This page has been archived and commenting is disabled.
Sean Corrigan On Six Sigma Events In The Bond Curve, "Inexorably Rising Risk", And Other Observations
Diapason Securities' Sean Corrigan is rapidly emerging as one of our favorite macro commentators. With his dose of weekly skepticism, he has quickly assumed the position vacated by Goldman Sachs' Jan Hatzius when it comes to the 3Ms: market, monetary and macroeconomic commentary (courtesy of the now well-known and very infamous flipping by the German strategist on his outlook on the economy). In his latest outlook piece, Corrigan dissects recent moves in the bond market, noticing a 6 sigma, three-decade statistical aberration when it comes to the 2s5s30s butterfly, and continuing through the implications of increasing bond vol on other risk assets (a topic which we believe will receive much more focus in the coming weeks and months), on fund flows (his views on the implications of the December Z.1 statement are worth the price of admission alone), on the cooling off of the European "economic miracle", and lastly, on what China's refusal to attempt a soft landing means for global risk. His conclusion is as always absolutely spot on: "in short, that risk assets can continue to rise, pro tem, it also means that RISK itself will be climbing inexorably up the scale and on into the danger zone."
From Sean Corrigan's December 17 edition of Money, Macro and Markets
As the increase in the total of US Federal debt outstanding since the LEH-AIG collapse reached the $4 trillion mark, another week began and another sell-off took place in the bond market, with 2004 Euro$ now a cool 140bps off their early November highs in one of those classic, up by the stairs, down by the escalator moves to unwind the previous four months', Fed—inspired rally.
Only a little less dramatic has been the thumping taken by the belly of the curve where — for example — the 2x5-30 butterfly has jumped 120+bps in just five weeks, a sizzling six-sigma move in a three-decade statistical record.
When we note that this was preceded by a 3½ sigma, 28-year outperformance of the middle versus the wings, taking it then to a series record low — and that half the rejection move occurred just during the past week - we can perhaps grasp some measure of the dislocation being suffered (as well as give vent to our usual despair at the idea that modern financial markets somehow exist to assist in the rational allocation of scarce capital!)
Interest rate markets had, of course, been under pressure in any case - partly as a result of the slow diffusion of core European creditworthiness out to its prodigal fringe, via the ECB and its market support operations; partly because basis swaps showed 'Zone banks were again scrambling for USD roll-overs; and partly due to the year end reallocation of funds into an equity market which had only struggled back to par as late as early September, but which finally made a new high on the very day the bond rout began.
It did little to deter the liquidation/allocation switch when Tweedledee and Tweedledum agreed not to have a battle over the US budget but just to let everyone eat cake (or, rather, pork) instead. Given that November saw the worst deficit on record in seasonal terms (despite the pick-up in receipts attributable to the weak recovery), it was no surprise that the Ghosts of Bond Vigilantes Past were moving the furniture about at the prospect of another large slug of deficit finance.
All in all, Blackhawk Ben must be well pleased with himself: since his infamous Jackson Hole address, the S&P500 has returned no less than 25% in excess of 7-10yr USTs, with the S&P600 Small Cap adding a further 10% on top of that.
Fully living up to their embarrassingly undifferentiated, 'risk asset' status, commodities — as per the DCI index — have matched the broad equity market more or less bp for bp, tracing out an r2 with them of 0.95 over the past six months and never varying by more than 5% from the mean of their combined ratio.
At least until the point where the market again feels happy to hold bonds for income, rather than playing them, as everything else, for leveraged beta on their capital value, both the potential widening of the deficit and the Fed's decision to help fill it should continue to be of help to equities and commodities. With the private sector still frying to pay down debt (with one rather glaring exception we shall come to in a moment), government incontinence is the fuel on which the printing press will run. As the following graphs, reveal, this has, indeed, become the primary mechanism for inflating prices in the US.
Remember, that for as long as people accept the money it spends into existence, a maintenance - or even a debilitating over-expansion - of the quantity of the medium of exchange needs no other agency than a determined treasury acting in concert with its willing accomplices at either the central bank alone, or among the commercial counterparts over which that engine of inflation broods and clucks, in addition.
Though we have yet to parse the report in detail (thanks to the demands made by a hefty year-end writing project with which we are currently wrestling), a cursory glance at the quarterly Flow of Funds release did reveal some interesting quirks in the vexed matter of 'deleveraging'.
For instance, the household sector seems to have disposed of a signal $540 billion (all numbers saar) in corporate and foreign bonds in the third quarter, but a closer inspection shows that the bulk of this could be set against a net $400bln contraction in outstanding ABS paper (bonds -$460b1n; CP +$60b1n) which was effectively the flipside of that same household bloc paying down (or defaulting on) $290b1n of its own stock of mortgage and credit card debt (the rest of the ABS paydown comprising another incestuous-cancellation of GSE holdings). Again, non-corporate business - shrinking its collective balance sheet once more - relieved itself of $118bln in mortgages, more or less accounting for the registered $100bln reduction in funding corporation loans.
Meanwhile, commercial banks and the foreign sector between them issued -$330b1n in bonds, more or less satisfying the $345b1n in demand for paper emanating from Lifers and mutual funds.
This effectively left foreign banks domiciled in the US (+$440b1n) and bank holding companies ($98b1n) to finance the hearty $490b1n appetite for more credit expressed by non-financial corporates - something which should have been a cheer to all those anxiously awaiting the next debt-fuelled orgy of ill-judged hiring and gross malinvestment.
What a shame, then, that the funds were put to no more productive use than manipulating the P/E ratio - while hiding executive comp dilutions - by buying back $370bln of equity (the largest amount since Bear, Stearns went under) and in financing a $113 billion inventory accumulation which was the largest in the 58-year record.
The markets have not exactly been kind to European fixed income, either, with mid-strip contracts adding 75bps and a whole series of chart lines giving way. Basis swaps have also been heading south once more; forex risk-returns have not shown much follow through since their initial, feeble bounce and — whisper it — peripheral yields and spreads are moving the wrong way, once more. The battle for the Euro is by no means over yet.
Part of the problem for the market is that — unlike in the US — the business of reinvigorating the flow of money peaked no less than 22 months ago and has been decelerating ever since (though this has been offset somewhat by the more aggressive use to which this money is being put, at least in Germany).
If past is in anyway prologue, the story for the next few quarters should be one of relative disappointment in economic performance, with the disappointment in economic performance, with the IfO and the business revenues (to which the survey tends to respond) peaking out and headline inflation potentially catching up.
In these same German revenue data can be seen the global dichotomy, writ in rather large letters and bearing the rubric: 'Go EAST, young man!"
Tellingly, the domestic component of sales is still some 10% below its peak of almost three years ago (with domestic consumer goods a woeful 13% off their best). Similarly, sales to the benighted Eurozone lie 11.5% from the top for the category. Contrast this lingering depression with the score for non-EZ exports (only 4.3% down) and the capital goods portion of these latter (-3.0%) and we can see that the Chinese Greater Co-Prosperity Sphere is still of primary importance in helping keep economic activity going elsewhere in the world.
Thus, the crucial significance of this past weekend's Chinese Central Economic Work Conference and its seemingly pusillanimous decision not to raise interest rates in the face of rapidly mounting consumer prices and a pace of monetary creation which has quickened again in the past two months.
One can only suppose that the Chinese have clung to the hard lesson that there is nary a single successful instance of a 'soft landing' being engineered, once a malinvestment boom has truly taken hold, but have not followed the reasoning through to the necessary conclusion that the longer remedial action is postponed, the higher the eventual bill tends to become.
Perhaps they hope that food prices will come down at the next harvest (or that they can import — and subsidise — enough grain to supplement the domestic supply). Perhaps they fear a further influx of 'hot money' and doubt their ability to sterilize the same. Perhaps they are dimly aware of the size of the tiger to whose tail they are clinging — frightened it will devour them in an inflationary upsurge if they do not fight it and equally terrified that its claws will shred them if they if do not keep it fed instead with sufficient credit to support the vast array of sub-economic projects they have called into existence these past few years.
If this last is the case, they might just be keeping their fingers crossed that the deceleration in real money supply already in evidence for some time past will temper the pace of industrial activity and even allow for an amelioration of the rate of price rises, as has typically happened in the past.
The problem with relying on the working of such a macroeconomic comovement to spare them this toughest of decisions, however, is that it both makes the fatal mistake of assuming ceteris is indeed paribus AND that the inevitable magnitudes and delays - inherent in what is not, after all, a law of hard, physical science, but merely a dim mirror of the combined effects of millions of subjective human choices - will not come to bite them most grievously in the behind.
That the debate may not yet be fully settled may be seen in the official Xinhau mouthpiece which ran a post-Conference piece saying, correctly, that:-
"It is one thing to be patient with the fight against inflation, it is another thing to make an urgent and exact diagnosis of the root cause of mounting inflationary pressures. In fact, after the country announced a record harvest for this year, it has become clear that the latest round of inflation is not so much about food supply as the double-digit food price hikes suggested."
"If that is the case, Chinese policymakers should promptly acknowledge excess liquidity as the main culprit behind soaring inflation. It is high time to take the firewood from under the cauldron as 5.1 percent consumer inflation in November is biting deeply into the pocket of Chinese consumers, who can currently enjoy a one-year interest rate of only 2.5 percent for their deposits."
In the meantime, what we can say is that for so long as they fail to act, the malign effects of too-easy money being drawn into its own self-fuelling vortex of higher prices, a larger collateral, more concentrated leverage, and fleetingly greater gains will not receive much of a check from one of its main contributors.
If this means, in short, that risk assets can continue to rise, pro tem, it also means that RISK itself will be climbing inexorably up the scale and on into the danger zone.
»
- 13045 reads
- Printer-friendly version
- Send to friend
- advertisements -
Nigel Farage saying happy holidays to the EU parliament. Calls Euro crisis a slow motion car crash lol
http://fedupmontrealer.blogspot.com/2010/12/nigel-farage-euro-crisis-is-like.html
Enjoy
Lieb, vati wird für Ihr zerschmettertes auto zahlen
http://www.youtube.com/watch?v=nRgVVX_rLO8
Nigel Farage is quickly moving up to the top of the hit list of the European Syndicate of the International Banking Cartel.
He almost died a couple of months ago in a plane crash... not sure about the circumstances but hey... von Rumpoy must have been disappointed when he heard Nigel was alive...
Ahh the "old plane crash" trick. Still works nearly every single time.
straight out of the CIA playbook (International Banking Cartel's muscle).
Yes it appears so. But if he never gets "Traficanted" , then we will know what he is really all about .........
Just remember what Lenin said. To control the opposition, you must lead it. Mr Farage spent a great deal of his earlier career , working for the Rothschild syndicate in jolly old City of London. Before one bestows the mantle of leadership on a person, one must be sure just who this person is and what he or she is about.
+1
interesting.
http://www.youtube.com/watch?v=9b7RmJJP5uM
Original thinking here. No re-hashed guru crap. Corrigan rocks.
He's been writing Austrian-flavored commentary for several years if I remember right.
sigma bitchez... come on, I know you all wanted to say it!
20% interest rates bitchez
It was either 'inflate or die'.. now comes the die part.
I believe TD was writing about the sigma event also.. went over my head of course. Credit mkts are a whole other level.
Used to Read Sean when he wrote the Sovereign letter always great stuff.
Theme for an electro-plated age.
-----
Jeezus...I thought I was starting to understand this stuff
...maybe not.
I am with you, reread several parts and I'm still scratching my head
thanks, guys...I thought I was the only one. so we supposed to buy TLT or avoid it like the plague, or buy the shorts?? huh?
I hear you. Is there a buy the dip style cartoon for this stuff?
+1
Yep......
discussing statistical probability when the bond curve is no longer dominated by random movement is a bit absurd, no?
The Fed decides arbitrarily which chunk of the curve to buy and without relation to the probability distribution of curve history.
Good point. But old habits die hard, and how are you gonna fill your weekly quota of verbiage if the only thing you have to offer is: front-run the Fed?
Yes. Where are the independent variables when there is only one bidder who matters?
Only a hedge fund would be silly enough to apply stat to an intermarket butterfly spread. Hunting sparrows with a howitzer. Still, it's hard to disagree with the general thrust of the piece. The longer markets are distorted, the greater the eventual shock when reality intrudes.
No, it is not. What you need or *should* be used is a conditional distribution. That is Pr(Y|X=x), where in this case X is the Fed buying a chunk of the curve and we are interested in the outcome Y.
Unfortunately, the MBA types can't handle notions of conditional probabilities, so you usually get the watered down version of unconditional probabilities. Don't read into it too much.
The notion of large sigma events in these times are made in reference to the use of unconditional Gaussian distributions, which is very questionable. In today's environment what *should* be used are conditional heavy-tailed distributions.
Michael Vick playing a killer game today..
And Deshawn Jackson just scored and won the game with seconds left...
Wow.....Unreal
Never give up Bitchez!
New York blows
They looked great until the last 7 minutes...I'd hate to be a giant right about now..
Can Brady carry the Patriots' weak d?
The higher the sigma the blacker the swan.
Butterfly flaps in Bangladesh Down 7% and riots ensue
He doesn't get Chinese inflation.
Its coming from the Fed and the best way to deal with it is to revalue up.
Surprised at the insane level of bond market volatility?
No one should be. These (former) "markets" are now nothing but policy tools and the playthings of those with access to virtually unlimited ZIRP funds.
It wouldn't be a casino without the volatility, so we have to have the volatility.
OK...I might be a few bricks shy of a full load [probably], but when I read something like THIS ARTICLE, THIS ARTICLE then becomes evidence in support of my theory that our problem is that we have far too many criminal syndicate Wall Street bankers in our system. I'm still dizzy from reading it.
I tried to explain this in another comment thread by talking about bankers and mason jars. You see, if you put a banker in a mason jar, and even if you poke holes in the lid for air, the banker ceases to exist, anyway.
***warning: this is an analogy and not a call to put bankers in mason jars...again***
Why does the banker cease to exist when put in a mason jar? Well, in a mason jar you can see him. You can look at him from all sides, turn him around, top bottom, back. And that examination is not hard to conduct. In fact, it results in a clearer picture.
Let me try to register an opinion on MASSIVE RECENT T BILL MOVEMENTS OF LATE in a way that works in a mason jar. These moves have been MASSIVE [true]...or I guess SIGMA 6 [fancy]. But anyway...I'm going to try to state what I think is important about this fact.....
SELLERS
That's right, people have selling the crap out of T bills [and other debt instruments]. And last I checked, sellers means bad. Buyers means good. There.
So remember, don't try to put a banker in a mason jar because that was an analogy about the importance of TRANSPARENCY...and the last place you'll get any of that is from a criminal syndicate Wall Street banker who, by definition, needs everything to be SUPER MURKY.
And also, Treasury rates are going up [prices down] because people are sellin' the crap out of them [and other debt instruments]...and something very similar started happening in Europe about six months ago resulting in little Ms. Euro getting really blotto and falling down in a big pile of upchucked Euro dollars over the past couple weeks.
Hmmmmmm? Maybe we can learn something from a simpler view of things...and prepare?
Hope that helps.
Cdad
" our problem is that we have far too many criminal syndicate Wall Street bankers in our system".
Ummm...? Isn't our system designed by Wall Street Bankers to be a criminal syndicate for Wall Street bankers?
Isn't that why buying is called a bull market and selling is called volatility? Is the volatility in the bond market designed to stimulate money flow and buying in stocks?
Well put, Cdad. It is quite the mode right now to give Ben a lot of crap because QE2 was supposed to keep bond yields down and they instead are going up. Sometimes markets say more by what they don't do rather than what they do do; it's just a little harder to hear the message. Ben is basically for a period of time buying the equivalent of all the new US grovelmint supply. Maybe he is just postponing by a few months the inevitable end game of the bond rate moon shot that 1) causes the resumption of the depression, 2) Crashes precious metals as suddenly Benjamins (the other one) are king, and there is no effective strategy left in the Fed war room.
But, but, but....gold and silver are just a big bubble, I tell you, just a big buble damn it. You got to believe me......
alex jones...
Oops. I smell another money bomb coming. This time I want all of you guys and gals to reach into your pockets real deep and send this man your money. After all, he is our fearless leader and without his wisdom and leadership in this dark hour, we would all be doomed, I tell you, doomed.....Ha ha ha ha
So,... what is his point? Any trade recommendations? We all know risk is increasing with the rising (mis)price of risk assets. Oh, and I just experienced a six-sigma event to do with time delays trying to get my son over from Edinburgh due to 7-sigma snow-falling and 8-sigma European unpreparedness.
"Any trade recommendations?" Yes, try & avoid this 6,7, or 8 sigma, gizmo event if rates continue to rise.
http://data.imagup.com/6/1107484195.GIF
Oh, and remember the "kiss of death:" dollar crashing, bonds tanking, stocks water-falling lower. When that happens, apply the power of prayer because it's too late to do anything unless you're well stocked in gold & silver to try & preserve your wealth. Good Luck & I hope your son arrives safe & sound back to you.
Perhaps the Chinese think that matching inflationary memes with the US will be in their better interests
The upper ratio is what I jokingly call the Holy Grail. It is showing a high risk of at least a 3 to 5 day decline.
It is one of my systems, it forces me into a short position.
Now has anyone been paying attention to what this Holy Grail Is? Check it out, I wish I had 40 years of data on this, as 2 years of data can mislead, especially since this has been an very curious 2 years in the markets.
http://oahutrading.blogspot.com/2010/12/holy-grail-and-fear-factor.html#...
When does the fed realize it's "losses"?
Or another analagous question might be. When does the United States get to stop sending Israel billions of dollars a year in aid, while at the same time, many sick and psychologically messed up former US soldiers are living under bridges in many of our cities? Soldiers that are fighting and dying for nothing I might add.
I can't wait until that "shitty little country" is sieged.
Amen!
It doesn't. Losses are for the people, not the privileged.
Record bonuses - nothing less.
When does the fed realize it's "losses"?
The cost of ink and linen exceeds the value of a c-note.
Total gibberish, intended to keep all options open, the good ones speak English.
Futures:
That was some good stuff in the article.
I guess, rising risk means rising interest rates this way comes. But Bernank promised.
China is now doing some things to keep a lid on inflation which means it will come back here just like Bernank wants. Ben thinks he can control it.
Note: if anyone sees Volcker stalking in the background, for God's sake, say something.
I am only partially joking as I post this correlation between Eclipse and Market. This Tuesday is an Astro event that hasn't occured for about 400 years
Eclipses on the Solstice are associated with massive mania.
Also, appearance of the word Eclipse in books are correlated with bull markets and subsequent crashes.
http://oahutrading.blogspot.com/2010/12/manias-and-astro.html
Oh geez, just what we needed with all the black swans on the horizon too. Just got off the phone with a pal of mine who is into astrological portents, made plans to go watch it tomorrow night. 456yrs to be exact, which, I guess, has the Numerologists panties in a wad also. Massive moon mania, wahoo!
Topic Interuptus - Please Excuse
Has ZH already covered this? If yes, please provide a link. I looked but could not find.
The Wall Street Pentagon Papers: Biggest Scam In World History Exposed - Are The Federal Reserve’s Crimes Too Big To Comprehend?
http://ampedstatus.com/the-wall-street-pentagon-papers-biggest-scam-in-world-history-exposed-are-the-federal-reserves-crimes-too-big-to-comprehend
now back to your regularly scheduled flaming.
OK, my front office finance is a little rusty, so I am going to take a stab at what 2x5-30 Butterfly means, but please feel free to correct me.
A butterfly is a put/call spread, yes?
2x means put/call?
5-30 is the term? Does that mean 5Y to 30Y?
So, does that imply that the volatility in the 5 - 30Y bond bid/offer spread has blown out?
I would assume that means bigger profits for banks, but tighter credit for counterparties?
Any light shed would be appreciated.
The 2x5-30 can also be written as "2s5s30s butterfly" (as TD wrote above). The 2s5s30s butterfly shows the relative changes of the 2-year, 5-year, & 30-year USTs. The "wings" refer to the outermost numbers - 2s & 30s.
One way in which this butterfly can be used is as a measurement of an unparallel shift in the yield curve. For example, if the 2s & 30s increased relatively more than the 5s. Said shift would have implications for convexity, etc.
Edit: The butterfly spread that you are referring to is an options strategy that involves future realized volatility vs. implied volatility at initiation of the trade. This is an entirely separate concept. I hope that my explanation helped a little bit.
Thankyou, that helped a lot. I still can't work out from the OP whether the curve became more or less convex.
If the 2s5s30s butterfly jumped 120bips, did that smooth out the convexity in the middle, or increase it? Or, to put it another way, did the short/long end of the curve blow up, or the middle?
Thanks for replying.
"Only a little less dramatic has been the thumping taken by the belly of the curve..." The belly of the curve refers to the 5s (middle number). The 120bp is reffering to the relative movement of the belly.
To answer your question, the middle of the curve blew up (If I am understanding your question correctly). Someone else please chime in if you can articulate this concept more clearly.
*Deleted