yet we see FFN9 +2.5 on the day (and traded as high as +5.5 on the day). 1bp of it could be the FFER printing 2.37 today. We have had 216K FFN9 trade today. It's possible that someone really likes playing for a June ease. But there's also a chance that it's a cheap play at causing a panic in the markets, and using that opportunity to unwind bullish trades further out the curve. Let's see how rates trade today, but it wouldn't surprise me if rates were flat on the day. This is not my central view - just that it wouldn't surprise me.
A trade that makes sense to me is to sell FFQ9 vs buying 1-3x (EDN9 97.875-98.00 call spread vs selling EDN9 97.75 put). The weight would depend on your perception of risks. There are 18+bps in FFQ9 that we could conceivably pick up. I think mid-July is too early for the eases to get taken substantially out. But if they do, the June and August meetings should be substantially removed. The ideal scenario would be my central scenario where the June and August meetings get taken out, but the Sept meeting remains priced. The call spreads would protect you on more eases being priced, as the calls are ATM.
I actually think the best way to play the EDU9 buyer is to sell FFQ9. If I think a June and July ease are unlikely, and there are 19bps of ease priced into those two meetings, we can sell FFQ9 and buy some bullish protection (25+bps wide) further out the curve. FFQ9 will also be faster to converge and contains most of what I think is the mispricing. You may make money on both sides of the trade if the Fed eases, but doesn't ease until much later.
EDU9 OI increased 103K yesterday. We are clearly seeing additional buying today. I think there is a lot of value in fading this move through puts (relatively). I’m not sure what the large market participant is looking at – this may be options-related. In any event, whenever he stops buying, you could see a massive move in EDU9. I had previously mentioned that EDU9 looks about 10bps too rich. I suspect they may be selling reds against their “wrong” position. I mean really, you basically have to think the Fed can ease more than 50 bps to want to own EDU9. Otherwise, you are picking up pennies trying to collect the small amount to 50bps. I just don’t see it… because the Fed is not easing in June, they are probably not easing in July, and so they only have Sept and a fractional part of the Nov meeting to get 50bps. I’m not saying the Fed couldn’t ease 100+ in a meeting if the situation required. I’m just saying a lot of things have to happen, that can not be considered “central scenarios”.
Since 1) downside to payrolls already priced, 2) a Mexico deal eventually gets done, 3) the Fed may not be as dovish as the market pricing, and 4) Trump and Xi reaffirm their BFFness, I think we need to look at cheap put structures. The main thing holding me back from strongly recommending put trees and put 1x2s on N through U on ED and 0E are that I think there were a lot of risk reversals going through. I’m most uncertain about how 1) and 2) play out. So maybe I’ll look at these structures later this week, or early next week.
I’m thinking about 4 key timing points this month, with some thoughts on positioning:
1) Employment Report (June 6). The whisper is probably to the downside on the headline. I think the recent fixed income support should probably hold until at least then (aotbe).
2) Mexico trade talks (ongoing). The tariff deadline is Monday. However, it’s possible talks go on longer, since 5% tariffs are nothing – especially since USDMXN already rose over 3%. Mexico would have to be truly desperate to give us “what we want” this weekend. And we have a “cheap option” to just keep saying “it’s not enough” for the next month. We may want to agree earlier for market stability reasons. Any agreement any time soon would be gravy. I would think we want a Mexico deal before the G-20, just to signal to China that tariffs can be removed (assuming we want a deal). I’m not clear on what is priced into the markets. But I think a Mexico trade deal should get done by the end of the summer at the latest.
3) FOMC meeting (June 19). My central view is that the Fed highlights the risk of trade negotiations, and the dots fall 25bps MAX (trimmed mean). So I think this will be “disappointing” to the bulls that may want a stronger signal. While the Fed are open to an ease based on incoming information, it would be idiotic to ease or signal an ease based on negotiation rhetoric, which can change day to day.
4) G-20 (June 28-29). Trump and Xi are meeting. Right now, I think there’s a 3:1 chance things get “better” (continuation of talks with a new “beautiful” understanding) than get worse (no talks) after this meeting.
Here are my thoughts on select meetings:
• June 2019: We still have the Employment Report. Assuming the ADP was an outlier (and equities don’t collapse in the next 1.5 weeks), I don’t see a June ease. The Fed have emphasized data-dependency, and nothing thus-far has been poor. We also get little data before the FOMC. I also get the feeling that they are not going to want to overreact to headlines. So 5bps being priced into the June meeting is a little high, but could be picking up quarters in front of a steamroller.
• Q3 2019: The beige book stated that the “outlook for coming months solidly positive but modest”. So I’m also a little dubious that the July 31 meeting (only 1 more payroll after Friday) would provide enough data for the ease. I think people selling FFN9-Q9 (currently 15bps for the August meeting) are mostly making a “dovish statement” play. Of course, it does provide some protection in case equities puke. I would want to get much better than 2.5:1 on a 50bp move to want to be long FFQ9 (which combines the June and July meetings). The Sept meeting is about 21bps priced. I can’t get excited about that either, but I do think that a Sept ease could be possible.

Taking a step back, I think we could get a 10+bp move to the downside on EDU9, from the June and part of the July meetings being taken out. Considering: (1) I think we get a positive G-20 result (which may or may not be meaningful), (2) the data so far has been decent (not good), and (3) equities seem to be trading positively towards the G-20 and positively from the Fed puts, I’m not sure a fair over/under on an ease by the end of Q3 should be 40+bps. I can believe 25-30bps. So I feel like the markets are all positioned into bull steepeners and have stretched the markets accordingly. Of course, the data/news may prove them correct. I am just not seeing it right now, with both Trump and Xi looking to extend talks (delay). As with any time there are crowded trades, some caution needs to be exercised, before the exit gets crowded.
The best trade right now is to sell the FFG0 3mo fly (-1.5/-1) and buy some other fly behind it. It is incredulous to me that this fly could be higher than the flies behind it – especially since I think Q4 through Q1 are the highest probability ease candidates. If you can’t get liquidity in buying a fly further out in FFs, you can buy an ED 3mo fly (or 25% of a 6mo fly) further out against it. Or you can just sell the FFG0 3mo fly outright (as I had been suggesting).
I think the best way to fade any delay in eases is to buy put structures on EDN9 through EDU9 put structures. Because of how high vol is, you can select a put fly or put 1x2 for relatively low cost, to fit your view.
I thought the Fedspeak was mostly “data-dependent” the pat two days. Apparently, the markets think that the data will start falling off enough for the fed to ease (early), despite any “progress” at the G-20. We do have the impetus from the strong front-loaded Q1 GDP, which should put downward pressure on the GDP the rest of the year. The rest of the data today should be interesting, as we get a “forward-looking” ISM data. The fixed income bulls will be in charge the rest of the week, with that low ADP print that should cause the Friday NFP whisper to be lower.
Powell didn’t sound like he was going to ease in a couple of weeks. He said he is “closely watching implications of trade negotiations for US econ. outlook.” As I mentioned earlier, while the Fed may do “one” insurance ease (unlikely), it’s not clear the Fed is going to “go to zero” any time soon, since trade talks will probably continue well after the G-20. It’s also unclear equities will collapse while trade talks go on. Therefore, I think:
1) we have too many eases priced into 2019 (while trade talks go on) [look at EDN9 thru EDZ9 put structures. EDN9 75 straddles around 18-19 seem high – especially if data come in-line this week] , AND
2) we don’t have enough eases priced into 2020 [consider scale selling FFG0 3mo fly, or selling any 2020 calendar spread] , AND
3) there is too much steepness relative to the curve in 2021. [consider selling EDH1 6mo single and double fly, and/or selling EDH1 through EDU1 1yr single or double fly]
I think we had some massive stops go though in the front EDs overnight (and late yesterday). Curiously, EDU9 OI increased 36K, EDZ9 OI increased 45K and EDM0 OI increased 60K. Unless these were options hedges, if people went long, that means we could get pukage to the downside. There may have also been risk reversal positioning (buying calls) going through. It looks like my blow-off top call is going to occur over 2 days.
I like buying 0EU0 98.00 puts vs selling 2EU1 98.00 puts at 0.5. There are similar structures in 0EQ vs 2EQ and the 97.875 strikes offered at 0.5. I think on a “beautiful” G-20 meeting, we could see the front eases taken out and Druckenmiller & Co would put the later eases back in.
We have some very large flows going on in EDU9, and we’ve had large options flows going through in EDU9 the past two weeks. I’m looking at FFN9-V9 (Q3 eases) at -31.4bps and Q4 eases at -27bps. I realize Bullard said a rate cut may be warranted soon. Barkin said she is “nervous” about the global economy. However, because of the timing of the G-20, I think the central scenario has to be that Trump and Xi reaffirm they are indeed BFFs and agree to play nice and they go back to negotiating. So we probably won’t have any trade certainty until later this year or next year.

I think it’s “possible” that with trade uncertainty, we get an early insurance ease (not my base scenario, unless equities or the data puke). But that may only be 25-50bps total. The full series of “eases to zero” would be when they think recession is near. Is the Fed really going to empty the clip on eases while (prolonged) trade talks continue (barring pukage)? That seems premature. We also have firmer inflation (core PCE was in-line, Dallas trimmed mean was higher and tariffs should add to pricing pressure), that may hold the Fed at bay.

As a result, I like the idea of looking for a way to fade the early eases, and/or play for later eases (in quarters that don’t have 25+bps priced).
Trump must have watched the Godfather last week, and was inspired the scenes of Michael getting rid of his opponents simultaneously. Since next year is an election year, maybe it’s not completely insane to clean all your dirty clothes this year (or early next year) so by next year you have fresh laundry to show off. Maybe.

1) Mexico. I laughed thinking about Trump saying, “Hey, AMLO, since you are busy and all, how about you cut me a check for a piece of the border wall I’m missing, and we’ll call off the tariffs? It’ll be cheaper than you trying to defend that huge border by yourself from your side.” Was this his Grand Plan to get Mexico to “pay for the wall”?!?
2) India. India is China 10 years ago. So if you are having problems with China now, you might as well nip the whole preferential trade treatment in the bud for the next China. On net, I think elevating India trade could be a longer term plus for the US, although the timing could have been better.
3) Japan/EU. As an American, I can say that with some exceptions, American cars are basically c**p. That is why nobody outside the US buys US cars. I’m inside the US, and I’ve never bought a US car. Here’s the current list of the most reliable cars according to Consumer Reports (Lexus, Toyota, Mazda, Subaru, Kia, Infiniti, Audi, BMW, Mini, Hyundai, Porsche, Genesis, Acura, Nissan, Honda, Volkswagen, Mercedes-Benz, Ford!!!). That’s right. #18 is the first American car. USA! USA! USA! Trump must realize this. So IF he’s making a big stink about US cars as a manufactured negotiation chip (as with steel, etc), a trade deal with Japan and the EU could come along.
4) China. While I was reading the article on the Chinese white paper, I got the impression that the Chinese were okay with the trade deal until Trump said “we’ll leave the tariffs on.” Then they started walking everything back. I mean really, the only reason the Chinese are at the negotiating table is to get the tariffs off! So IF : (1) we are to believe the Chinese are sincere (ask Obama, Clinton, et al), and (2) Trump is just using the “leave tariffs on” as a manufactured bargaining chip, the odds of a trade deal are higher than I previously thought and the quality of any trade deal may be better than I thought. But with Trump apparently willing to pull the “tariff” card out at any time (see Mexico), that’s going to make the negotiations tricky. In any event, it’s probably in both parties’ interests to be on good terms at the G-20. Because if Xi is playing the waiting game, he may as well say whatever it will take to delay Trump. So I think we wait for the “news” for any bullish trades.

That’s a lot of fights… and I’m not even including Iran, Russia, and what seems like half the world Trump has managed to p**s off. I think that may be the extent of his trade laundry, as the above covers most of the US trade partners with large surpluses that we don't have a deal with. Let’s see if he does any cleaning the rest of this year.
As a result, I like taking profit on most of the short FF flies before or after the ISM (depending on your view). FWIW, I think the market should perceive a downside risk to the ISM print today, so the whisper may be lower. The FFF0 3mo fly is strange much lower than the FFG0 3mo fly – I would unwind most/all of the FFF0 3mo fly and keep more of the FFG0 3mo fly.

Because we are symmetric, taking a chunk of profit on your other bullish trades (like FFK9-M9) could make sense around the ISM (before or after depending on your view). I think locking in profit and using the G-20 to reload on bullish trades makes sense. I think it unlikely thing get worse at the G-20. Nearer term, after the ISM today, it’s not clear Powell will be much more dovish (noticeably change his message) tomorrow, and it’s not clear the Employment data will have gotten worse already.
It’s nice to be back! “Everyone” seems to have switched to the “no trade deal” narrative. I think the tail risk is sufficiently priced here, and I think we could get a blow-off top today IF: (1) ISM comes in roughly in-line, and (2) equities don’t fall further. The reason why I think we could correct is that:
1) unlike other “recessions”, the cause of this move (China trade) could easily be (temporarily) reversed later this month at the G-20. I still think a good trade deal is “unlikely” any time soon. But that doesn’t mean it can’t happen. And we could get some “beautiful” words and a truce between Trump and Xi.
2) We are now pricing in over 100bps of ease. We are almost halfway to zero rates. The larger risk is no longer to the upside – we could get a large move in either direction. Before, the amount of eases possible caused us to price in net eases. Now the amount of possible moves is close to symmetric. And the Fed could go on an easing cycle and not get to zero, so any slowdown could already be substantially priced.