Returning to the issue of supply and yield levels. Earlier I found no relationship between supply of AUD bonds and 10y yield levels with simple regressions. I tried the same for net issue of Eurozone bonds and EUR 10y yield levels, Italy – Germany spreads on relative net supply, and found no relationship either. Before that I found no relationship between TIC data and treasury yields, Japanese portfolio flows and JPY, Eurozone portfolio flows and EUR/USD, so need to change my approach for the task. The ivory towers have done enough research on the topic. Scanning the academic papers today revealed a median result that changing bond free float by 1 billion (in the US) changes the yields by 0.7 bps instantaneously with the effect eventually dissipating but leaving 0.06 bps permanent impact. Another paper shows that this increase in yields due to net supply is related to excess returns. The same 0.06 bps holds for eurozone, or 3.5 bps for 1% of debt outstanding. If we apply that result for the syndicated issue AUD issue in February, it’s 11b net supply increase, about 2.5% of outstanding debt, so 9 bps increase yields. It would also mean ~16 bps increase for the Q1 net supply of ~20b AUD. Intuitively this seems too high. With the 0.06 figure we can also return to the Fed balance sheet. My understanding of current reinvestment policy is reinvesting all maturing bonds into newly issued bonds in proportions that the Treasury is offering the new bonds. There are also coupons that need to be reinvested. This means we have 230b maturing in 2017, 500b in 2018, and exponentially declining to 60b a year in 2024. It’s hard to imagine them letting policy run as it is because they would then suck up good chunk of duration supply. What happens if they decide not to reinvest 500b? If they change nothing, they will could possibly crush yields. If they cut reinvestments in half this will keep duration free float for private sector about unchanged but would increase net free float by around half. If they stop reinvesting at all, this increases free float twice and also net supply, so yields could explode, but it’s tricky to say by how much. Does 0.06 bps apply to 500b of foregone investments for 500*0.06 = 30 bps permanent upward shift? This seems too small. Do we use the 0.7 bps figure on 250b of foregone demand (versus this year) for 175 bps yield jump that over time gets down to 250*0.66 = 15bps permanent shift? I am worried to find myself on the same side with zerohedge, but they ran a story about Fed reinvesting purchases going up from about zero in 2015 to over two hundred billion in 2016. Yields did not go down in 2016, so this begs question where the yields would have been had the Fed not sucked the duration supply up. SOME holdings analysis suggests that purchases did amount to 200b in 2016: 2y 16%, 3y 16%, 5y 27%, 7y 22%, 10y 11%, 30y 7%, average maturity of around 7. This looks slightly skewed to short maturities versus gross issuance numbers from SIFMA but I did quite sloppy calculations, so probably they do reinvest proportionally to gross issue. An interesting observation is that average maturity of net issue has slowly over years gone up to around 13 years in 2017 but expected to increase to 18 years in 2018, so there will be more duration on offer for Fed should they decide to keep reinvesting. It would also be interesting to pinpoint change in Fed buying to yield curve. I’d expect that Fed purchases matter the most for sectors where gross issue share is the largest relative to net issue share. This is so because the Fed would be overweight securities that are under-offered in the market. A chart below suggests that Fed allocation to 30y bond was <6% even though issue of 30y bonds accounted for 30% of net supply increase. On the other extreme, Fed allocated lots to 5s and 7s even though they accounted for little of net supply. However, the academic papers also suggested that markets are more sensitive to net supply for longer-maturities (because there is more duration risk), and the guesstimate if taking almost all supply of 5s matters more to yields than slightly underbidding on 30s is kinda difficult. From supply POV it looks like there is a good chance for a big sell-off in 2018 if the Fed decides not re-invest because instead of having Fed’s demand for $250b of duration the debt office would turn to sourcing $250b of duration from the private sector. If they reinvest it all, overall demand is unchanged and demand for duration goes $250b up but is partly offset by higher duration on offer. If reinvestments are cut in half, Fed’s bids will be offset by the need to source $250b from outside. In keep reinvesting scenario 5s and 7s will remain well-bid at the same time most new supply comes from 30s, so we get steepening of 5s30. In no reinvestments, 5s and 7s are no longer bid while net supply is still 30s, so 5s10s30 is pressured downwards. In half reinvestments, 5s and 7s get worse bid and the private sector has to suck up more duration, so 5s30 might not steepen. I’ve also been thinking about what happens to VIX after the April contract expires. Surely folks need an instrument to play the French elections with, so maybe longs will bid up the May contract after exiting the April one. Open interest for the April contract has gone from 325k on 21/03/2017 to 124k on 12/04/2017, so the roll is two thirds one. The change in relative open interests versus the April – May changes has an R^2 of 0.31 for 17/03/2017 – 12/04/2017, and 0.61 for 03/04/2017 – 12/04/2017. This could instead suggest that vol sellers are having hard times finding buyers to cover their April shorts. Fed 2016 = Fed purchases in the given maturity in 2016 as % of total Fed purchases in 2016 Net-2016, net2017, net-2018 = net supply in the given maturity as % of net supply Vix May - April spread change versus relative OI change
Short 10 ED H8 @ 98.495. The market hike path has got too low relative to the fed projections. The market hike odds are almost back to pre election levels. Core CPI wasn't good on Friday, but that's a single point.
Tl;dr gilt yields declined too much versus the treasuries, but GBP doesn’t want to depreciate against the USD. In hindsight GBP/USD entries were premature. Am I likely to remember next time a political event happens that on 18/04/2017 someone got stopped out 8 hours later after the event and it might make more sense to wait longer than six hours for things to settle down? Probably no. On Brexit my end of day shows we had GBP/USD 8% down when results came in on Friday, then 3% over the weekend, so total of 11%. Today we had 2.2% up, so a fifth of what we had in June 2016. This time the market was absolutely not prepared. In June 2016 it kind of was and kind of not. Yes, everyone knew there is a referendum, but in the last days the market decided to ignore consistent out vote lead, focused on the latest few polls that showed remain was leading and moved GBPUSD up from the “uncertain outcome” range of 1.42 – 1.45 to almost 1.49, from where it crashed 11% over 2 working days. If we take the 1.42 level, then the drop is 7%. Today’s 2.2% move would then be a third of the Brexit day move. Is fundamentally a general election’s importance a fifth to a third of importance of the referendum? Maybe, but a lot more than that would definitely be an excess, and if it does go further up I am going to short more GBP. As alluded in post #69 fixed income hadn’t become an obvious short until around 200 bps on 10y US stuff. If I am not mistaken in 2016 Q1 dollar was beaten and EMFX, Eurobonds rallied hard with the help of Yellen giving very dovish testimonies and interviews. Despite all that dovish talk back then we had 10y at around 180 bps. The Fed is now more hawkish and wants to do something about balance sheet, so now I would find yield of 180 bps very hard to justify. In summer 2016 US 10y stuff moved below 130 bps after Brexit, so maybe it makes more sense to wait until after the French elections to short duration or think how to cover bases in case of an unfavorable result. The above paragraph (waiting 20 bps down move in yields) is obviously inconsistent with shorting long gilt today. The reason for the shorting long gilt is that it seems to me that long gilt pricing is getting inconsistent with the pound valuation. In the same post #69 on 13/04/2017 my take was that 10y GBP stuff is too low relative to 10y USD stuff by 0-20 bps. Interestingly, the decline in 10y GBP yields began around 25th of Jan despite strong econ data in 2 weeks around there: okay flash GDP, PMI’s, CBI, lending data incl pick up in non-financial-corporations loans that I put more weight on than mortgage growth. Could be the result of BoE meeting in early Feb, where they updated their measures of equilibrium unemployment and overall the message was quite ambivalent: yep, stronger econ but we may ease it if wage growth isn’t sufficient. Now the point with the GBP is that it stayed at the 1.25 level ever since Trump victory even though we had quite sizeable widening of the rate differentials, depreciation of EUR versus the dollar that often pulls GBP along and some Trumponian reflation narrative still alive in certain market segments like metals (but dead in others like JPY). Now it’s plausible that 1.25 was too cheap in early November, and events since November merely justified the 1.25 level instead of pushing GBPUSD even lower. I’d argue that no – it was not. Pound traded at around 1.50 in Q4 2015 before the Brexit fears started kicking in but after the China worries settled down, so 17% move down. What happened since then: yields drifting apart in 2y swaps by more than 50 bps, QE extended in the UK, most importantly a need for currency readjustment in a new trade set-up, the story that UK might be the first hike was totally thrown out. Those are hard to quantify except the swap differential (5%) conservatively, but I don’t think the remaining 12% is too much for the other factors. Shorting 125k GBP will partly subsidize the negative carry on the 100k GBP of gilts.
EURCZK has recouped 1.5% after the 1.85% move down on 6th of April depeg. The idea that more specs would drive it down did not work out (entered at the bottom), so I am thinking if it’s better to get out and get in again if there is a stampede out of CZK that gets EURCZK back above 27. Below is a chart of the 2y government bond yield and central bank FX reserves. The FX reserves went up by more than 60b EUR as the yields fell. Czech Republic GDP 2016 stood at 175b EUR, so this is a very significant increase, a third of GDP. CZK have strong trade balance of 13b EUR, but -11b in primary and secondary income, so this 60b reserve is equal to thirty years of current account surpluses. The government debt statistics show that foreign holdings of central government local currency debt increased from 7.5b EUR in 2014 (14% of outstanding) to 22b EUR in February 2017 (42% of outstanding). Amounts outstanding increased by 5%, so local players were crowded out. Government debt represents more than half of all country’s debt securities outstanding (around 100b EUR). Stock market cap is around 40b EUR. MFI aggregated balance sheet statistics show that external liabilities increased by 29b EUR without a corresponding increase in external assets (sold the FX to the central bank and thus replaced external assets with a claim on the central bank) , that’s 120% growth over 2015-2017 and those liabilities now make up 20% of total MFI liabilities versus 10% in 2014. The percentage increase in residential overnight deposits has been more moderate percentage-wise (30%), but around 24b in EUR absolute terms. On the asset side the claim on MFIs (that includes central bank) increased by 43b EUR (130% growth). For cross-check the central bank liabilities of central bank to MFIs increased by 45b EUR in 2015-2017. This set of data doesn’t include March, where FX reserves went 20b up. Loan subsector data shows that lending to financial institutions grew by half (previously did so in 2007-2008), but only 2.5b EUR in absolute terms. Commercial banks’ liabilities show that non-resident deposits increased by 27.5b EUR that roughly matches the 29b figure about. Resident deposits grew 20% with growth in O/N depos and contraction in term depos. Most loan growth was in 5+ maturities, so it doesn’t look like locals are borrowing money to bet on currency. Based on the above I’d guess that the 60b reserve increase is around 50b to foreign money speculative inflows, with more than half inflows into government bonds. Local pension funds and insurance companies aren’t large enough to hedge that much anyway. The other 10b is probably soaking up EU subsidies, CA surplus and FDI. Balance of payments statistics also revealed that there has been 2b EUR entry for capital account in addition to 2b CA surplus – most likely EU subsidies that will keep going, 5b of FDI (how many more car plants can you invest into?), 6b portfolio inflows, 5b the “other” category with mostly deposits. In best case scenario we keep the same FDI and EU aid flowing with the same trade balance for total of 9b EUR/year. At this pace we would clear the spec positions in just 3 years! If wage inflation makes the economy less competitive with lower trade surpluses and less desire on behalf of German carmakers to put more money, and incompetence at regional levels prevents absorption of EU funds, then this could be only 3-4b/EUR.
weekly EDU1-EDU2: +750 USD Short EDH8: +375 USD Short EURNOK: -5800 USD Short EURCZK: -3488 USD Short GBP, short long gilt: -769 USD, -120 GBP Long bund, short long gilt: -1600 EUR, +240 GBP Long BTP, short bund: +1860 EUR Short EZ7-EZ8-EZ9: +1875 EUR Short IRU8: -96 AUD Long BAZ8: +1500 CAD Steeper CAD/flatter AUD: -888 CAD, -1672 AUD Overall: -8923 USD, +120 GBP, +2135 EUR, +612 CAD, -1768 AUD
Weekly pnl: · EDU1-EDU2: 0 USD · Short EDH8: +1250 USD · Short EURNOK: -1598 USD · Short EURCZK: +756 USD · Short GBP, short long gilt: -1813 USD, +420 GBP · Long bund, short long gilt: +840 GBP, -1920 EUR · Long BTP, short bund: +3740 EUR (halved pos from 2 lot to 1 lot) · ER Z7-Z8-Z9: -1125 EUR · Long BA Z8: -250 CAD · Steeper CAD / flatter AUD: -1013 CAD, -752 AUD · Long IR U8: 0 AUD Total: -1405 USD, -752 AUD, -950 CAD, +1260 GBP, +695 EUR