Daily Clueless Musings 5/31

It is the last trading of the spectacular May rally in Eurodallors. What else can we expect but another rally. Europe brought the market Greek bailout 2.0 just in time before US market opened after a long weekend. The details are not announced yet. The basic plan is that in exchange for the 32 billion new money, Greek will fund the gap through expected privatization receipts, rollover of debt mostly by Greek banks and issuance of bills. What a “brilliant” plan! Stocks rallied all over the world and Eurodollar futures traded lower overnight. Insolvency can be solved through selling productive assets or internally transfer liability (Greek banks extend credit to the government), maybe we should rewrite the bankruptcy law. The can could be kicked down the road once again, the question who and when are going to recognize the loss remain to be answered. Greece's problem is lack of a money printing press to force creditor to take loss. US tells us merely a money printing press will not guarantee economy recovery. Today's data again confirmed slowing economic activity since Q1. The headline Chicago PMI data tanked in May, showing the slowest rate of monthly growth since November 2009. Growth in backlog orders almost entirely evaporated while inventories surged, which will put more pressure on the future manufacturing activity. The only thing that did not slow is the input price for raw material, which printed 78.6. Soon, stagflation is going to be the most used word in my summary. The Conference Board’s measure of consumer confidence dropped 5.2 points in May to 60.8. The labor market differential widened from -37.3 to -38.3 in May. This bodes ill for the coming NFP this Friday. Vols came in again. Paper continue to put on bearish trades on the EDU1 together with bullish trades on the back contracts. Paper bought U1 p> and sold Q1 97c as a package. They also bought 0U 92-5 C1x2, which further crashed the mid curve call skew. Although mid curve vol path has been performance in line with the steep skew slope as futures slowly grind higher, market seems to be under pricing jump risk in the future at this point. The market is complacent. As the short risk trade (long Eurodollar futures and shorting volatility) has work well for so long, the risk for marginal profit is absurdly high, and yet no one (at least those who are still riding the trade) seem to concern.

Daily Clueless Musings 5/26

The second print of Q1 real GDP growth still shows the economy expanding at a paltry 1.8% annual rate. The much anticipated upward revision did not come, even after yesterday’s upward revised March inventory building and core capital good shipments of durable goods. The number is due to a weaker-than-expected print on consumer spending. More disappointingly, the consumer income is revised down more than the spending, which led to a drop in savings rate from 5.7% to 5.1%. A weaker than expected job market is not doing any help to US consumers. The jobless claims data disappointed, rising 10k to 424k, the seventh straight week claims have stayed above 400k. In the euro land, things are not getting any better. The head of the Eurogroup Jean-Claude Juncker highlighted that the IMF will only release the next tranche of its funding for Greece if the source of Greece's financing needs over the next twelve months is clear. The timing is pretty interesting. At the time of the last review, three months ago, it was assumed that Greece would be able to reaccess capital markets next year. Even the most optimistic people will not believe it is the case anymore. This could be intended to put pressure on Greece and EU/ECB to come up with a resolution. Both GDP and the claims are worse than expected, futures regained strength to continue this run up, after couple days of consolidation. Vols are lower again. Market seems to be less concerned about a credit crisis, even EDU1 participated the rally. Paper started to put on some bearish trades to fate the rally. They bought M2 88-91 P> and sold 96C.

Daily Clueless Musings 5/19

Guess how the Eurodollar futures traded after yesterday's break? The day after the 6 breaks that we had in the past 30 trading days, 100% of the time futures bounced back. The day after Fed released its blue print for exit strategy, the rally continues. The market has been modeling the movement of financial instruments after random motions on the belief in efficient market. While, if this is true, the 6 down days out of 30 trading days in EDM2 would imply a 3.3 standard deviation event, which should happen every 160 years. Information flow does not fully justify the move. Initial claims declined 29k to 409k. The first time in a while, the number came better than expectation. The data also suggest the weakness in the prior weeks appears to be due to distorting factors including temporary auto plant shutdowns and Easter in the seasonal factors. Existing-home sales is a little weak. It fell 0.8% to a seasonally adjusted annual rate of 5.05 million in April from a downwardly revised 5.09 million in March. But a weak housing market is not much of a news any more. The yield on 10 year treasury dipped below the headline CPI the first time in this cycle, even though Fed does not believe inflation is sufficiently high in this economy. Even assuming inflation stays at current level (although even Fed thinks the risk of inflation is tilted toward the upside), the only way for a buyer to make profit is to find another sucker, who is willing to pay higher price. Do people still remember the reasoning when they bought luxury condo in Sun belt or no-cash flow tech names in 2000? This is exactly the recipe for a bubble. As longer the trend holds up, the easier for people to justify paying a higher price. It is interesting to see how the current uptrend ends. There is no ceiling price on stocks or houses, but there is one for interest rate. 0M straddle traded 12 today. Vols are very low, even though the implied to realized ratio does not seem to be cheap. Fed successfully and proudly created a low volatility rate environment, which appears to be desired. The problem is that most of the market participants are short term oriented in nature. They are evaluated by their quarterly or even monthly PnL. In order to survive in such market, they are forced to follow the trend and take on enormous leverage and exposure to tail risk to squeeze out the last drop of premium (think about the nearly negligible carry priced in front Eurodollar contracts or the premium in the 3 week mid curve straddle.). Besides some N1 92 puts buying, there is no big downside play by the paper in the option world. The music will go on, until it ends.

Daily Clueless Musings 5/18

Finally we have some actions in the market today. Front eurodollar contracts were under heavy selling pressure before the release of FOMC minutes. Inflation and exit strategy were the two main themes of the minutes. The minutes said that “Many participants had become more concerned about the upside risks to the inflation outlook.” , however on economic activity the minutes said that “Although most participants continued to see the risks to their outlooks for economic growth as being broadly balanced, a number now judged those risks to be tilted to the downside.” As commodity prices have come down and industrial activities have cooled down since the April meeting, Fed likely has tilted toward more accommodative policy. Ironically, as Fed seems to be slightly accommodative than the market had expected, stocks and commodities all traded higher after the minutes and yield curve steepened. More importantly, the minutes also laid out details of their exit strategy. The sequence will probably be: 1) End of QE2 at the end of June, 2) stop reinvestment payments of principal on agency securities. Therefore the size of the balance sheet will the first signal of the tightening cycle 3) removing "exceptionally low levels for the federal funds rate for an extended period" 4) Rate hike is like to come two meetings after. 5) sales of securities will come after rate hikes. Futures finally have a down day today. It is not because the expectation for next rate hikes is not pushed forward. Futures just price in too much certainty. Although FOMC provided the market more details on their exist strategy, the expected monetary policy is contingent on assumptions of inflation and economic activities. The effect of ending QE2 and fiscal policy are way more uncertain than what the current market has priced in. Vols remained very cheap on this down tick. There are not much options flows, even as futures made a significant turn today. Paper has not yet put on big bearish trades or take off their bullish trades. It is interesting to see how the market will reaction, if the sell off follow through.

Daily Clueless Musings 5/16

US officially hit the debt ceiling today. Mr. Gross, the largest domestic bond buyer, again bashed US treasuries on CNBC. TIC data showed in March foreign accounts increased their holdings of long-term US securities by $24.0 billion, $9 billion less than forecast. China, the largest Foreign US treasury holder, reduced their holdings for the 5th consecutive month in a row. They reduced their holding by 9.2 billion, and the largest one month decline since November 2010. And, yet, once again, futures traded higher, as treasuries rallied. The Empire State manufacturing survey’s headline reading declined from 21.7 to 11.9 in May. As the first glance, manufacturing activity slowed more than expectation, which seems to push futures higher. But the key components, which are included in ISM manufacturing survey, are better than the headline number. ISM-weighted composite index for the survey increased from 57.1 to 58.1. The price paid index, which advanced 12 points to 69.9, the highest since mid 2008. The index for the number of employee also increased to 24.7. It is difficult to justify lower rates when inflation is strong and job is expanding. Paper continue to put up bullish trades. They sold 0N 91 calls to buy 2u 82-6 c1x2. Upside gamma continue to get crushed as futures traded higher. Mid curve gamma options are particularly cheap. 0M straddles traded 13+. Market is pricing the future uncertainty with a incredibly narrow margin of error. As Vladimir Nabokov once said "Complacency is a state of mind that exists only in retrospective: it has to be shattered before being ascertained".

Daily Clueless Musings 5/13

CPI had another firm increase last month. Headline number rose 0.42% on the back of higher food and energy prices. The core CPI increased 0.19% and has risen at a 2.1% annual rate over the last three months, already above Fed's target range and trending higher. Ironically, the ongoing double dip in the housing market "helped" lowering the core CPI. Tenants' and owners'' equivalent rent increased a modest 0.07% last month and have generally decelerated since last Fall. The Five-year-ahead inflation expectations in the Michigan consumer confidence report also rose from 2..9% to 3%. Europe GDP report printed even stronger at 3.3%q/q saar, boosted by strong performances of the core countries. The strong number will cause ECB to raise rates faster. However Euro was sold off in the middle of the day, as market was concerned about bad headline news on Greek credit over the coming weekend. As risky assets are sold off again, Eurodollar back contracts rallied in a panic mode. Futures seem to habitually trade up in response to any panic sell in risky assets. On the other hand, as the volatility in risky assets increases, there is tremendous amount of cash parked in short duration security. As a result, volatility in the short duration is artificially low, which helped to attract more cash in a positive feedback loop. However the margin for error is extremely. Vols are very low and still remain above realized volatility. However the low volatility environment in the short duration securities could prove to be illusionary. Just as the ever appreciating housing prices in the previous cycle, the longer market remain artificially stable, the more complacent people will become. The more complacent people get, the more volatile the market is going to be ,when things turn.

Daily Clueless Musings 5/10

Futures finally had its first down day in a while. Import Price Index is 2.2% higher than last month and up 11.1% year on year, lead by higher imported food prices, which is up 20%, the biggest jump since 1977. It is not much of a surprise given the declining dollar in April. CPI and PPI later this week will give a better picture of inflation. The recent bust of commodity bubble will not show up in the April data, but it is going to ease the pressure on headline number. Lower energy and food prices are stimulative to consumer demand, which might create some upward pressure to core inflation. It seems likely that commodity prices will stabilize at a lower price level. China reported a widening trade surplus in April, due to lower than expected imports. The volume of all the imported major raw materials are down from last year, which is consistent with the recent slowdown of Chinese economy. Dollar looked still very weak. Even as Euro is dragged down by the sovereign credit problems, dollar index still cannot break the 75 level. Stocks decoupled from another risky assets and continue to rally on thin volume. Despite the reverse of the recent upward trend, vols remained very cheap. Paper are still putting on bullish option trades. They bought 0N 91-2 Call 1 by 2 and 0z 91-3 call 1 by 2, which kept the upside gamma very cheap, even as futures traded lower.

Daily Clueless Musings 5/09

Greece did not exit EU over the last weekend as some had speculated. Rating agencies took the opportunity and tried to jump in front of the curve. All the big three rating agencies warned multiple downgrades of Greek debt. It is pretty clear that the Greeks are not happy that everyone else (the Irish and the Portuguese) are getting a better deal in the bail outs. European officials are engaging in a fig leaf operation to extend maturities without inflicting net present value losses on its creditors. It is amazing how the stock market behaved so fearlessly today. Stocks were up and vix was lower. Fixed incomes are higher today. Weaker euro helped US dollar to firm up from oversold level, which helped US dollar based interest rates. The front end performed strongly on the uptick relatively the back end of the curve, as the flight to safety trade resumes. The long end of the curve seems to be losing its safe asset status, as market is more confident on Fed on hold than inflation and deficit risk.