Window Dressing?

Friday, November 20, 2009

Macro Man is back in the saddle, or at least his office chair, this morning after his first decent night's sleep in what seems like forever. It's expiry day today in equity land, and indices are producing the seemingly-obligatory squeeze up, despite the rather poor performance of other measures of risk appetite and/or reflation.

One issue that has captured macro punters' fancy this morning is yesterday's price action in Treasury bills. The Feb-10 bill traded to a low yield of 0.005% yesterday, and some bills of shorter maturity reputedly traded at negative yields (though Macro Man in fairness has yet to find them.)
This raises the question of who would purchase bills at zero or even negative yields the week before Thanksgiving? There has been some mumbling that the flow into bills represents some sort of "window dressing", though why one would start doing so on the 19th of November defies explanation. Why, too, would any bank buy bills when they could simply deposit cash as reserves at the Fed and earn a "tasty" 0.25%? (This is a legitimate query; Macro Man is not intimately acquainted with the regulatory/capital impact of bills versus reserve deposits for bank holding companies.)

Anyone who can shed light on this action is encouraged to do so in the comments section; from a distance, however, it wouldn't appear to be a particularly healthy phenomenon for bills to trade through zero yield!!

And that in turn would jive with the last 36 hours' price action, which has suddenly taken on a very "risk off" feel. Equities and FX carry traded poorly from the get-go yesterday, and while the former has managed at least a tepid bounce, the latter still looks pretty poor.

In any event, Macro Man's Bloomberg inbox has been stuffed to the gills in recent days with analyses purporting to entice him into doing x,y, or z trade on December seasonality. "The euro almost always goes up from [insert cherry-picked date here] through the end of December!" "The January effect has moved to December!" Blah, blah, blah.

The EUR/USD phenomenon is well-known to everyone who trades currencies for a living; on the basis of price action over the last couple weeks, it seems as if every single one of them are long as a result.

There's also been a lot of mumbling about the potential for an equity rally in December, based on the solid performance of equities thus far this year. Here, at least, we have a sufficiently large data set to do a study that at least borders on statistical significance.

Taking monthly SPX returns since 1930, Macro Man compared the returns of the first 11 months of the year with those of the ensuing December. Sure enough, there is a positive relationship between the two, as illustrated in the chart below.
Macro Man ran the regressions both with and without a constant; both regressions generated statistically significant (t-stat >3, p-value < 0.002) results. Based on the 20% y-t-d returns on the SPX thus far, both regressions suggest Dec,ber returns of roughly 2%, give or take. That's broadly in line with the historical average; in the 11 prior cases in the sample of 20% + 11 month returns, the average Decmber return was 1.84% (with eight winners.)

So is Macro Man trading in his ragged furry suit for a nice new pair of horns over the next six weeks? Not quite yet. While the possibility of an equity melt-up/window-dressing orgy is clear and present, your scribe cannot quite shake his feeling that the rally is tired and fundamentals remain poor. The bizarre price action in T bills, be it window dressing or a "shoulder tap" allocation, has left him scratching his head....

Posted by Macro Man at 9:50 AM  

29 comments:

The same thing happened in Japan in the late '90s (I believe '98 but could be off by a year.) Bills traded at zero and Tibor (Japanese bank lending rate) was 75-100 bp higher than the rates posted by foreign banks. As a result libor (which was a sort of average of the two) was about halfway 'tween, and a fiction--used for swaps etc but not as a lending rate.

The issue (straightforward) was that there was way too much cash and no one knew what to do with it. I actually borrowed at -5bp and was going to post it at the TSE (AAA) as margin but then other opportunities came up.

I don't have any particular insights except that it was caused by major stresses in Japanese financials and was a very scary time.

It would seem that people still don't trust the banks, or the Fed got it wrong and there's too much cash, obviously not being used, productively or otherwise.

Steve said...
11:00 AM  

Isn't the end of November the end of year as far as bonuses go for most of the IB's? Would seem an appropriate time to derisk and not to take any market liquidity.

Anonymous said...
11:37 AM  

It must be for the reason you say, MM. It must be some peculiarity in capital requirements because the banks could simply leave the cash at the fed which is almost but not quite the same thing.

However... perhaps some banks are placing a risk of default on the Fed seeing their asset side is basically shit :-)

jc said...
12:32 PM  

Meanwhile Japan implodes.

I read somewhere that soon compounding could get them as the debt is so large.


And in typical fashion they look at the unfolding events like deer in headlights.

jc said...
12:35 PM  

we are of the understanding that there is a shortage of bills as money-market funds have plowed into this market leaving the street a bit short...compounded by less issuance in this sector as the treasury focuses on allocating supply further out on the curve.

Anonymous said...
12:40 PM  

Remember big dollar accounts aren't FDIC insured. Short term bills are used for their safety of principal benefits.

Fullcarry said...
12:42 PM  

anon:

the banks could sell their bills and place the momney with the fed and gain arb.

Your suggestion still doesn't explain it.

jc said...
12:43 PM  

Anon@11.37: There are no more investment banks! They're all bank holding companies now, with calendar-year fiscal years....which is why liquidity is expected to be absolutely dire next month...

Macro Man said...
12:46 PM  

jc,

It is rather risky shorting short term bills. With fail penalties of -3%, I am not sure too many arbs would short too heavily for 7 to 8bps.

Fullcarry said...
12:47 PM  

Just speculation: Chinese bidding up bills as they try to concentrate their US holdings in securities that (a) lack interest rate exposure and (b) give them leverage over the US with a credible threat to demand return of $1 trillion in 3 months. They can keep this leverage indefinitely and keep extracting concessions from the US.

Possibly Obama's visit either didn't reassure them that the US would avoid inflation, or convinced them he was weak and blackmailable.

Either case, of course, is not bullish for risk assets.

PJ said...
12:50 PM  

Viz provisioning you don't have to provision for sovereign debt that is investment grade so that's probably not it either.

Or, it could just be that all these banks and fast money guys are having their Wile E Coyote moment.

Nemo Incognito said...
12:51 PM  

This was out in the market yesterday. Observation - Year End Turn - See attached chart of 3-month T-Bills, since Tuesday the yield has dropped to 1 bps from 6
bps. With Gold making new highs and risk assets significantly
weaker overnight, the easy read through is risk aversion and in
a large way like someone knows something. The more likely scenario now that all financial
institutions have the same December year end that many of
them this week officially went into year-end mode given the
uncertainty over the next 45-days. Point being, 1-month bills dont cover the turn yet and there is even less room for error so bill players are preparing earlier this
year. I think this was consensus amonst bill desks yesterday as well...

Anonymous said...
12:59 PM  

Ukraine CDS pricing these days anyone? Bloombergless pal. thx

Stefan said...
1:00 PM  

Ukraine debt noise, whether state or soverign related, sounds specious at best. I think the larger observation is the credit sensitivity in turkey, greece, south africa and now ukraine. Point being, look at Greece CDS and rates yesterday explode. Their equity indices (Greece and Turkey) are unwinding hard, etc.

Anonymous said...
1:11 PM  

i see 5yr cds Ukraine 1571.94
(+49.3)...but was +17 when i arrived 1.5 hrs ago.

Anonymous said...
1:11 PM  

This is purely anecdotal, but in my market (Canada) there were huge liquidity issues last year over year-end, with absolutely no one wanting to take anything but sovereign risk. This credit situation today is quite different, but perhaps there are lingering memories of last year, and investors are trying to act before anyone else.

PPM

PPM said...
1:48 PM  

Too Much Noise...Many Want to be Sidelined Today --- Bearish follow through is coming from all angles this morning: Hawkish commentary from Trichet following a resignation call on Geithner yesterday, EMG credit sensitivity is bleeding into more countries (Greece, Turkey, South African, Ukraine), dollar bottoming and one-touch barriers in EUR 1.48, recent housing data is a reminder of how far apart equity and property markets are, Dell earnings, Japan deflation weakness, etc. Groundhog day says -- risk-off trade is a dominant theme, the inventible question has a correction began, and the past 9-months is to buy weakness regardless of concerns about the underlying strength of the economy. While I am always sympathetic to the idea that this time is different, that is a reactionary response and you are supposed to trade the pattern until proven wrong. Point being, it rarely pays to call a top especially when SPX is still positive on the week (ex pre-market futures) and the USD Index still well below its November highs. Yesterday saw prudent hedging and minor risk reduction but was more of a spectator sport. With expiration, the same themes should dominate in equities. Risk becomes a larger event in EUR that spills over to Gold causing professionals to react to broader risk asset weakness beyond equities.

Anonymous said...
2:01 PM  

so to summarize, on the neg t-bills... seems to be a combination of 3 things

1) lots of cash in non-banks like money mkt funds and real money funds that have guidelines that require them to hold securities

2) not so much supply with the SFP bills gone and agency discount note issuance not enough to make up for it (discos evidently trading 10-15 thru libor when they normally trade flat)

implications? hard for me to get into the fetal position when red eurodollars keep printing new highs (unlike last year) and 3-6 mo usd libor is thru jpy libor.

Anonymous said...
2:03 PM  

Turkish stock exchange shed over 8% over the last 4 days. Ouchs..

Ukrainian railroad missed a payment. another eastern European saga start┼čng from a completely unexpected source rather than financials.

Also 2-yr Tbilss at year low this morning.

Next week could certainly be an interesting week.

Cheers

Anonymous said...
2:32 PM  

My guess is it was GS buying bills to protect the bonus checks!

Anonymous said...
3:29 PM  

On another topic: The US unemployment rate has been held down by millions of people leaving the labor force, according to the BLS. If the labor force had remained constant in size over the last three months, the unemployment rate would have grown to almost 12%, not 10.2%.

We have an independent, if noisier, measure of the unemployment rate in the form of a Rasmussen survey. They find a national self-reported unemployment rate on the order of 13% -- Democrats and independents about 15%, Republicans about 10%: Rasmussen survey.

Presumably millions of people who the BLS has classified as out of the labor force are self-reporting themselves as unemployed to Rasmussen.

PJ said...
3:47 PM  

PJ, you don't need (or IMO want) Rasmussen when the Census is delivering a much higher-quality survey to you. All you want is to look at U-6 unemployment instead of U-3, and you'll capture much of the effects. Alternately, you can do your own labor-force adjustments, but I don't see the point.

U-6 is ugly. Ugly, ugly, ugly.

wcw said...
5:28 PM  

ICE cancelling dollar futures trades twice in a few weeks. Conspiracy theories being spun from some quarters about the DXY 75/EUR 1.50 level.

The alternative explanation could be that the EZ is finally succumbing to its internal contradictions, as evidenced in sovereign CDS spreads widening.

But hey, who says economic problems necessarily translate to a weaker currency as the yen drives below Y89...

Crisis Management said...
7:51 PM  

wcw - U-6 includes "underemployed" part-time workers, and also relies on the workforce denominator. I prefer the employment to population ratio myself.

But I agree, the situation is ugly.

PJ said...
9:34 PM  

"RISK OFF"..then it's On and then it's off..etc etc.

The closer you look the less you see worth seeing.Revisitinga couple of texts from traders gone by in the form of Livingston and even the circus fellow whose name now escapes me. There is one common denominator running through winning outcomes and that is don't get too close to the market noise because it will destroy your returns.Even on those random occasions when you can say "I knew it" because your analysis of the market action turned out right it won't add to your return overall.
More often than not more (analysis and decision making) turns out to be less (return).

Anonymous said...
9:26 AM  

Well, a few things. First, FF(Fed Funds) rate trades just like any other fixed income instrument, but at the FED's decision for price. However, the boundary or limitation to acquire this rate for overnight funds is that you need to be established as a bank. So hedge funds and most money managers cannot borrow from the FED at this rate. Here is a listing of the last month or so. http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm

Notice how the low is .05, high is .38. Sometimes it blows out to a high of 2-5%(happened twice this year.) Reason being the FED is lending at discretionary means...so banks that desperately need capital or are on the verge of bankruptcy won't be able to lend at reasonable rates. This was especially true of the Lehman bankruptcy.

Another explanation could be that big funds at the end of the year safeguard themselves from downside risk in equities - especially if they have had a banner year. No one wants to go into Christmas/End of the year with a ticking timebomb on their balance sheet. This is why in the interbank LIBOR market, December rates are always higher than the month prior and subsequent.

Below is a forward curve of the Eurodollar futures. By Month/Rate/Price(100-Price = Rate)

Dec 2009 .2650



- - 99.7350
Jan 2010 .28



- - 99.720
Mar 2010 .335



- - 99.665
Jun 2010 .495



- - 99.505
Sep 2010 .795



- - 99.205
Dec 2010 1.18



- - 98.820
Mar 2011 1.56



- - 98.440

In comparison to the cash market. BBA announces the LIBOR rates daily. Fridays USD Libor was.

Overnight .17
1 Week .21500
2 Week .22563
1 Mo .23594
2 Mo .24688

Just wanted to show that December is always an inflated month in rates as banks want to clean up their balance sheets and have zero risk, so they buy up bills or put their reserve into the FED.

Usually the curve is a bit more out of whack, but it looks like the banks have hedged themselves up pretty well this year. Around Lehman Dec08 Eurodollar futures had > 20 basis point difference than the months before and after, which was...enormous for that time.

Either way, I believe banks are just hoarding cash, taking their vacations, locking in their bonuses. I also spoke with some of my ex-coworkers and they said it's just dead in the market(in Eurodollars.)

So, onto how to play this. Well two things can happen. Last year 30 year yields dropped like a stone to 2.50% as fund managers were hedging their duration exposure while the S&P was in a volatile up and down mood until year end. So we can see something similar happen if we see bad numbers come out, fund managers now targeting 5 year notes as the S&P becomes choppy in year end and banks take profit year end.

Another thing that could happen would be a double bottom in t-bills for the past 14 months, in which case we can see this being the ultimate low and by end of the month or in January, banks and hedge funds back into the equities game.

My recommendation is to have tight stops this month on longs in the S&P, big downside risk if yields stay low and banks decide to take profit on the year.

Anonymous said...
11:59 PM  

It probably means the obvious, someone is pushing large amounts of money out of harm's way, at least in the short term. Since bills can't rally much from here, we would expect to see a move out along the Treasury curve into 2y, 3y, 5y at least, no?

leftback said...
2:19 AM  

MM I've been thinking maybe the expiration of money market guarantees in the U.S. on 11/19 (i think) might be pushing some large HFs to move into Treasuries. Its a bit hard to tell since the outflow from Money Markets has been going on for a while, supposedly into risk, nor out.

Dan said...
5:27 AM  

oh and I remembered another thing, for the first time this year the banks have moved their fiscal year-end to Dec 30; don't know which if any HFs have done the same; but if I knew in advance (as all did) and thought my line might get shortened right at the end of the year, what would I do. (I don't know; I'm just asking)

Dan said...
5:40 AM  

Post a Comment