A few fixed income thoughts

Yesterday provided a perfect example of how getting the market right is rather different to getting the short term fundamentals right.   Would you ever have thought that with bonds trading very poorly indeed that a massive uptick in the non-manufacturing ISM (including the largest-ever rise in the employment component) would have rung the bell for the lows of the day?


Such is life in the macro trenches these days, where fixed income sells off after a blah ADP figure but rallies after a strong PMI figure.   Algos taking profit or a venture into the Matrix?  Either way, the employment component does offer up the possibility that Friday's figure could be a strong one despite the "meh" ADP; Macro Man's model is shaping up to deliver its most upbeat forecast of the year.

One fixed income position not able to take profit is that 50y Italy bond, which shed nearly two and a half points from the issue price through yesterday's close.   Annualize that, and it will be in default well before Christmas.  That's a joke of course, and the bond may well trade bid today after the Treasury rally in the New York afternoon, but Macro Man remains somewhat skeptical that this will be a terribly successful investment- and that's without the Stiglitz outcome.


Macro Man did a little trimming yesterday, closing his position in the EDZ6/EDZ8 steepener.  it's been a good spread to trade, but he didn't like the bond market reaction to the ISM.   While his model would suggest an outcome that should produce further steepening, frankly this thing has traded in a well-defined range for the past several months, and at an extreme he has chosen to respect the range.

At 25, it will look nice to get back in again.  A disappointing payroll figure would probably put us there.   On the other hand, a clean break of the summer support would suggest plenty of fresh air to the downside, and perhaps call for re-establishing it with a tailwind.  While it might not be terribly fun to miss out on the potential gap wider, by the same token it hasn't been much fun holding the trade at current levels over the past few months.   In any event, he is long a bit of USD/JPY, so in the event of a rip-snorting figure your author will at least have something worth celebrating.
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Rossco
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October 6, 2016 at 11:30 AM ×

There is no macro, only central banks. Discuss.....

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Rossco
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October 6, 2016 at 11:30 AM ×

There is no macro, only central banks. Discuss.....

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Leftback
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October 6, 2016 at 12:48 PM ×

The dollar continues to be bid. Discuss…..

A few markets may be somewhat dislocated by the imminent arrival of Hurricane Matthew, e.g. oil etc. although this is far from the rigs that fuel the usual pre-storm spike. Nevertheless, it is usually sell the rumor buy the news in re-insurers and buy the hype sell the news in many commodities. On top of that we have BLS bingo. Nobody seems to fancy a stonking number from the world's most influential random number generator. [Cynical? Well, how can one not be at this point?] Still, what one can see in FX markets is the USD creeping up even in the face of a raft of relatively soft data, almost as though a slow squeeze were moving participants out of the short dollar trade. A face-ripping move higher in USD would probably cause some pain in Risk Land.

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Anonymous
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October 6, 2016 at 12:58 PM ×

LB - on Oil, while I'm fully in the loop on supply side, I havethe feeling that other factors are now at play in price action. We've had a big shift in stance from the Saudi's and Iran. That matters. Also, perhaps more importantly, the Russia/US breakdown in relations. Something could go wrong here. Another incident like Turkey shooting Russian plane (which I predicted as an Anon here at the time). We keep inching closer to an event. That's what oil price is reflecting in addition to Hurricane. I've gone from being bearish all year to thinking $60 is coming soon. Add $20 if there's an incident.

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washedup
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October 6, 2016 at 1:14 PM ×

@anon - when I look at the history of opec cuts, prices have always been lower, not higher within 6 months of them doing so - -funnily enough, Fed rate cuts would tell you a similar story on spoos.
I admit I am a bit perplexed by the bullishness in the last 3 inventory reports - I also think talking about fundamentals, geopolitics and whether or not iran and russia will be allowed at the mean girls table or be each others date to the prom, are far less relevant to oil than what the dollar does going forward, especially vs the euro.
Also - I think oil prognosticators are over focused on supply, much like early 08 - aside from the mundane observation that US production has already bottomed at 8.5 MM Bbl/d, around 500k/d higher than most analysts projections last year, there isn;t much to talk about there (oh and thank you OPEC for letting us have your lunch and market share).
Demand, however, is a pretty big wildcard - China is a black box demand wise for the next year or so now that their SPR is anywhere from 50% to 99.99995 full, and ME demand could very well show a contraction given where their economies are headed. Not thinking about demand was this markets achilles heel in 2008 as well.
All that said, dollar impact will overrule any of that - positively or negatively.

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Anonymous
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October 6, 2016 at 1:22 PM ×

USD is breaking to upside yet oil is too? If, USD weakens on NFP, where will that leave oil?

It's all guess work of course. Simplpy trying to look at it from a different angle and curve fit the current strength.

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JohnL
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October 6, 2016 at 2:26 PM ×

With CDN housing and related business being well above long term trend at about 25% of gdp. New mortage rules may be the pin that begins the deflation of the real estate gas bag. Bets on loonie appreciation due to energy price strengthening may face some headwinds as the impact of these new regs are priced.

http://www.bloomberg.com/news/articles/2016-10-04/end-of-canada-s-unique-mortgage-system-means-higher-bank-costs

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wcw
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October 6, 2016 at 2:37 PM ×

@LB, the dollar bid looks like a simple yeah-the-Fed's-finally-gonna-hike move. Yes, prime-age employment rate could be a lot better and housing production and attendant demand is still a bit broken, but initial claims as percent of employment is fine. Bonds being sold, gold being sold, though what doesn't fit the thesis is copper being sold. Maybe that's China.

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Flowthrough
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October 6, 2016 at 2:40 PM ×

Washup, I admit I am an not a pro, but I do watch the oil markets as I am invested in US midstream and it tends to trade with oil.
I disagree with almost everything you said. One comment I agree with are oil tends to trade lower after an OPEC cut . OPEC is a cartel, so they are always going against market and usually fail. The other I do not disagree with is that oil will trade more with the dollar than anything else.
As to US production, where do you get it has bottomed? It is down 350,000 b/d since end of April. And demand is not really question. Peg demand at 1.4 million b/d and you are very unlikely to be off more than 300,000 b/d, while there are more than 10 countries where supply estimates could be off by more than that. It is all about supply.
The real key to oil markets will be when offshore starts to decline. These are long lead time projects and offshore production increased in 2015. But almost no offshore really works with $50 or even $60 oil.
I have no view on oil this year, but am bullish in 2017. Seems like a very short runway to go short oil at this point.

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Anonymous
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October 6, 2016 at 2:47 PM ×

Haven't seen the peanut gallery get under our host's skin as they did yesterday since the Obamacare debate. For what it's worth (not much), the whole thing seems like typical annoying government nosiness to me (similar to the census). They are probably hoping to find some tidbit they can use during the Brexit negotiations.

A bit surprised there hasn't been more politics in the comments recently (although, regarding the U.S. election, it is easy to make a strong case against either major party candidate, and difficult to make an enthusiastic case for either one).

Am I imagining things or has gold become nothing but a proxy for a wager on the path of future interest rates? I seem to remember that it used to spike on such things as increased tension in the Middle East (been plenty of that lately).

Leftback, I like the idea of short oil, but the price action is still warning me off. Still trying to figure out (as with many other assets) how long the silliness continues.

One question about European QE. I thought the ECB was literally not going to be able to find enough bonds to buy (due to "permanent" holders among other reasons). Wouldn't that keep a pretty tight lid on yields, or are enough discretionary sellers going to magically appear out of the woodwork to push rates higher?

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wcw
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October 6, 2016 at 2:48 PM ×

@Flowthrough, see the EIA forecast, http://www.eia.gov/forecasts/steo/images/Fig13.png Per the EIA crude production has not bottomed, but net production has thanks to NGLs.

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johno
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October 6, 2016 at 3:21 PM ×

Thanks to LB for explaining his oil thinking yesterday. Also to washed today for the observation on post-cut price performance. Not my usual style, but made some excuses and shorted some crude futures. I tend to think that OPEC is cutting because they see where the market is going. We're still building, not drawing globally, and even with the cuts, the picture isn't going to change much in 2017. Chinese SPR is approaching/at capacity, as washed points out. Etc.

My question is what part of the curve do US shale producers look at when deciding to drill or not? Some have suggested the 1y1y forward part of the strip. Anyone have thoughts on that? I mean, when a producer says they break even at, say, $50, what does that mean? $50 today or $50 6 months forward or what?

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Leftback
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October 6, 2016 at 4:16 PM ×

Interesting thoughts on crude, but perhaps influenced by media chatter and the event-driven mentality that commodity traders seem to live on. We have no special insight or knowledge, but we are chart watchers, or perhaps more accurately we are chartaholics. In fact, we don't even take a dump without looking at the charts first.

Oil is a mean reversion trade for us here. If it reverts back from straining against the top of the Bolly bands to the bottom of the Bolly bands, that's more or less a 15% excursion lower. The August round trip was a good example of this kind of behavior. In January there was a round trip in oil prices in the opposite direction. Markets do this stuff. If you do want to talk fundamentals, the US rig count is rising, so the argument that production has declined in the face of the supply glut is fallacious.

It's possible that crude peaked this morning to a level not seen since July, and is rolling over. We added to our short USO trade one more time this morning. Of course there is always room for one more silly spike higher. These excursions almost always end with a very obvious reversal with a characteristic daily candle.

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Leftback
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October 6, 2016 at 4:25 PM ×

We sold our UUP Oct 25 calls today. MM's long USDJPY is looking like Bran Flakes - tasty, tasty, very very tasty.

https://www.youtube.com/watch?v=92r9H_6B2kI

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johno
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October 6, 2016 at 5:07 PM ×

LB, yesterday you mentioned a market is over-stretched when it pierces a bollinger band. When I look at CL2 Comdty and run BOLL, I see it at but not through the top of the band. Guessing you use different parameters than the BBG defaults?

FLowthrough, I do think DXY has pretty good explanatory power for oil, especially the long end of the curve (reasoning would be that marginal oil is produced in non-USD countries, and DXY roughly tracks movements in the USD-marginal cost). Shorter end is driven more by supply-demand.

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AB
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October 6, 2016 at 6:48 PM ×

The Cleveland Fed Inflation Nowcast has Core PCE at 1.76% YoY come October. If you get core PCE YoY readings of 2% where do you think the Fed will want to see rates? 1.25% at a minimum? 1.75%? We could be there in the spring. That is 3 - 5 rate hikes. Core CPI is already 2.3% YoY and does not look to be behaving any differently than it did '05-'07 when rates were what?

Btw, I think this is the wrong way to look at how the world works and where rates should be, but we are subjected to the stupidity of the FOMC.

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Mr. T
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October 6, 2016 at 8:15 PM ×

AB - the way I read the fomc consensus is they want some moving average of inflation at 2% - like a post-2008 mean. In theory that means they will be happy with 4-5% for years without the prospect of feeling "behind the curve". Personal feelings aside (which is hard to do!) the case for basic materials gets stronger (especially those with crummy balance sheets), and its a recipe for an absolute bloodbath in fixed income.

I can't get in the hammock, but I'm doing everything I can to play tight defense these days.

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washedup
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October 6, 2016 at 8:22 PM ×

T - I agree with your thesis, but I think the bulk of the inflation is going to come from OER and healthcare premiums (about 50% of the indexes), or seen a different way, from wages (70% of indexes) - not a pretty picture for FI like you said, but I am not sure its played best through the commodity channel like 2002-2008 - honestly we may be entering a light version of the 70's when there wasn't really a clean hedge to inflation except for short periods of time - I have no idea what a bulletproof long dated long only portfolio looks like from here.

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Anonymous
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October 6, 2016 at 8:23 PM ×

Counted 5 $SIRI ads urging folks to invest in CRE funds/REITs. It's starting peeps;when we get close to the end, what happens in that space will make heads spin

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AB
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October 6, 2016 at 8:34 PM ×

T & Washed: There is no way they are going to let any type of inflation run at 4%-5% with rates this low. What happens if Core PCE is above 2% and headline CPI is at 4% with the Fed holding rates at 1%? The Fed would have to expand its balance sheet to hold rates that low because investors are not going to take the rate risk. Are they willing to hold real rates and expand there balance sheet while they are currently achieving their inflation targets? No way. If core inflation runs above 2% they will move towards 2% as well.

I am interested in what others think would happen if core PCE went above 2% in the next 9 months.

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washedup
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October 6, 2016 at 8:54 PM ×

@AB - i think it would depend on how the rest of the macro landscape is shaping up - if risky assets look wobbly they will prefer to lose control over inflation (did I mention I think they are complete frauds?) than to tighten - if spoos are at 2300 and heading north they will be willing to take the risk.
Look, the problem these guys ultimately have, is crappy productivity growth - frankly the monetary apparatus a.k.a the fed is quite powerless as far as that goes, so they'll settle for the 2nd best alternative, which is high enough nominal growth to afford interest payments on ballooning debt, and then hope for the situation to not get out of hand.

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Anonymous
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October 6, 2016 at 9:40 PM ×

@LB,

While I agree with you on CADUSD pair, it seems to me that CAD is in a better position compared to other commodity currencies: AUD and NZD. One is potential oil shock mentioned by others. More importantly, it is the fiscal expansion direction taken by the current government that supports CAD. So in that case, I would try to short AUDCAD and NZDCAD, seems to have a larger room at the downside and maybe safer.

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Flowthrough
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October 7, 2016 at 1:02 AM ×

OK, LB I love your comments, so take my comments in that context.
Your statement If you do want to talk fundamentals, the US rig count is rising, so the argument that production has declined in the face of the supply glut is fallacious.'
Man, what are you saying? US production is down 1.2 million b/d from the peak. So production has declined. Period.
As to rig count, yes it is rising from a very low level. Oil rig count is at 522. At peak it was at 1600+ and at bottom was at 480 or so. So tell me, is it closer to bottom or top?
The oil rig count only works with 6 to 9 month lag. As they drill the well, frac the well, normally seal it for some time to allow pressure to build, then hook up well and then you start production. This is at best a 6 month process, and often a 9 month process.
Also, the depletion rate of the oil shale wells depends on completion methods. These have changed quickly. So no one really has a good handle on decline rate of US shale oil wells.
To Johno, other than Russia most oil stuff and a lot of the personal are US, and get paid in dollars. SO I think dollar movement is clearly key short term, not sure it "should" matter as much long term.

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