Lower Bound
March 17, 2020
–DJIA was down 13% yesterday, with accelerated sales after Trump advised that disruptions could go on until August. SPX fell 12%, with the total loss from the Feb high of 3393 at 30%. Yields fell significantly after the Fed’s Sunday night cut to ZIRP, with tens down 23 bps to 0.718% but 2’s only down 12.2 bps to 0.358%. In dollars, reds +11.0 to 99.556 (avg), grns +16.75 to 99.355, blues +18.875 to 99.207 and golds +23.0 to 99.094. A dramatic FF cut is typically a steepener, but the market appears to believe that the Fed is out of bullets in the front end, therefore support operations will occur in longer maturities.
–Companies that diluted their balance sheets by taking on debt and buying back shares on the wings of previous QE ops are now on tenuous ground. Perhaps financial engineering will be much less prevalent going forward. In any case massive stimulus globally should make people think twice about buying duration. I would rather own 2’s at 37 bps than pick up an additional 36 bps for ten years. By the time twos mature and the virus is in the rearview mirror, tens will likely have MUCH higher yields.
–That sort of sentiment is on display in euro$ options. For example, 0EU0 9962.5 straddle settled 27.5 vs EDU21 at 9959. However the atm 3EU 9925 straddle settled almost twice as high at 54.5 vs EDU23 at 9922.5. Both expire on the same day. It makes some sense of course; the strike price of 9962.5 is 37.5 bps and the blue is 9925 or 75 bps, so the strike is twice the yield. However, it appears to indicate that the US market respects the idea of a zero bound, and intuitively prices for a steeper curve.
–Peak prices on the curve are now EDU20 at 9967.5 and in FF’s July20 thru Oct20 all settled 9992. So dollars have roughly 1/4% premium to FF; this, as large banks are getting ready to tap the discount window in an effort to make it a more mainstream policy tool.
–Treasury options functioned pretty well yesterday. TYM 138 straddle was sold at 4-06 down to 4-01 and settled 3’60 vs 137-31. Mid-market pre-open was around 4’15. Canada March BA contract matured yesterday. On Friday afternoon it was 98.955. Monday’s final settle was 98.632, a difference > 30 bps. Something to ponder with respect to front end vol sales…
