Removing Preemptive Accommodation
October 25, 2020 – Weekly
Lael Brainard gave another speech on Wednesday, outlining the macro situation since the onset of COVID. She said housing and autos rebounded strongly, “a welcome reminder of the power of monetary accommodation” but that many service sectors have come back only about 60% from the March/April plunge. She therefore calls for targeted assistance and, echoing other Fed officials underscores the necessity of fiscal aid, which again fell short of Congressional agreement last week. She notes that in the coming year inflation is likely to exceed 2% in yoy comparisons as March and April data fall out, but that the Fed will stand down. About the new Fed framework with respect to employment, she said:
It [the new framework] commits that the Committee will aim to eliminate shortfalls of employment from its maximum level, rather than the previous reference to deviations, which could be in either direction. By eliminating the rationale for removing accommodation preemptively when the unemployment rate nears estimates of the natural rate in anticipation of high inflation that is unlikely to materialize, the new framework will avoid an unwarranted loss of opportunity for many Americans. The broad-based and inclusive definition of maximum employment calls for a more comprehensive assessment of areas of slack in the labor market, such as the disparities in employment outcomes I discussed earlier.
The potential problem is, if inflation does materialize and the Fed sits idle, it may also create lost opportunities and hardship for households. Powell, in testimony made prior to Covid, often said the Federal Reserve “stays in its lane” regarding the dual mandate of maximum employment with stable and low unemployment. There’s a lot of room for swerving in the above excerpt, with possible unintended consequences. This is like the 85 year old man driving his pride-and-joy 1980’s Cadillac Sedan de Ville down the freeway with the left blinker on as he casually drifts to the right. Clearly, the Fed has pegged the short end. However, this week tens rose nearly 10 bps to 84 bps, and the thirty year bond jumped nearly 12 to 1.645%. While the ten year yield has not surpassed the spike in early June at 89.6, the 30-yr did slightly exceed the June 5 peak of 166.7 to hit 167.7 this week. Also worth noting is that both 2/10 and 2/30 exceeded June’s highs of 68 and 145 by reaching 70 and 152 on Thursday. Clearly the longer end is where the action is. However, option activity suggests that it will be tough to get through the 1% yield in the ten year. For example, on Tuesday vs 138-23 in TYZ, there was a buyer of 50k TYZ 139/138/137.5 put trees for 3 and just higher. (+1/-1/-1). Max value at expiration is between the 138 and 137.5 strikes. Currently, the 137.5 strike equates to about 93.5 bps in cash tens. Downside breakeven (ignoring the futures hedge and assuming a price of 3/64) is 136-17+. There was also selling later in the week of TYZ 137/140 strangle at 22 to 23, and TYZ 137.5./140 strangle at 29. On Tuesday there was a block seller of 31k TYF 136.5/139.5 strangle at 44. All of which express a view that upside yields are capped in tens… at least for the time being. In TYZ, the 140c has maximum open interest of any strike at 99k, while on the put side it’s the 138 strike at 186k, followed by the 137.5 at 151k and the 137p at 147k. TYZ has 3.18 million open.
Settles vs TYZ 138-11+ TYZ 139/138/137.5 p tree 10, TYZ 137/140 strangle 21, TYZ 137.5/140 strangle 29 and TYF 136.5/139.5 strangle 42.
Brainard’s testimony suggests USD softness, although structural problems with EUR, GBP and JPY are all apparent. CNY has consistently rallied vs USD, going from 7.17 on May 27 to 6.6868 Friday. On June 5, as UST yields had hit a high on the strong employment report, CNY was 7.08. Where USD has shown consistent weakness is against bitcoin and gold. In fact, bitcoin, now at $12998, is approaching the spike high set in June 2019 of $13851. Bitcoin priced in some other currencies is already slightly through the 2019 high, for example when priced in yen. Of course. in TRY and ARS bitcoin is at all-time highs. When priced in gold, bitcoin is still somewhat below the 2019 high. The June 2019 high in gold was 1439, and it’s now 1902. I suspect that when and if bitcoin is able to surpass this 2019 peak, it will provide more of an indication of stress in the global financial system. At least, I will make that unsubstantiated claim, which seems to be the style these days.
What we’re seeing is the fight for dominance between the physical and the digital (although there are so many derivatives on gold that the distinction is blurred). In any case, physical commodities currently are outperforming outside of energy, as the store of value attribute of fiat currencies erodes. In any event, value is not being held by fiat currencies as global central banks become more activist.
Election is next week. This week the treasury auctions $54b 2-yrs, $55b 5-yrs and $53b 7-yrs starting Tuesday.
OTHER MARKET/ TRADE THOUGHTS
Once again, there are warnings about stocks being overvalued, notably Jeremy Grantham saying the bubble will burst in months if not weeks. John Hussman, while currently neutral, says the Fed has sown the seeds for a financial implosion. The election could easily be a catalyst, though there will likely be another large stimulus package passed post-election. On a blue sweep I am inclined to sell Russell vs buy SPX, or buy SPX calls vs short Russell. On a Trump victory with Republicans holding the Senate I would be inclined to buy fossil fuel companies vs green energy.
| 10/16/2020 | 10/23/2020 | chg | ||
| UST 2Y | 14.3 | 15.3 | 1.0 | 15.7 wi |
| UST 5Y | 31.7 | 36.8 | 5.1 | 37.7 wi |
| UST 10Y | 74.2 | 84.0 | 9.8 | |
| UST 30Y | 152.7 | 164.5 | 11.8 | |
| GERM 2Y | -77.5 | -75.8 | 1.7 | |
| GERM 10Y | -62.2 | -57.5 | 4.7 | |
| JPN 30Y | 61.6 | 64.0 | 2.4 | |
| EURO$ Z0/Z1 | -1.0 | -1.5 | -0.5 | |
| EURO$ Z1/Z2 | 8.0 | 10.0 | 2.0 | |
| EURO$ Z2/Z3 | 14.5 | 18.5 | 4.0 | |
| EUR | 117.18 | 118.62 | 1.44 | |
| CRUDE (active) | 41.12 | 39.85 | -1.27 | |
| SPX | 3483.81 | 3465.39 | -18.42 | -0.5% |
| VIX | 27.41 | 27.55 | 0.14 |
