Crisis levels of stimulus
December 15, 2019 – Weekly Comment
In Q2 2018 stocks and other assets levitated due to the tax package (Tax Cuts and Jobs Act). At the time, many analysts warned of a ‘sugar high’. In April ‘18 both Morgan Stanley and the IMF put out reports warning that growth was being pulled forward, and that future deficits might make it difficult to engage in fiscal stimulus should the economy slow. Obviously, at the end of 2018, the Fed’s attempt at normalization, coupled with trade tensions, derailed stocks.
Currently we’re in the midst of massive stimulus even as growth is good and unemployment is at historic lows. The Fed is pumping gargantuan liquidity to prevent another repo scare. M2 is growing at a 7.3% yoy rate and is accelerating. The Federal government is running epic deficits, though there is little in the press to suggest the public has any concern about such matters. The 2019 deficit was $984 billion. In October, the first month of fiscal 2020, it was $134 billion and in November, $209 billion. This compares with previous year levels of $100b and $205b. “The Treasury Dept reported Wednesday that the federal gov’t took in $225 billion in tax and other revenue but spent a record $434 billion in November.” Going into the election year there is little to suggest anything besides wide-open spigots on spending, and the Fed has overtly said that hikes are off the table unless inflation is persistent and significant. A 2020 deficit of over $1 trillion is a lock.
Against this backdrop, the administration completed Phase One of a trade agreement with China, and the Tories won a resounding victory on the ‘Get Brexit Done’ slogan. After the Q4 2018 rout in stocks, returns this year have been phenomenal with SPX up 26% ytd. However, versus the 2018 high the current level is only 8% higher, which is still, of course, a solid showing.
Even with a layer of trade uncertainty being withdrawn, SPX only gained 70 bps on the week. Of course, these are all-time highs. Yields were little changed, with tens down 2.8 bps on the week to 1.819%. Implied vol in the short end was crushed and is on the low end of the recent range in treasuries. The market continues to forecast one more ease in 2020, with Jan20/Jan21 FF spread settling exactly at -25 bps. With EDZ9 expiring Monday, EDH0/EDH1 will be the front euro$ one-year calendar and it’s also the most negative, at -24 bps. Twin engines of money supply growth and Federal Gov’t deficit spending should be cranking up inflation and term premium in the long-end, but confidence in the Fed to provide ‘whatever it takes’ to guarantee absorption of treasury supply (or absorbing it itself) is rock solid for the moment. The NY Fed’s Q4 GDP Nowcast of just 0.7% allays any fear of an uptick in inflation. USH0 at-the-money 158 straddle settled just over 4 points at 4’06, just 7.5 vol.
There was a lot of press surrounding the Phase One deal and China’s vow to buy $50 billion in US agricultural products over two years. Sounds like a lot. But what the US really needs someone to buy is the near $90 billion per month of treasury supply to plug the deficit. Maybe that’s the undertone of a China deal: we’ll make it easier for you to again sell goods in the US, but take those tariff savings and recycle them into US bonds to help our funding needs.
The only market beginning to reflect a modicum of concern about US policies is the dollar, which is starting to turn lower. The fact that stocks didn’t see more of a boost this week is a warning sign going forward.
OTHER MARKET/TRADE THOUGHTS
Quick update on large call calendars bought in the week previous to last: TYF/TYG 130 call calendar had been bought from 14 to 16 in size of >100k. A grinding rally going into Jan expiration (Dec 27) works best for this trade. I had surmised that China talks would drag on, making this a reasonable play. In fact, the December tariffs were suspended as Phase One appears to have been completed, and the Tory win diffused another situation that removes, at the margin, demand for the safety of treasuries. However, on the week the ten year yield actually declined by 2.8 bps, with TYH0 going from 128-28+ to 129-01. TYF 130c settled 5 and TYG 130c settled 21.
Last week I highlighted some call structures that had been bought as plays for continual (forced?) easing. I had mentioned EDU0 9887.5/9937.5 call spreads which had settled 4.75 on Friday, Dec 6, versus EDU0 9844.0. This call spread settled at 3.5 vs 9843.0, but with the dip during the week, the buying shifted one strike lower, to the 9875/9925 call spd. At least 60k were bought in the week just ended, settling at 4.75. Two more 25 bp eases would likely see EDU0 approach the 9875 strike, but an actual payoff would require three cuts…prior to the election.
On Friday, I mentioned buying EDF0/EDH0 9825 straddle spread for 3.0 (traded and settled there Friday). EDH0 9825 straddle settled at just 8 bps with three months to go. On 9/13/19, with three months to go, atm EDZ9 9800^ settled 24.0. On 6/14/19 with three months to go, atm EDU9 9787.5^ settled 26.5. Certainly the market was poised for Fed eases earlier in the year. But the market is now really, really, really sure nothing is happening in the next three months. On Friday, EDU0 9837.5 straddle settled 27.0 with NINE months until expiry. In June the THREE month until expiry straddle settled 26.5.
| 12/6/2019 | 12/13/2019 | chg | |
| UST 2Y | 161.9 | 160.2 | -1.7 |
| UST 5Y | 166.8 | 165.3 | -1.5 |
| UST 10Y | 184.7 | 181.9 | -2.8 |
| UST 30Y | 228.3 | 225.3 | -3.0 |
| GERM 2Y | -62.5 | -61.8 | 0.7 |
| GERM 10Y | -28.6 | -28.9 | -0.3 |
| JPN 30Y | 44.4 | 42.1 | -2.3 |
| EURO$ H0/H1 | -20.5 | -24.0 | -3.5 |
| EURO$ H1/H2 | 6.0 | 4.5 | -1.5 |
| EUR | 110.62 | 111.22 | 0.60 |
| CRUDE (1st cont) | 59.20 | 60.07 | 0.87 |
| SPX | 3145.91 | 3168.80 | 22.89 |
| VIX | 13.62 | 12.63 | -0.99 |
https://fiscal.treasury.gov/files/reports-statements/mts/mts.pdf
