Markets trade decidedly risk off since President Trump’s press conference last night. We can blame whomever we choose or whatever fits our agenda, but market is today voting squarely in a classic “flight to quality” fashion, with front end of yield curve blazing the trail. It has taken awhile for the markets to react in textbook “flight” fashion but that is clearly the case now, with multiple implications after all the cash that sought safety in the USD products is now also being exposed to risk. That means this doesn’t go away soon, and there are implications for the DNA of the market, just like in ’08, ’98, and ’87. As of 9:15 AM ET, Treasuries are 7-9 bps lower in yield led by the front end, with 3m bills a whopping 6.5 bps lower (that’s EXTREMELY important as well), while US equity index futures are down roughly 2% ahead of the cash open.
Risk opened flat to slightly better bid to kick off the Asian session in the minutes leading up to Trump’s press conference, but shortly thereafter turned south and has rarely looked back today. WHO statistics came out at roughly the same time as the press conference wrapped up, and they continued to paint a bleak picture of a spread to the virus. Confirmation of plans to close schools in South Korea and Japan added to the negative sentiment, with Asian stocks again under pressure led by a 2.1% loss for the NIKKEI, although Chinese indices were all small to better.
Early flows in Treasuries saw Japanese real money selling intermediates, 7s ahead of today’s supply and some 10s. The theme for Asian real money today was selling across the entire curve, nothing massive but consistent. The buying was in swaps. Early in the session, there was deal-related receiving in USD 10y swaps, followed by better buying across the curve by portfolio and asset management types as yields took out their :”old” lows. The break to new highs in Treasuries caused CTAs to cover in WN ultras and FV contracts. Central bank was seen buying new 5s after Tokyo lunch, while continuing this month’s program of adding 2s and 3s throughout the session. Different from the crisis trade to date, this week is not at all about “adding duration” or any of those little tricks; this week is ALL ABOUT seeking safety in a flight to quality trade, hence the US front end move.
Treasuries pulled back slightly after the European open. It has been a barrage of “C-19” tape bombs during Europe, but early one involved a WHO official (who is NOT an infectious disease expert??) opining that the Italian tests might have be overstating the number of ill, with a higher probability of false positives. That caused a brief risk rally, one that was shortly torpedoed by Italian health officials categorizing the virus as a major health threat. You get the idea. Treasuries saw better European real money selling of 10s, along with macro fund selling of very rich 2s outright and on the curve against new 5s, more CTA buying new highs this time in TY contracts. There were block sellers of TY and WN, as blocks are used more this week to give away money to market makers willing to take a small amount of risk on larger size trades during the European session. There was very good hedge fund trading of Eurodollar blocks between the European open and the NY arrival, as European funds bought EDJ 88/90 call spreads (100K), EDM 86/87 call spreads (75K, and selling the EDM 86 put against), and EDM 85/97 call spreads (75K, also against selling the EDM 85 put). These were some of the more interesting large block trades overnight, much of which was position management.
As for Europe, the risk of theme has never faded this week. There was continued selling of peripherals, as there should be, with switches being done against bunds and EUR swaps as peripherals continue to widen to core. There was selling of bunds early in the session in concession for Italian supply. Interestingly, after a good back up (hesitate to write that, since Italian debt is effectively a worthless asset at this point), the Italian supply in 5s and 10s was met with decent overbidding and the auction went relatively well. We’ll see how long it takes accounts and banks to unload this paper, guessing it won’t be long. Gilts are underperforming slightly after a very poor 40y “mini-tender” auction that was significantly underbid. European equities are trading down between 2.5% and 3.5% across the continent.
Today’s full embracing of the flight to quality event highlights that data will be a nonevent for awhile going forward, save sentiment indices. We get some of the latter tomorrow, but today was just GDP, claims, and durables. Nothing that will generate a trade, and it didn’t. 10 AM ET brings us pending home sales and 11 AM will be KC Fed Index. Fed speakers will take on greater importance in a classic FTQ trade, so watch Evans speaking at 11:30 AM (in Mexico City), and then Mester at 3:30 PM ET. Treasury will issue $32BN in new 7 year at 1 PM ET; that will likely go okay despite possibility of a 1.125% coupon as accounts need to match month end extensions (.12 years for Treasuries). As for extensions elsewhere, gilts extend a very rare small .03 years, Europe extends a normal .08 years.
So what is a fella to do??? Hiding would be a great start. With the move in swaps and spreads and a better informed community there, you can’t even touch a receiver swaption at a reasonable level. Because it involves Treasuries, or futures, or funding, there is some relative value to trading exchange options, especially on the call side. Until the call skew in FV, TY and US, along with ED reds and greens to a lesser extent, catches up to swaptions, that’s the place to play. How about a 25% delta call in FVJ series into FVM futures? 29 days to expiry, 123 call (12/64 currently), 20 bps out of the money (.85% cash 5y barrier effectively) and do it either against delta or (I like this!) against US calls like the 174 strike which is roughly 20 bps out. You could also do green April calls against TYM call skew if you really want to embrace the spread narrowing, but be careful because somewhere in here we need to widen spreads for the credit component. All right, enough for now. For choice today in TYH, call the range at 133-27 to 133-05. 133-27 will take you through the 1.25% level in cash 10s enough to run a few stops and is a .618 extension off yesterday’s bull move, while we are taking a crazy view that the oversold Ts and some signals of a potential bounce here in stock indices might engender a little back up for month end. Take out 133-27 though and it will get ugly quickly: then watch 134-05 for a 1.2% trade, 134-17, and then wait for 1% tomorrow if we are going to jack this thing. Ideally we can get through 133-05 and trade down to 132-28, but I don’t want to get too greedy.
All right, enough for now. Sorry this is long today but I think the map is getting a lot clearer (unfortunately).
Have a good day,
mjc