Random thoughts. Perhaps I don’t read enough blogs and editorial articles, but finally saw in the media this week the argument that looks the strongest to me against the loony idea of raising the inflation target: if you change inflation once, you’ll add a lot of uncertainty because in addition to guessing the inflation we will also have to guess where the central bank will set the inflation target at. It’s becoming mildly annoying to see more and more people shit on central banks for “rigid thinking” and advocate changing inflation target, nominal GDP targeting or price level targeting. Likewise I am annoyed by my perma-sloppiness in calculations. It seems that the 6m-base rate basis in NOK is narrower than 60 bps that I had taken in the post above, so 2y swap dipping from 120 bps before the May norges bank meeting to <110 bps recently did not indicate that a small possibility of a cut was priced in. Forecast change is quite interesting. Anyway, reaction was quite muted and NOK slightly appreciated, happy to keep EURNOK short. Long bund, short gilt still doesn’t want to perform since pos inception on 20/03/2017. I am curious what the market positioning is for potential change of ECB programme. Schatz seem cheaper now and back to mid-2016 levels but it could as well be the result of political risks subsiding. Bunds have become more expensive (which in isolation would imply no expectation of tapering), but so have become USTs. Week 19/06/2017: EDU1-EDU2: +1500 USD Short EURNOK: -875 USD Short EURCZK: -587 USD Short GBP, short long gilt: +875 USD, +170 GBP Long bund against short gilt: +340 GBP, +680 EUR I Z7-Z8-Z9: -375 EUR Long BA Z8: +1000 CAD Steeper CAD / flatter AUD: -1350 CAD, +1326 AUD Total: ~+2640 USD
First full quarter since the topic inception is over. Portfolio is 4.21% down in EUR terms, 2.86% up in USD terms from 10/02/2017 (50% USD, 50% EUR portfolio). PNL from trading is roughly -8200 USD (-0.8%). It’s confusing to analyse the results in this way as annualized SR in USD is 1.25 and in EUR -1.56. Currency fluctuation free SR has been -0.5. I will simplify the exercise and keep it in USD for measuring Sharpe ratio and keep hedging volatility outside the calculations. 99%-VAR target was set at 1%. The target was not met with zero instances of 1% daily losses over 100 days, 4 instances of 5000 USD losses. Annualized 30d vol varied from 4% to 8% and an average of around 5.5%. The reason vol target was undershot is that position sizes were picked with a rough idea that the portfolio would contain around 20 trades, but as the number of hours I spent on this was quite little, the number of trades open at month-ends varied between 8 and 12. Total of 19 trades were done over two quarters, 10 winning with 3600 USD average profit, 9 losing with -4900 USD average loss, 8 trades are still open. I looked through the worst trades again. One of the conclusions I came to is that managing four-legged trades is too complicated and things should be kept simple. Short EURNOK: shorted on 28/03/2017 at around 9.22 with 8.80 target, currently 9.54. NOK looked cheap since nov-16 when it failed to respond to OPEC meeting. It traded around 9.40 in summer 2016 when further NOK cuts were still deliberated and oil traded hovered around 50. 9.40 -> 9.22 wasn’t sufficient to account for improvements in econ outlook, imo. Did not enter before 28/03/2017 because was concerned that a dip in oil could weaken it further. Losses came in 2 waves: 9.11 on 14/04/2017 to 9.52 on 04/05/2017. This coincided with another dip in oil prices. It slightly appreciated when oil r, but the second wave started around 22/05/2017 from 9.37 when oil started sliding again to 9.54 now. Inflation hasn’t been good but there was a turn in trade balance figures last October, retail sales have started growing from Feb, IP readings improved this year, PMIs averaged 54 recently. EUR repricing from this week could bite EURNOK. Scandies strengthened on Friday despite EUR doing okay against JPY and USD, and overall week-on-week move doesn’t feel adequate for what happened in EURUSD and EURJPY. Targeting 9.05-9.10 now. Long USDRUB from around 59 on 10/03/2017 with 60.40 target but moved to 57.20 by 10/04/2017. By 10/03/2017 RUB appreciated by more than 4.2% YTD despite front brent falling from 55 to 51. Local stock market was more than 11% down and reversed all post-Trump gains. Government wasn’t too happy with RUB getting stronger past 60. I disregarded the risk on the dollar side because last year this currency pair was numb on big dollar events like Fed meetings or GDP releases. Dollar fell against a range of currencies around the Fed meeting on 15/03/2017, and RUB decided to respond too. Oil then recovered to 55, so this was pointless to hold. Short schatz against Euribor Dec17. I related this to French elections. The spread moved 13 bps after Fillon probe was opened in late Jan in addition to the 7 bps it had moved in 2016Q4. The spread had previously bounced off the same levels in Dec. EURCHF reaction was quite muted (and SNB data later revealed they were not selling CHF in Jan and Feb). I thought that Fillon would shake off the accusations (wrong) and Le Pen had little chances to win in the second round against either Macron or Fillon (ultimately right). Risk-reward seemed like 3:2 with prospect of clawing back the 20 bps versus losing 30 bps if I am wrong. Choice of 30 bps was halfway to spread levels that were seen in 2011 as Le Pen winning wouldn’t be as serious as situation was in 2011. Had quite conviction, so accepted a not so high risk-reward. The idea was not too bad but it was probably silly to assume whole 20 bps would be clawed back without seeing the election result. 45 Schatzes was also too big a position for my vol target. I should have waited for better entry level and done smaller size. In hindsight the position was closed prematurely as the spread recovered and would have made 5 bps (just ¼ of the 20 bps I had assumed) profit by March end, though again plunged in April (presumably on Melenchon rising in the polls but could be I am overestimating the impact of the elections). Steeper CAD / flatter AUD. This has been a train wreck with meh idea, poor assumptions, poor attention to circumstances and operational screw ups. The idea itself was that 2s10 in AUD has steepened too much against 2s10 in CAD without reasons I could see (historically AUD has always been flatter than CAD). At the position on 21/02/2017 inception BoC communication seemed to indicate they were committed to keep rates low (and both were unlikely to move) and CAD economy was doing better. Combination of central bank restrained short rates and CAD economy doing better had suggested CAD steepener should have outperformed. However, the primary motivation was that historically CAD has been steeper than AUD. CAD 2s10 stood at 84 bps and AUD 2s10 at 90 bps, so +6 for the box. The box was range-bound between +11 and -1 until 12/06/2017 when Wilkins indicated they could remove some accommodation. This violated the underlying idea that central banks would remain inactive, and should have cut the position a day later when 10y sold off and offered an excellent opportunity to get out of trade. This would have saved 0.5% of portfolio. The 2s10 box has been 13 bps up from 21/02/2017 until 30/06/2017 with AUD 2s10 falling by 6.5 bps and CAD 2s10 falling by 19.5 bps. PNL has been different because the actual trade was CGB futures, XT futures, BA Dec-17 and IR Dec-17, and it has been worse. This construction lost 24.5 bps versus 13 bps for 2s10. The CAD part flattened by 31.5 bps in the construction versus 19.5 bps in the 2s10. The differences were receiving 10 bps in BA Z7 roll-down, losing from 3rd BA cheapening versus 2y swaps by 5 bps (and prior to Wilkins speech they had overperformed the 2y by 5 bps, so 10 bps loss), Canadian government bonds richening to 10y swaps by 17 bps. -10+5+17 = 12 bps indeed. The AUD part flattened by 7 bps, so roughly the same as 2s10, with no change in 10y swap spread, paying 11 bps in rolldown, profiting from 3rd IR yield falling less than the 2y swap by the same 11 bps. When entering the trade I completely disregarded the spreads for CGBs versus swaps under assumption they would stay constant, which definitely was not a proper thing to do. The construction correl with 2s10 was 0.86 on CAD side and 0.74 on AUD side. To make matters worse, initially calced the DV01 incorrectly for the CAD, and had -5 bond futures instead of -4 in the June contract. I only noticed the excess 1 lot short that when it was time to roll to Sep, and the bond was more than 4 CAD up. This trade also was not a good complement to long BA Z8. The conclusion I am drawing from this is to avoid four-legged trades that are in fact tracking another structure and stick to intuitive simple things. I am closing this next week after the RBA meeting as I think they could flatten the curve by moving IR Dec17 yield higher. Week 26.06.2017: EDU1-EDU2: +1500 USD Short EURNOK: -2125 USD Short EURCZK: +1063 USD Short GBP, short long gilt: -3912 USD, +2610 GBP Long bund against short gilt: -6400 EUR, +5220 GBP ER Z7-Z8-Z9: 0 EUR Steeper Cad, flatter AUD: +4545 CAD, -8883 AUD Long BA Z8: -5500 CAD Total: -8165 USD
Thanks, but there is nothing to applaud. Full-time market participants definitely put more effort in a week’s time than me in a few months’ time. I think it was s0mmi here who advocated that it’s absolutely essential to no-life the markets up to 15h a day. ------- I am also curious if putting effort into reading stuff like inflation reports, economic forecasts (EC, IMF, whatever), OPEC outlook or any other long reads really pays off for anyone. I write down the projections and close the pdf because for me the content goes in one ear and out the other but there must people who read those reports cover to cover. I don’t know who the target audience but there is some sense of shame for slacking and not reading those reports. -------- I have also thought a little bit about benchmarking to the “best-off” currency, i.e. capturing EUR/USD or USD/EUR, whichever is positive. It’s probably foolish to actively manage because there is a risk of significant underperformance and better yet look at costs of hedging the base currency, so in my case of having the depo in USD I’d have to look at how much it costs to buy EUR/USD 2x calls for depo. I plotted the cost of buying 2x ATM calls by annualizing the premium paid, so this would be the maximum cost if we get no volatility whatsoever. The caveat is that the “ATM” longer-term options are in fact OTM in certain periods because of the forward premium, so you are on the hook for losing more if the implied carry is not realized. For example, for 5y the annualized implied carry is about 2.4%, and good chance USD will actually deliver that with capacity to deliver more hikes than ECB has. Obviously shorter-term options cost more because with monthly options you get to bet 60 times in 5 years’ time than just once with a 5-year option, so it’s better to compare the return results. The returns in the table are the averages of the pay-off at option expiration from holding $1 and buying 2 EUR/USD calls without being paid for the balance and without bothering to find geometric average. I don’t know what the magic is, but for some reason 6mo ATM options were the cheapest – but not 25delta. The sample is a lot smaller for 2y and 5y options. I also tried regressing the pay-offs on implied volatility or on premium between implied and realized volatility. Again for some reason the only combination that produce R^2 of at least 0.2 was regressing returns from 1y options on 1y implied vol with r^2 of 0.24 and return_1y = -0.0111 * ATM-Impl-Vol-1y + 0.1033, so breaking even at 9.30% for Oct2003- Jul2016, and about 10.40% break-even by extending to Jan2000-Jul2016. I suppose that p-val shows that it’s significant because of overlapping returns. By looking at the graph it doesn’t look significant to me, though. Now this is actually quite funny that my initial post has a somewhat unrealistic set-up. 1% daily var translates to 7% vol, and with just hedging running at 2% average cost and 6% vol, can you really get an SR of 1? I’d need to increase returns by 9% while increasing vol by 1% only. Set up for failure. 1: premium/fwd 2: premium/fwd 3: premium/fwd 4: returns 5: returns in the next 1y from holding 1y options to expiry
Rolled CZK for 3 more months at 0.17 cost. AUD/NZD is getting more interesting. The way I read AUD/NZD below 1.05 is that RBNZ is potentially in a hiking mode but RBA is not. Last week’s RBA meeting confirmed that they were happy with accommodative stance. That said, last week we also had AUD rates go higher. Either we’re getting risk premium in rates on the back of global rates rise or it’s a reaction to iron ore prices, strong PMI, good retail sales and most importantly solid employment figures (this will allow RBA to make a change in its statement in labour market paragraph from mixed to positive). If latter, AUDNZD should go higher. I am also looking at 3yr AUD fut. If I am reading it correctly, YT yield has risen from 174 bps on 14/06/2017 to 201 bps now, +27 bps. The white strip has risen by 12.25 bps and the red strip by 24.75. This would imply that were there an active green strip, it would have to rise by 27*3 – 24.75 – 12.25 by 44 bps. Unless my EOD data in swaps is out of sync with the futures, 2y1y rose by around 30 bps, so the 3y fut is (44-30)/3 = 5 bps too expensive vs bills. That said, if I plot YT against the bill it’s most correlated with (6th), the differential is stable at 14 bps. TYU7 has gone more expensive. If I am calcing it correctly, yield of white+red stripes in Eurodollars has risen by 14 bps since 14/06/2017 but only by 9 bps in TYU7. I should probably explore if long XTU7, short TYU7 is a good idea to take advantage of swap spreads without creating multilegged monstrosities. Last week’s PNL: EDU1-EDU2: -750 USD Short EURNOK: -95 USD Short EURCZK: +503 USD Short GBP, short long gilt: +1900 USD, +240 GBP Long bund against gilt: +480 GBP, -2760 EUR I Z7-Z8-Z9: +375 EUR. I am puzzled about why this is not working. At the time I established this I3-I7-I11 (using interpolated continuous futures) was at -3 with individual legs I3-I7 at 21 and I7-I11 at 24 bps. This biggest risk I saw was major flattening of the curve with both spreads going down and losing 3 bps. Now four months later the fly is just -4 bps. I wanna see more steepness because I suppose 2019 is more uncertain than 2018 is but the markets are probably concerned with ECB bringing depo above 0 in the next 18 months and pausing with hikes with no chance of 3rd hike. Long BA Z8: -2000 CAD. I am trying to rationalize how this trade got so bad. This was established on 20/03/2017 at 98.53 because BA3-BA7 looked too high versus ED3-ED7 and I relied on BOC-speak that they are dovish. It peaked at 98.86 on 17/05/2017 and slipped to 98.79 by 09/06/2017 with total repricing starting on 10/06/2017 and falling to 98.31 last Fri. Peak-to-trough of 55 bps on a rather short maturity is embarrassing. On 17/05/2017 it still looked cheap to ED3-ED7 and BOC sounded dovish, so I chose to ignore the econ data incoming between after 20/03/2017, esp the GDP acceleration in March (reported in late May). Though if I ask myself now if I think being long STIR in the face of improving economic data when first-third contract spread is just 5bps and third-seven is 25 bps, the answer is no. I am getting out of this on Tuesday before the BoC on Wednesday. Steeper CAD/flatter AUD: +990 CAD, -1147 AUD. Promised myself to get out of this week starting 04/07/2017 but did not, so also a thing to get out of before BoC. Total: -1870 USD
i need a privilege to be able to edit posts for 15 days, not 15 minutes. Obviously I am talking about TU against white+red, not TY, above.
closed BA Z8 @ 98.34, CGB U7 @ 139.62, BA Z7 @ 98.625, XT U7 @ 97.24, IR Z7 @ 98.20 Waited too long to get on AUD/NZD and missed today's action. Long 1 6A U7 @ 0.7598, short 1 6N U7 @ 0.72. Will add more at 1.04.
Getting rid of CAD steepener and long BA Z8 was a good move yesterday. I interpreted the statement that they could hike more but Poloz didn’t sound too hawkish at the q&a. In one of the answers to a question if they were willing to run the economy hot he answered that in such a long business cycle one has to deal with legacy issues and the economy would have room to grow and add jobs past the output gap being closed by the end of 2017. He also emphasized wage growth being too low. BA U7 dropped almost 40 bps from early June, so it’s 15 bps of expectations of further hikes once we take the 25 bps hike out. Too bad there will be three more meetings this year that BA U7 will cover, so it’s pain in ass to back out implied expectations. BA U7-U8 is some 37 bps, so roughly in line with ED U7-U8. 15+37=52 bps over 2017 and 2018 doesn’t make me wanna either long or short BA’s yet. BA U7 would look more attractive at 98.80 or shorting at 98.60. Pricing three hikes would be a stretch, so would go long BA U7 at 98.10. I am not sure about what Yellen said. We are close to the neutral rate but the factors holding down the neutral rate will dissipate. Does it mean that they want to hike once-twice more, take a pause, then hike a bit more? EMB ETF is only 0.59% up today, with duration of 7 this is equivalent to 8 bps yield fall. I’d expect a lot more given OAS of 302bps and performance in stocks and EM FX. If they are so blunt that neutral rate is so close, then maybe FV-TU yields should have narrowed because hardly anyone expected rapid hikes in the next two years? Balance sheet reduction has lately been a unison opinion thus far. The longer end is also more globally linked. In conjunction with higher rates in Europe (taking those as given without thinking if it’s right or not) those two propositions would ask for a steeper curve. WN-FV isn’t as steep as buxl-bobl is. WN-FV steepener is a bit scary with DV01 weights because a blowout CPI on Fri could flatten it, so maybe WN-UXY is better.
Going to close GBP short shortly. The currency doesn’t look too expensive against interest rates and given where EUR/USD is anymore, and don’t wanna bet on trade concern centered weakness after the Anelay letter. The US budget deficit is progressively deteriorating with TTM deficit of 406b in Feb-2016 and 707b last month. This could make WN-UXY more attractive. It is up from 51 bps since Wed to 54 bps, so 7 bps above local min and 7 bps below local max (since mid-may). Don’t have the resources for proper calculations but back of the envelope shows DV01 would be 5:2 with >100bps carry/rolldown per WN, level-neutral looks like 11:5 with > 150 bps per WN. I am looking at swaps 10s30 1:1 versus 10s30 1:0.88 for the past 17 years or so. The 1:1 is 30 bps above the 2006 bottom and level neutral spread is 60 bps above the 2006 bottom, so looks like the level-neutral one would heavily underperform had the Fed started rapid tightening. The 30y bond could also richen to swaps. Those two look like the biggest risks to me. I am finding similarities between the earlier BA Z8 trade and current long bund against gilt. In both cases I am disregarding the improving economic situation. The stuff I think that’s really important in Eurozone has largely improved: services HICP, house price growth in Italy, broad-based growth of labour costs, unemployment. I still think that gilt is too expensive and want to short it. Similarly I wanna be exposed to 5s10 in Eurozone. At the moment I’d take it off if the G U7 – FGBX U7 widened to 1%. Holding bunds in front of potential ECB tapering is a bit scary. Yes, the chart looks impressive with that 25 bps jump in 10y EUSA in late June but I am fairly sure 15 years ago that could be a daily move. 10y swap spread (cash-swap) has jumped up in Eurozone but it’s still not what it was pre-QE, and the US swap spreads have since gone up then. R:R looks 1:1 to me there. Dovish ECB could send it some 10 bps down, hawkish 10 bps up but it’s harder to envisage a huge drop than a huge jump, so tail risk is for widening. yuck, short at 98.80, long at 98.60, not vice-versa. Week 10.07.2017: EDU1-EDU2: +1500 USD Long AUD/NZD: +840 USD. I have already started questioning this position. US dollar is so beaten that makes me wonder if it makes sense to drop the AUD part and short NZD part. Short EURNOK: +3933 USD Short EURCZK: -550 USD Short GBP, short long gilt: -2700 USD, +10 GBP Long bund against gilt: +1300 EUR, +20 GBP ER Z7-Z8-Z9 less curvature: -750 USD BA Z8: +1125 CAD (closed) Ba Z7/CNU7: +90 CAD, IR Z7/XTU7: -752 AUD (closed) Total: +4078 USD
i dont know much about inflation forecasting and rarely do I bother checking how much sense the forecasts make sense or make my own, but the 1.9% yoy for today's NZD CPI we have in the econ calendar looks like a shitty forecast. Regression shows it's 57% tradeables, 43% non-tradeables. Q2 average is 0.63% for CPI, 0.74% for tradeables, 0.65% for non-tradeables. Econ is running hot, so I'd expect non-tradeables to clock at least 0.43% (2/3 of avg). Oil q2 average was just 2 bucks below q2, NZD/USD was 0.5% lower in q2 than q1, so clocking 2/3 of q2 average for tradeables makes sense to me. 0.57*2/3*0.74 + 0.43*2/3*0.65 = 0.47. This brings yoy up to 2.24%, and id say the risk is skewed to the upside if there was acceleration in non-tradeables prices. Maybe I am a simpleton and you need 10-equation VAR systems and a phd to forecast this, but we shall see. My forecast is hedged by my AUD/NZD long that will perform if I am wrong and inflation indeed comes in low. edit: Q2 average is 0.63% for CPI, 0.74% for tradeables, 0.65% for non-tradeables - for the past 15 years or so