Nearing an emergency ease?
February 27, 2020
–Once again, yields made new lows with tens -1.6 bps to 1.314%… though once again, at the end of the day, there was heavy selling of fixed income. Stocks rallied early but faded and have made new lows overnight. Industrial commodities are showing very little sign of a bounce. CLJ0 is down $1 this morning at $47.75. Copper has plunged over 10% from the high of this calendar year, and Aussie continues to make new lows. The back part of the curve, for example reds to golds, +1.875 yesterday, is starting to steepen.
–Germany announced that it may loosen budget rules to provide fiscal stimulus. The US announced new virus case on Long Island and Trump called on Pence to lead the US virus response. San Francisco has declared a public emergency.
–I initially didn’t think the Fed would respond with lower rates. However, it’s pretty clear that the US is a flow economy rather than a wealth building, save-for-a-rainy-day economy. Borrow to buy, or lease. Depend on the monthly flow of income to service the payments (easily seen with stretched auto loan maturities and leases). In a way, the repo crisis of September is emblematic… the system risks seizing up when funding becomes scarce. If businesses and homeowners need to borrow to meet obligations (if income takes a virus hiatus) the Fed probably should provide funding as cheaply as possible.
–In terms of timing of a possible Fed ease, it’s moving closer as April FF have rallied from 9843.5 last Friday to 49.5 yesterday. Six bps is 25% of an expected 25 bp move at the March meeting. In euro$ it’s somewhat interesting that all the virus related buying was in EDM0 with the front EDH0 more or less anchored by the daily libor settings. This can be seen in the EDH0/EDM0/EDU0 futures butterfly which has dropped like a rock from -3 to -16.5 since mid-Feb. The reason is that H/M has fallen from -12 to -27 while EDM0/U0 moved from -8.5 to -10.5. The March FOMC is March 18 while the expiration of EDH0 is March 16. I.e. the meeting is after expiry. EDH0 appears to be indicating smaller odds of an ease than April FF. There are just under three weeks for the FOMC and a bit over 2 weeks for EDH0 expiry. Might be enough time for full blown panic to occur in the US (whether warranted or not). Corp spreads are starting to widen. I now think it’s a mistake to discount the possibility of a 50 bp move in March. If it were to be the case, there would have to be a Fed statement or speech to prepare the market. I would now exit the EDH0/J0 spread recommended shorting at -2 to -2.5, settled -9 yest.
