Fear! S&P 500 Tail Risk (SKEW) Near All-time High While 10-Y Zero Coupon Volatility Lowest Since 2008

The Federal Reserve has been slowly normalizing monetary policy, more at the short-end of the Treasury curve. And the US is trying to normalize trade tariffs as well.

The result? CBOE Skew index (S&P 500 tail risk)* has risen to near all-time highs.


While the equity market skew (or fear) index is near the all-time high, the 10-year Treasury volatility measures remain subdued (the 10-year zero coupon Treasury volatility index is back to February 2008 levels).

tyvixzero But can The Fed vanquish fear?


*What is S&P 500 tail risk? The risk of outlier returns two or more standard deviations below the mean.  The Cboe SKEW Index (“SKEW”) is derived from the price of S&P 500 tail risk. Similar to VIX®, the price of S&P 500 tail risk is calculated from the prices of S&P 500 out-of-the-money options.

Numb Is Good? 10-Y Treasury Shorts Hit Record Highs, 2-Y Shorts Close To Zero, Volatility Low

Global Central Banks have so numbed Treasury markets it is as though Bernanke and Yellen gave a massive shot of Lidocaine to financial markets since 2008.


The 10-Y Treasury Note continues to see record net short positions. While the 2-Y Treasury Note net short is close to zero.


10-Y Treasury Note volatility?  Numb.


2-Y Treasury Actives zero coupon vol? Numb.


The Federal Reserve thinks that numb is good.


警告! 11 Chinese Companies Default on 32.5 Billion Yuan of Paper, Yuan Continues Devaluation (Dollar Meh)

The Chinese economic juggernaut may be in trouble.

The yield premium for Chinese AA- rated corporate bonds over AAA rated municipal bonds widened to 3.44 percentage points on Tuesday, the biggest gap since April 2015, reflecting a shift in favor of relatively safer local-authority paper. About 11 companies have defaulted on at least 32.5 billion yuan of paper in China this year. Investors generally view municipal bonds as more secure on the assumption that the central government will bail out indebted local authorities.


Meanwhile, the CNY is being devalued relative to the US Dollar.


And its the Yuan, not the Dollar.


Meanwhile, China’s current account is in negative territory.


Relax and chill-out with a pint in Suzhou’s fake London Tower Bridge.


Europe Credit Pessimism Grows Even Before ECB Halts Bond Buying

All eyes are on European markets, once again.

(Bloomberg) — European credit may be nearing a tipping point as investors take notice of worsening risk indicators just as the region’s biggest bond buyer prepares to exit the market.

Volatility has swept back into the market as the European Central Bank readies to end a program that’s bought $190 billion of corporate bonds in little more than two years. Spreads have widened to levels not seen for more than a year and the supply of new corporate debt has been patchy. Political and economic risks have also triggered sell-offs as investors grow sensitive to the future health of the economy.

“Most people’s general view on credit has shifted from bullish to bearish,” said Juan Valencia, a credit strategist at Societe Generale SA. “The big issue for European credit investors is risk-reward — there is too little upside and lots of downside.”

Pessimistic investors can point to economic warning signs, such as the biggest drop in German exports since 2012 and declines for the euro area manufacturing purchasing managers’ index. The ECB will also cease stimulus measures at the end of this year, and potentially think about raising rates late in 2019, stoking concerns about how much longer the euro zone’s five-year-long economic growth stretch can run.

“We are in a late phase of the cycle,” said Gilles Pradere, a portfolio manager at Geneva-based RAM Active Investments, which oversees about $5 billion. He’s favoring bonds that can withstand a downturn and trading credit-default swap indexes to maintain liquidity.


Investor pessimism has helped drive spreads on investment-grade euro bonds up about 30 basis points this year to 116 basis points, according to Bloomberg Barclays index data.


If we compare European and UK banks and US banks, we see that Deutsche Bank’s CDS has actually relaxed over the last month. Bank of American and Wells Fargo (as well UK’s Barclays Bank) are in the safe zone.


European sovereign CDS remain high for Greece, Italy and Russia (all over 100).


But the mac daddy of CDS spreads is not in Europe, but South America! (Venezuela is at 10,550.80!). South and Central America have 9 countries with 5Y CDS in excess of 100.


Allegedly, the ECB is supposed to be raising rates and halting their bond buying. We shall see.


Hail Zorp!


Federal Appeals Court Rules That Single-director Structure Of FHFA Is Unconstitutional (But Doesn’t Override Treasury Profit Sweep)

WASHINGTON — A federal appeals court in Texas has ruled that the single-director structure of the Federal Housing Finance Agency is unconstitutional but validated a dividend agreement requiring the government-sponsored enterprises to deliver nearly all of their profit to the Treasury Department.

The U.S. Court of Appeals for the Fifth Circuit in Texas reversed the previous court’s decision and agreed with the shareholders that the FHFA was “unconstitutionally insulated from executive control” since its single director — as opposed to a board or commission — cannot be fired by a sitting president without cause. If upheld, the decision could render the agency’s actions void.

The court panel consisted of Chief Judge Carl Stewart and Judges Catharina Haynes and Don Willett. Haynes agreed with the court’s decision, while Stewart dissented on the constitutionality issue. Willett also dissented on the profit sweep issue.

The Court of Appeals ruling.

2. The FHFA is Unconstitutionally Structured
Our Constitution divides the powers and responsibilities of governing across three co equal branches. Each branch may exercise only the powers explicitly enumerated in the Constitution—executives execute, legislators legislate, and judges judge. This structural division of power aims to ensure no single branch becomes too powerful.129 The Framers were not tinkerers; they upended things. The Revolution produced evolutionary design. “Ambition must be made to counteract ambition.” The Constitution’s unique architecture is “the central guarantee of a just government” and essential to protecting individual liberty.

Yet when one branch tries to impair the power of another, this upsets the co-equality of the branches and degrades the Constitution’s deliberate separation of powers. Accordingly, the Supreme Court “ha[s] not hesitated to strike down provisions of law that either accrete to a single Branch powers more appropriately diffused among separate Branches or that undermine the authority and independence of one or another coordinate Branch.”

Here, the Shareholders assert the FHFA, as currently structured, undermines the separation of powers; they claim that the Executive Branch cannot adequately control the agency. Before evaluating the merits of the Shareholders’ challenge, we must discuss the powers and obligations of the two branches implicated in this case.

Etc., etc.

But the reaction for Fannie and Freddie preferred stock? Meh.


“You talking to me?”


The Fed’s NIRP Policy (Real Fed Funds Rate Remains Negative)

On the one hand, The Federal Reserve has been raising its target rate (upper bound) in recent years, from 25 basis points (Dec ’15) to 200 basis points today.


But if we subtract inflation (CPI YoY) from the target rate, we see that The Fed is still practicing a NEGATIVE REAL RATE Policy (NIRP).


Housing Starts Fall 12.3% MoM, Biggest June Decline Since 1959 (Inventory Crisis Worsens)

US housing starts in June crashed 12.3% MoM, the biggest June decline since 1959. And maybe before 1959.


This does NOT help the limited housing inventory problem in the US that is helping to drive housing prices through the proverbial roof.

The largest decrease was in multifamily (5+ units) that declined 20% MoM.  1-unit detached “only” fell 9.11% MoM in June.

The decline was all over the nation, but with the Midwest suffering a 36% decline. I call this “The LeBron James Signing Effect.”



Fed’s Powell Says Trade Barriers Threaten Wages and Growth (VIX, TYVIX, Baltic Dry, Credit Spreads Calm)

(Bloomberg) — Federal Reserve Chairman Jerome Powell said protectionism can hurt economic growth and potentially undermine wages, just as the U.S. ratchets up trade tensions with commercial rivals as well as longstanding allies.

Testifying Tuesday before the Senate Banking Committee, Powell was responding to lawmaker questions about the economic impact of President Donald Trump’s tariffs.

“In general, countries that have remained open to trade, that haven’t erected barriers including tariffs, have grown faster. They’ve had higher incomes, higher productivity,” he said. “Countries that have gone in a more protectionist direction have done worse.”

The Fed chairman also said concerns about trade policy “may well” have an impact on wages and capital expenditures, which are known as capex. “We don’t see it in the numbers yet, but we’ve heard a rising chorus of concern which now begins to speak of actual capex plans being put on ice for the time being,” he said.

Global Growth

Powell’s comments come as an increasing number of economists and policy makers warn that trade tensions threaten to undermine global growth. The International Monetary Fund on Monday said world output could drop by about 0.5 percent below its projected level by 2020 if threatened trade barriers become reality. The U.S. economy would be “especially vulnerable” because it would be the focus of retaliation in a tit-for-tat conflict, the Fund’s chief economist Maurice Obstfeld said.

Powell was more circumspect in his opening statement on the topic of trade, saying only that it’s “difficult to predict’’ how tensions will shape the economic outlook. His remarks on the economy were otherwise largely optimistic, as unemployment stands close to an 18-year low and inflation rises around the Fed’s 2 percent target. Powell said the central bank will continue to gradually raise interest rates “for now.’’

But senators of both parties during the question-and-answer session tried to draw the Fed chairman into the political debate by pressing him on trade. Powell was careful not to specifically criticize Trump’s policies, which are designed to pressure partners to reduce barriers against American goods. The White House in recent months has slapped duties on shipments of high-tech goods from China as well as steel and aluminum from most of its trading partners.

“Trade is really the business of Congress, and Congress has delegated some of that to the executive branch,” Powell said. “But nonetheless, it has significant effects on the economy. And I think when there are long-run effects we should talk about it, and talk in principle.”

Asked whether he viewed the European Union as an economic foe of the U.S., Powell said “no, I do not.” Trump said earlier this month he sees the bloc as an adversary on trade.

If trade tensions are heating up, I can’t see if in the market risk measures.

Let’s look at the VIX (S&P 500 volatility index).  It is showing no signs of stress.


How about the 10-year Treasury Note volatility index (TYVIX)? Nada.


Baltic Dry Index? That spiked prior to The Great Recession? Nein.


How about the IG credit spreads? A little stress.


But other credit spreads (Baa – Treasury 10-year) do not show anything to speak of.


So, where’s the (trade) beef?


Inversion Alert! Treasury Slope Plummeting Towards 0 BPS As Corporate Debt To GDP May Be At Credit Cycle High

One of the effects of The Federal Reserve’s zero interest policy (ZIRP) was the massive expansion of both consumer and corporate debt. The US may be at a credit cycle peak (Corporate Debt-to-GDP).

corporate debt to gdp 2

Which brings me to the UST 10Y-2Y slope, plummeting towards inversion (now at 24.5 BPS). The last time we saw the 10Y-2Y slope so flat was in early August 2007, 4 months before The Great Recession began.


You will notice that the glacial unwinding of The Fed’s balance sheet has been uneventful for the 10Y Treasury yield, but the rapidly rising 2Y Treasury yield (that corresponds to The Fed’s rising target rate) is pushing the Treasury curve to inversion.