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.