Quite a week
March 13, 2020
–DJIA fell almost exactly 10% yesterday, with SPX -9.5 and Nasdaq -9.4%. Comparisons were made to 1987, as this was the largest one-day sell off since then. Let me just mention a couple of other things from 1987. At that time, the FF rate was 7.25%. In October 1987, Greenspan cut 50 bps to 6.75%, and had also put out a statement on Oct 20: “The Federal Reserve, consistent with its responsibilities as the Nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.” In February of 1988, the Fed cut another 25 to 6.5%. Later in 1988 it was back to raising rates to fight inflation. How different today is. The Fed Effective is 1.09% and April FF yesterday surged another 13.5 bps to 9984, or 16 bps. In 1987, the hot investment product was ‘portfolio insurance’, as I recall it, this spiffy product was a system of buying puts and then buying more puts if the market fell. It backfired. Now the market has been conditioned to low rates and there is simply no question that the Fed is ready to provide liquidity with every little wiggle. There is no comforting shock effect to a statement like 1987, because the size and flows are overwhelming with no cushion provided by high rates. In any case, the Fed yesterday announced massive repos, $1.5 T total in one- and three-month terms, and extended the $60 billion monthly QE out to longer maturities. Stocks were relieved…for all of about 15 minutes, and then made new lows.
https://www.newyorkfed.org/markets/opolicy/operating_policy_200312a
–Signs of stress and dislocations are everywhere, both in markets and in daily life. Trump’s speech on Wednesday night heightened the gnawing uneasiness that has gripped the public’s consciousness. In markets, there have been several articles about the treasury bond basis becoming unhinged; there’s a link below (thanks TH). In my opinion, it all comes down to one thing, the search for yield compressed everything to unreasonable levels. No yield means that clever people come up with all sorts of ideas to squeeze out a few incremental bps, whether that’s selling vol or engaging in highly levered strategies on ‘stable’ relationships. Then you wrap it all up in a fancy name. ‘Relative value’. That’s when one thing goes up and the other goes down and you’ve got it on the wrong way.
–The curve is steepening: as mentioned, April FF were up 13.5 bps while the Ultra Bond WNM0 settled -2’27 to 217-17. 2/10 made a new recent high at 37.3 bps, up 4.5 on the day. The red/gold pack spread in dollar jumped just over 9 bps to end at 52.5, also a new recent high. Straddle levels exploded yesterday, esp on longer maturities. On Wednesday, 0EM0 9950 straddle settled 27.5 vs 9955.0. Yesterday, the 9962.5^ settled 27.0 vs 9958.0. However, on Wednesday the blue 3EM0 9925^ settled 40.5 vs 9921.5. Yesterday the contract settled unch’d at 9921.5 and the straddle leapt 5.5 bps to 46.0. The USM0 at straddle went from 12’60 to 14’28.
–As mentioned the other day, the EDM0 9950 straddle is now worth more than the EDU0 9962^ with 3 months of extra time value, 26.5 to 23.0. Downside puts which were thought to have no value suddenly came to life. For example, EDM0 9825 puts traded 1.5, more than 125 bps out and the center strike of the massive put flies that had been accumulated (9837/9825/9812 flies).
–A week ago, FFJ0/FFJ1 one-year spread was around -28, with the thought of incremental additional easing over that year. Yesterday it settled -1.5. The market is demanding eases now. Not later.
