How do we do it? VOLUME
An abbreviated comment this week…
On the trading floor there were all sorts of nicknames and comments for people, some of which (ok maybe most) were derisive. One referred to a guy who was running a large floor brokerage operation, and someone said, “He woke up on third base and thought he hit a triple.” It’s so stupid it’s funny, but also a reminder that sometimes if you can just ride the wave you don’t need a whole lot of ‘smarts’.
I ran charts with open interest on treasury contracts, and a friend of mine (thanks DW) remarked, “I didn’t realize open interest was that large. It looks like a chart of the CME.”
Sure enough, above is a chart going back to 2007, with the Five-Year futures contract in white, aggregate FV open interest in green, and the share price of the CME in amber.
The CME is an innovative risk-management and risk-transfer institution. It’s on the cutting edge of technology. Markets are deep, liquid and transparent. But the stock price appears to be dependent only on the vast increase of US debt! Sure, open interest growth probably has something to do with the increase in rates (and related hedging demand) since 2016. But a key driver just seems to be that’s there’s a lot more of this stuff.
| All in trillions | Q1 2008 | Q2 2018 | % INCREASE |
| Federal Debt | 9.438 | 21.195 | 225% |
| Federal Debt Held by Public | 5.334 | 15.484 | 290% |
| Federal Reserve Balance Sheet | 1.2 | 4.1 | 342% |
| US GDP | 14.6 | 20.6 | 141% |
| FV Aggregate Open Interest (mio) | 1.82 | 4.76 | 262% |
It seems clear that open interest is dependent on the amount of Federal Debt Outstanding. It also seems pretty obvious that the boost in government debt hasn’t had as much of an effect on GDP growth as one might think. But it’s just as clear as a bell that what matters to the stock price is treasury open interest, driven by debt increases! Which brings me back to a Stanley Druckenmiller excerpt from a speech in 2015: “The other thing he taught me is earnings don’t move the overall market; it’s the Federal Reserve Board. And whatever I do, I focus on the central banks and focus on the movement of liquidity. Most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”
Of course we all know that correlation may have nothing to do with causation. However, the current theme with the Federal Reserve is a withdrawal of liquidity, which acts as a net negative for overall equity prices. As Citi said in a recent note, the combination of large budget deficits and balance sheet withdrawal create a situation where domestic savers must be relied upon to clear the (bond) market.
A quick survey of the week’s action finds treasury yields at or near new highs. The dollar index is also at a new high for the year. The CRB commodity index is very near the low of the year as WTI crude has plunged over 20% from the high close in early October. The euro$ curve remains inverted from reds to greens and greens to blues. SPX, Nasdaq and DJIA are still higher on the year, but Russell and DJ Transports are about flat or lower. The markets are signaling that the Fed is on the verge of being too tight, but official employment and inflation data suggest that more rate hikes are in order. Of course the Fed wants more ammo to fight the next downturn; it might be the case that Barney Fife’s fiscal bullet has already been spent. If a downturn does indeed materialize, then automatic fiscal stabilizers will only worsen the deficit and grow the supply of bonds. (So buy CME?)
The driver seems to be front loaded fiscal stimulus and a Fed that is leaning against the growth that is filtering through the economy, perhaps at a decreasing rate. A political dynamic between the White House and the Fed complicates the picture. The next Fed meeting is just over 5 weeks away. Prior to that I wouldn’t be surprised if there are hints of a slowdown in balance sheet reduction.
By the way, if you look closely at the chart above, you can see that CME stock declined marginally in 2011. Yes, that’s when they de-listed the pork belly contract. But treasury supply was even able to overcome that particular misstep from CME management…
OTHER MARKET THOUGHTS
Ten year treasury yields tickled new highs on Thursday, but pulled back Friday in spite of higher than expected PPI data, Core yoy +2.6%. On Wednesday Core CPI is expected +2.2%. A 2-yr yield that approached 3% this week provides strong competition for stocks. On the longer end tens left a (temporary?) double top just shy of 3.24%.
There has been a decent amount of call accumulation in Feb TY calls, which expire January 25, just prior to the January FOMC which is on the 30th. January TY options expire on December 21, just after the December FOMC on the 19th. Recall that beginning next year, every Fed meeting will have a press conference.
| 11/2/2018 | 11/9/2018 | chg | |
| UST 2Y | 291.0 | 293.2 | 2.2 |
| UST 5Y | 303.6 | 304.4 | 0.8 |
| UST 10Y | 321.2 | 318.9 | -2.3 |
| UST 30Y | 345.3 | 339.1 | -6.2 |
| GERM 2Y | -63.0 | -59.7 | 3.3 |
| GERM 10Y | 42.0 | 40.7 | -1.3 |
| JPN 30Y | 87.0 | 88.4 | 1.4 |
| EURO$ Z8/Z9 | 46.5 | 48.5 | 2.0 |
| EURO$ Z9/Z0 | 1.0 | 0.5 | -0.5 |
| EUR | 113.88 | 113.36 | -0.52 |
| CRUDE (1st cont) | 63.14 | 60.19 | -2.95 |
| SPX | 2723.06 | 2781.01 | 57.95 |
| VIX | 19.50 | 17.36 | -2.14 |
