One small observation before driving off

Macro Man is heading out for Thanksgiving before the crack of dawn today and will not be posting for the remainder of the week.  Normal service should resume on Monday.

Before driving off, however, he feels compelled to point out one interesting market development that may warn of some incipient danger or spell opportunity...or both.   Believe it or not, given all the fanfare about the fixed income sell-off recently, but German two-year yields reached fresh lows yesterday, settling at -0.735% according to the Bloomberg generic.  Schatz futures rallied a further eight ticks.   (In fairness, futures did trade higher intraday immediately after Brexit but closed well below current levels.

So the rest of the European front end must be ripping as well, right?   Ermmm....not really.   While ERZ7 is some 5 ticks off its recent lows, it remains more than a dozen bps off of the levels prevailing near the end of September.  The dichotomy between the two traditionally correlated instruments is striking.


So what's going on here?   Is this just an orthodox swap/invoice spread widening?   If so, what's driving it?  Or is it a case of Deutschland uber alles as investors try to get low-duration exposure to Germany in the event of adverse political developments in Italy and elsewhere?   Inquiring minds want to know.

The kicker is that Macro Man's vol-weighted bet on euribor flattening vs eurodollar steepening has worked a treat even with euribor lagging like this.  If it ever catches up to Schatz, whoa Nellie!  Macro Man would have to make a late addition to the list of things he's thankful for....


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botolo
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November 23, 2016 at 7:55 AM ×

expectations of ECB buying below depo rate AND need for risk free collateral

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Maverick
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November 23, 2016 at 8:42 AM × This comment has been removed by the author.
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Maverick
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November 23, 2016 at 8:43 AM ×

Could be flight to safety in response to European anti-establishment risk in the first instance and, as @botolo said, some sort of expectation of more aggressive ECB buying to accept bonds with yields below the deposit rate. I think more of the former. EZ infl exp currently at the highest since Jan, so it will be interesting to see how this develops and what impact it has on APP.

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checkmate
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November 23, 2016 at 9:38 AM ×

Bunds look to me just to be an attempt to manage the potential fallout of yet more EU political risk rather than anything to do with the ECB's programs.
In this I take the opposing view to LB on spread with US. At this point I think they are just two separate stories . Might some EU money flow to US because of the spread sure why not ,but if we think most of the money as to stay denominated in Euros then no. It will take the bunds against the problem EU economies. My view anyway and hey most of what we have are just opinions with a narrative.

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abee crombie
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November 23, 2016 at 11:19 AM ×

I guess trading the front end is back ! Coincides with a recent performance update i saw from brevan howard up 3% or so mtd, after years and years of crap returns. How they still manage multiple billions is beyond me.

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abee crombie
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November 23, 2016 at 11:20 AM ×

I guess trading the front end is back ! Coincides with a recent performance update i saw from brevan howard up 3% or so mtd, after years and years of crap returns. How they still manage multiple billions is beyond me.

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Skr
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November 23, 2016 at 3:48 PM ×

Mastro Geppetto has got his 112.5 target(as per usual). Ready to row in with the crew now.

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checkmate
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November 23, 2016 at 5:18 PM ×

Uk budget , underwhelming springs to mind. I feel so like getting short UK equity.

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Leftback
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November 23, 2016 at 6:16 PM ×

As possibly the only resident Treasury auction watcher here, LB has noted over many years that said auctions (especially the 7s and 10s/30s) can frequently provide a pivot for turns in the Treasury market, especially after deep sell-offs. It is almost as though punters want to see that someone out there is actually still bidding for the paper before committing their own hard-earned cash to govies. Or perhaps it is just that strong auction demand drives a short squeeze as sellers capitulate.

After weak auctions of 2s and 5s this week, demand for the 7s today was exceptionally strong, and Treasury bonds have since gone bid across the curve. Looks as though today may yet be good for the momentum indicators, if not providing the long-awaited reversal candle. We are not quite all-in US fixed income yet but we are getting closer to that point.

One more market mover today in the bond market and FX, and it is the FOMC minutes. December being a lock, the only interest would be in reading the tea leaves regarding 2017 rate hikes, and we wonder if the early November growth read by the FOMC was less optimistic than Mr Market's rosy colored view and Bucky's slightly irrational exuberance.

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MrBeach
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November 23, 2016 at 6:19 PM ×

Putting my own line in the sand here: starting to aggressively short R2K and buying leveraged Muni CEFs. IMHO, 60+ year American retirees and their money managers who remember Reagan think Trump is his second coming. Different world altogether. Unlike Reagan who benefitted from a wildly unlevered economy, Trump faces the opposite. Whereas after Volcker, Reagan saw a massive relevering of the economy built on a weak dollar and the confidence that inflation could be tamed at will, Trump faces the exact opposite: a wildly overlevered economy and a very strong dollar. He has almost no room to maneuver without breaking something significant. Can't aggressively borrow and spend without raising rates and weakening housing, consumer credit, auto loans, education loans, etc. Fed isn't about to restart QE. The strong dollar is wind in the face of American exporters.

As the Trump trade runs its course (my bet it is today is quite close to the end), the reality of our economic situation since 2008 will come back.

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checkmate
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November 23, 2016 at 6:56 PM ×

Bonds stay like that EOD I'd say you've got a short term top at least and bearing in mind where the vix it maybe the more usual bond/equity correlation might be in play.

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Nico G
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November 23, 2016 at 7:20 PM ×

Reagan had $1Tn debt, Trump 20... the Fed is done for

and yeah besides USD being at the opposite end of the spectrum the GOP majority of today is a much harder animal than in the early 80s

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johno
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November 23, 2016 at 9:21 PM ×

Agree with Nico and MrBeech re differences with Reagan years. The economy is WAY, WAY, WAY more levered now. Demographics worsening, not improving. And Fed is starting from near 0%. Still, the honeymoon may continue for some time. Deregulation, tax reform and tax cuts, and massive buybacks from repatriations are all supportive factors for stocks. And if inflation does head higher, the rotation from bonds to stocks can continue. I just can't get excited about shorting this market. 14 up days in a row on the RTY!

Interesting thought on Muni CEF's, MrBeech. Was wondering about those too. Tempting, though I read all these warnings that muni selling tends to persistent beyond a few days.

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washedup
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November 23, 2016 at 10:28 PM ×

@johno "massive buybacks from repatriations are all supportive factors for stocks"

Any idea why the exact stocks which would benefit from repatriations (AAPL, MSFT, GE, to name a few) have underperformed since the election? Also, why the assumption that Mr "equities are a big fat bubble" Trump wouldn't simply set a condition for repatriation where the funds would need to be earmarked for business investment, a small oversight from 2004?

As for the honeymoon, of course it could continue as far as equity punters go - R2K is seriously beginning to resemble nasdaq from q1/q4 99/00 both in terms of earnings (negative last year for the index!) and price action.

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Anonymous
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November 23, 2016 at 11:26 PM ×

"Investors desire to take more risk, moving money out of the safe havens and into riskier, higher returning assets is mostly predicated on what the President-elect is able to get done in his first 100 days in office. While I continue to believe that the result of this has overshot its mark, it is hard to stand in front of the train barreling down in front of you at great speed, even if you expect it to stop just short of taking you out! What is this word “reflation” and why has it so quickly replaced the Fed, trillions of dollar’s worth of stimulus, and many, many rate cuts as the reason why interest rates MUST go higher…now? Well it comes down to perception. This perception that the new administration is about to lead us down a path of less regulation, more debt, fewer tax revenues, and massive spending has sent surges into the equity market and the dollar, while reversing a year’s worth of low inflationary forecasts in just a few days. Amazing isn’t it? Hard to believe, isn’t it? Too good to be true? Highly likely."

https://raymondjames.com/pointofview/fixed_income_market_commentary

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johno
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November 24, 2016 at 2:11 AM ×

Hi washed, while buybacks may not be causing outperformance on a single-stock level any longer, I think taking supply of stock out of the market lifts prices overall.

It would be interesting if Trump did what you say, and require repatriations be earmarked for business investment. However, I'm thinking that won't come to pass because very little would end up repatriated (there being so little business investment to do given the demographic/macro setup). Trump needs a big repatriation and taxes associated therewith to fund all his fiscal stimulus.

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TraderJim
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November 24, 2016 at 8:00 AM ×

Hi Washed

"Any idea why the exact stocks which would benefit from repatriations (AAPL, MSFT, GE, to name a few) have underperformed since the election? "

Possibility is these are more international stocks (revenues, manufacturing bases) and perception is these will be negatively impacted by Trump's trade pullback in some way.

So R2K steams ahead as mostly US revenues and Financials up with the improved spread on their loan book (if rates orbit)

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checkmate
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November 24, 2016 at 9:17 AM ×

The international stocks underperformance and dollar strength translate to foreign revenue being balance sheet soft. By contrast just look at the Russell which is a proxy for domestic expectations of Trump and a strong dollar.

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checkmate
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November 25, 2016 at 2:34 PM ×


"Ed Balls: 'If Theresa May asked me to help Brexit work, I’d do it' "

Commentary from Kenny Everett would go ' Ed, you're such a slut ,but I love you'.

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Anonymous
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November 25, 2016 at 6:38 PM ×

The "Fade Nico" trade working brilliantly again, since he went short US stocks post-election we've seen the biggest single rise in US stocks since the 1980's... lol

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Nico G
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November 26, 2016 at 12:19 AM ×

we speak again in February.

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Anonymous
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November 26, 2016 at 12:28 AM ×

Anon6:38

Nico is not alone:

Rcube Asset Management’s Cyril Castelli says: "Our US equities model’s expected return has just plunged to levels last seen in 2000 and 2008. Expected annualized returns have dropped to ‐17.6%.

The model is based on corporate balance sheet leverage, non-performing loans, default risks, bank lending behavior, short and long term interest rates (mortgages & treasuries yields) and energy prices. Currently all factors individually have negative expected returns which is historically quite rare. Importantly for timing purposes, rates and energy inputs, which had been tailwinds until recently, have turned over the last 2 months…

Rates could move higher in the short term given the significant recent outperformance of cyclicals versus defensives sectors globally. This would put further downside pressure on equities.

Additionally, US equity volatility remains seriously mispriced. Our VIX model has a fair value in the high 20s. US Corporate leverage is a real concern. US high yield spreads have once again significantly diverged from fundamentals…

We are short US equities through VIX upside, Small caps and the consumer discretionary sector. Given the above we believe that risks are asymmetric to the downside at current levels.

A technical break below the 2120 level could trigger a significant downside acceleration with targets on the 200 days (2075), 2000, and possibly a re‐test of the lower boundary of the trading range of the last 3 years (1850/1900)."

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