Flattener

As Italian Yield Curve Flattens Dramatically (8 Standard Deviations), Is JEF Facing More Stress?

Based on the detailed exposures and DV01s thet Jefferies released on Friday, which we discussed as evidence of an implicit 2s10s (approximate maturities) curve steepener, it would seem that the dramatic shift flatter in the Italian bond curve this morning could be problematic. The huge 35-40bps compression in the spread between 2Y and 10Y BTPs is the second largest ever (largest being 4/8/11) and represents an 8 standard deviation drop compared to the last 8 years. This could mean a significant loss for the JEF book - unless they are perfectly hedged through BTP futures - which it does not seem is clear from the exposure sheet. The Italian yield curve has flattened over 100bps since the end of the EU Summit - inching perilously close to inversion which hasn't been seen since 1994.

Forget The Twist, Here Comes Operation Torque: Presenting Morgan Stanley's Complete Moral Hazard Profit Guide

While we often pick on Morgan Stanley's Jim Caron (the same guy who year after year after year keeps predicting the yield on the 10 year will soar, and not just soar, but soar for all the wrong reasons, such as bull steepening and what not), has just diametrically changed his tune, by bringing us, drumroll please, Operation Torque. To wit: "Policy makers in both the US and Europe get back to work in September, and this month will be rife with deliberations on stimulus and market support policies. In our view, a duration extension to the Fed's SOMA portfolio is an optimal policy tool to engender easing. This can initially be done through extending the duration of reinvestments from MBS and agency holdings but may ultimately culminate in selling shorter-duration USTs in its SOMA portfolio in exchange for buying longer duration assets (‘Operation Torque’, as we at Morgan Stanley have dubbed it)." Why 2 Years? Because as per the August 9 FOMC statement, we know that there will no rate hike for the next 2 Years, and hence no duration risk. Which means that the Fed can sell an infinite amount of paper into a mid-2013 horizon without worrying about demand destruction. And by doing so it will, as we have been predicting since May, expand the duration of its portfolio, in the process pushing investors into risky assets for the third time in as many years. But there is a twist...

Morgan Stanley Goes Short Treasurys.... Again

It has not been Jim Caron's decade. The Morgan Stanley rates strategist, riding on the coattails of the always wrong Morgan Stanley economics team led by David Greenlaw, has been wrong in his annual rates call year after year after year. Which is unfortunate because while unable to see the forest for the trees, Caron does have a better grasp of rates than most other Wall Street penguins. That said, just like everyone else in the status quo, Caron has just come out with another short duration call (i.e. sell bonds), probably the 6th time in a row he has done that in the past 3 years. Perhaps 7th time will be the charm. Amusingly, Caron, terrified to be seen in the same camp as Bill Gross who is short bonds on fears that there will be nobody available to step in an buy the 80% of gross issuance that has been monetized by the Fed to date, make this very loud caveat on his short bond call: "To be sure, our shift toward short from neutral duration has nothing to do with the end of QE2 and related concerns that there will be a lack of demand to buy US Treasuries once the Fed stops buying them. As we have stated many times in the past, the outlook for the economy will be the main driver of yields, not the end of QE2." No, instead Caron believes that the sell off in bonds will be due to the same bullish economic growth call that he has been predicting over... and over... and over... and over... etc. More interesting is how he suggests the trade is implemented: in MS' view the best way to be bearish on rates is with a DV01 neutral 7s-10s flattener: "we continue to recommend being short 5s on the 2s5s10s fly. In line with the butterfly, and in order to express a more robust short duration position, we recommend a curve flattener on the UST 7s10s curve: · Sell $133.7mm OTR 7y Notes; · Buy $100mm OTR 10y Notes." Perhaps those who want to be short bonds, but for the right reason, that predicted by Zero Hedge and then Bill Gross, this may be one of the better ways to put the trade on.

CapitalContext's picture

Credit markets continue to show glaring concerns as European sovereign risk, global financial systemic risk, and global growth scares drive HY and IG to six month wides. The critical aspect is the potential to reverse the virtuous cycle that has maintained primary issuance - and we are indeed seeing this starting to happen.

CapitalContext's picture

Top-down equities underperformed credit once again as day after day we see the QE2 froth being blown off the weak recovery beer. HY credit is at its widest in six months, financials CDS are starting to crack finally, and sector relative richness in stocks is beginning to sync back to credit.

CapitalContext's picture

Stock and credit markets closed weaker today as Europe came back to the party from their long weekend. Equities underperformed credit (beta-adjusted) and HY underperformed IG as we see the debt-equity relationship starting to wave caution flags and skew compression enabling some downside.

Peter Tchir On Risk Positioning Heading Into The FOMC Conference, And Outcomes Heading Out

So here we are, finally at the big day. We get the first press conference from the most important man in America. Before you gag on the claim that he is the most important person, can you name one other person who has so much power coupled with the ability to act virtually unilaterally? It's not so much what he can do, print money, change rates, print money, change reserve requirements, print money, that makes him so powerful, it's that basically anything that he wants to do becomes policy. Ahead of the Fed there are two interesting moves in the market that bear watching. Treasuries rallied strongly into the close yesterday, but have given back a lot of the late day gains already. The other more interesting phenomena is what is happening to Greek, Irish, and Portuguese spreads. The bonds are blowing out, as much as 80 bps for Greek 10 year debt, but the CDS is actually tighter. This divergence may be a result of the bonds starting to trade at recovery levels, so investors don't want the hedges, or an indication of yet another expected bailout, but it is worth watching as the divergence is quite large. So, now to the Fed.

Capital Context Update: Credit Where Debit Is Due

Only a very few names managed gains in both equity and credit today (an interesting bunch - MAR, TOL, HOT, DHI, PEP, and SVU) as homebuilders were interestingly near the tope on the list of better performers in credit (which we suspect was related to the underperformance of the CMBX and ABX tranche markets as well as the higher beta exposure in some of the credit indices). Every sector was in agreement between credit and equity with a deteriorating move today as we note financials, leisure, and media were the worst beta-adjusted in credit relative to stocks on the day. Capital Goods, Utilities, and Consumer Noncyclicals performed the relative worst in stocks versus credit. The up-in-quality theme in credit is increasingly leaking into vol as we saw much less impact higher in vols in better-rated credits than in lower-rated credits. This was also the picture in credit though we did see the very highest rated names underperforming (financials?). This picture was somewhat different in equity-land where BB-rated and below names saw their stocks drop far less than A- rated and above names - once again we think this is to do with both financials dominating performance as well as the typical ratings/momentum correlation unwind.

Morgan Stanley Launches Fed Frontrunning Toolbox, Asks What The End Of QE2 Will Look Like For Rates

By now it is no secret that the end of QE2, should one actually transpire as the alternative is surging bond yields which as described yesterday means gross interest expense as a percentage of total US revenue would hit a Weimaresque 30%+, the collapse in equities will be dramatic, once the marginal buyer of up to $8 billion in daily risk disappears, and as was further pointed out recently, the only variable that every asset class correlates with with no exception is the Fed's balance sheet. And while the drop in equities is all but guaranteed, a more important question is what happens to not only Treasury rates but to the shape of the curve. Even though the jump in rates seems inevitable (to those whose career does not depend on pursuing the lemming-like call of the sellside groupthink wild), the finer nuances in the curve shift have not seen a broad discussion. Morgan Stanley's Jim Caron, whose predictive track record leaves much to be desired, has released an analysis of what the end of QE2 will look like from a rates perspective. We urge readers to take this analysis with the same dose of skepticism as any FX recommendation from Goldman's Thomas Stolper.

Rosie On Why Coming Monetary And Fiscal Contraction Means "Selling In May" May Be Too Late

We have long claimed that in advance of the great "to be or not to be QE3" decision in June, there will likely be a major market swoon in March/April. The reason for that is that, as David Rosenberg explains in a very coherent fashion, the market will soon realize that the case for another bout of monetization is increasingly shaky: "when you go back to August 2010, when QE2 was announced, U.S. core
inflation was 1.1% and headline was 0.1%; by June of this year, we will
probably be looking at 1.5% on the core and as high as 3% on headline
inflation. That combined with the reality that the S&P 500 is 300
points higher now than it was then would certainly suggest that the case
for extension of the Fed’s QE program will not be there, at least not
by the time QE2 runs its course
. So this is what we would be looking for
in terms of chronology (it may be too late to sell in May this year)." So unlike before, the context this time around will be one of much higher inflation, making the stimulation case that much more difficult. The downside? 300 points of downside due to a marginal hole that will no longer be plugged by the Fed. And with a fiscal contraction coming for more (see Koo's notes from yesterday), one can see why as Rosie says "it may be too late to sell in May this year." We agree that there will be a return to market volatility in the months ahead of June, but we believe that the Fed will have no choice but to continue monetizing sooner or later courtesy of the $4 trillion in bond issuance over the next two years. There is no way around it. What it means for the "inflationary" thesis we leave it up to readers.

And Now For The First Gloomy Economic Outlook - Deutsche Bank's 2011 Fixed Income Forecast

There is more to Deutsche Bank than just that douchey joke of an economist who appears on CNBC every other day to repeat that the November NFP number was irrelevant (incidentally we agree, simply because everything out of the BLS now has the same trustworthiness as Chinese data, and the November number was politically motivated to pass the UI extension) and who changes his story diametrically and on a daily basis, with every incremental piece of economic data that does not fit his amateur theories. Deutsche Bank has always had a very decent fixed income platform, and we are happy to announce that in reading the firm's 2011 FI forecast we encounter not only views that diametrically oppose those of the aforementioned hack (for which alone the report is worth reading), but also has some very detailed and insightful observations (which we are confident David Rosenberg would agree with wholeheartedly). The report's summary: bonds may drop a little more, then surge once it becomes clear the economy is as scroomed as always. And another interesting observation, which has to the do with ending the 10s30s flattener trade. We tend to agree with that as well. Having almost penetrated 100 bps today, the second retest proved unsuccessful, and the time for a steeper long-end is coming (primarily due to a renormalization of the curve), and a flattening of the 2s10s.

Morgan Stanley's Top Rates Trades For 2011 (Hint: Sell Treasurys)

After Morgan Stanley's call for the 10 Year hitting 4.5% in 2010 ended up being one of the worst calls of the year (together with each FX call by the Goldman team), the firm's head rates strategist Jim Caron is back on the scene with his latest set of Top Trades for 2011, as well as some views on where the fixed income market is headed next year. In summary: just fast forward the firm's bearish 2009 view on yields one year forward. After all if the firm was so wrong one year, it can't possibly be wrong two years in a row...

Rosenberg Scours Commitment Of Traders Report, Finds Clues On Navigating The Market

Rosenberg looks for hints on how to navigate the market, and finds them in the CFTC COT report (which despite not reporting last week due to the Veterans' Day holiday, is regularly posted on Zero Hedge to glean precisely such clues). To wit: "The asset classes are merely unwinding the excess risk-on trades and pricing out the chances that QE3 will ever see the light of day. Yes, this is what the market was starting to think since Bernanke left the door open for more in the press statement, but we are finding out ex-post that the Fed chairman has less support around the table than was generally perceived. It may pay for the time being to avoid the areas of the market where net speculative long positions exist and is in the process of unwinding. Long covering is a critical source of selling pressure."

More On The Perplexing Record Steep 10s30s Curve: Is It (Finally) Time For Flattening?


After recently the market took all calls of a flattening in the 10s30s to task, one would think that those anticipating a curve flattening (Zero Hedge included) would finally have learned their lesson. This has not happened so far, especially since a continued sell-off in the long-end will soon move from being a boon to the curve carry trade, to a flashing red signal of inflation expectations which will likely wreak further havoc across all asset classes. Also, quant models are already on the edge of refusing to bid up the 7 and 10 Y even as they are forced to sell 30Y, no matter what the Fed is telegraphing it will do. In his attempt to anchor the curve around the belly, Brian Sack has let the 30Y flail in the gusts of increasing inflationary expectations, and quite soon the plan will backfire. Which is why we believe that with future POMO schedules, the FRBNY will disclose an ever greater portion of monetization in the 17-30 Y segment, over and above the 4% disclosed originally on November 3. One analyst who refuses to give up on the flattener trade is Morgan Staney's Igor Cashyn, who as of Friday, has reiterated a call for imminent de-steepening, although unlike before where the flattener was to be traded via nominals, this time the Russian goes straight into Real Yields.