There’s a bias toward ease; are option markets overpricing?
Nov 14, 2019
–On a day filled with events and news, trading was subdued. Yields fell with tens -3.6 bps to 1.874%. The curve edged slightly flatter. Red euro$ pack (2nd year) settled +4.75 while greens through golds were +5.0 to +6.0. Stocks started the day lower but were able to close positive, as Powell said the neutral rate might even be lower than the Fed suspected, and deemed the recent liquidity surge to juice reserves nothing more than a technical trifle. (’tis but a scratch).
–Inflation data was softer than expected with core yoy CPI 2.3% vs 2.4 expected. The NY Fed released its Underlying Inflation Gauge (UIG) which also showed a small decline in the “full data set” to 2.3%. However, the report also says, “The gap between the two UIG measures continues to narrow. Trend CPI inflation is estimated to be approximately in the 2.1 to 2.3% range.” [ Sounds like the NY Fed thinks we’re AT target ]. The budget deficit for the first month of the 2020 fiscal year was released at a whopping $134.5 billion after having closed out fiscal 2019 at $984 billion. Oh, Powell also hollowly admonished the gov’t on its profligacy, while supporting it with policy.
–A couple of select trades and prices reflect the market’s sentiment, leaning toward lower rates with no fear of the downside. EDM0 9850/9875/9900 call fly bought for 2.5 covered 9836.5. This one needs a couple of more eases to end in the money. EDU0 9862/9887/9900/9925 broken condor also bought in 20k for 2.5 vs 9840.5-41. As we say in Chicago, “couple, two-tree” eases needed for that one too.
–EDM0 settled exactly at 9837.5. The 9800p, 37.5 away, settled 1.25 while the 9875c settled over 3.5x higher at 4.5. This, of course, makes call flies “cheap”, as, for example, the 9825/9800/9775 P fly settled 4.75 while the 9850/9875/9900 C fly settled 2.75. So, some are jumping on call flies, while others look to fade this pricing as the Fed tries to hold the line on additional easing. Here’s a fade: a new seller of EDU0 9800/9875 risk reversal at 5.5 ref 9841.5. The call settled 8.5 and the put at 2.75 vs EDU0 9843.0 settle; open interest up 80k in puts and 73k calls. Look, near term FF contracts have priced at MUCH lower odds of further Fed cuts. Example, FFJ0 (with 3 FOMCs beforehand) is only 9853.0 or 10 bps premium to FFX9. I.e. FF are not indicating aggressive ease, but the risk reversals reflect that fear. Hmmm.
–Germany narrowly missed falling into a technical recession with Q3 GDP +0.1%. China data was soft with Fixed Asset Investment at 5.2% vs expected 5.4%, said to be a “key driver of economic growth” (RTRS) and the weakest since 1996. US news includes PPI today followed by Retail Sales tomorrow. More Powell. (sorta rhymes with cowbell).
