An Occurrence At The Federal Reserve: Increased SMART Money & Equity Volatility, Crushed Bond Volatility

Ambrose Bierce wrote a short story about a man being hanged during the American Civil War and what went through his mind in his final moments. It is called “An Occurrence At Owl Creek Bridge.” Hauntingly similar to today’s plight: overoptimistic expectations before being hung, then …. snap.

In summary., Ben Bernanke and The Federal Reserve entered the markets in 2008 in force. The Fed Funds Target rate was raised once during President Obama’s two terms as President, but eight times since President Trump’s election as President. Plus, The Fed’s Quantitative Tightening (in terms of its balance sheet) begin in earnest in 2019.

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Once The Fed hurled its monetary weight at the economy in 2008, the stock market had an amazing run. but since The Fed started to raise rates and began their balance sheet unwind, the S&P 500 index has increased in volatility as has the SMART Money Flow Index.

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The bond market volatility indices have gotten crushed by central banks.

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On the real estate front, equity REITs, like the small cap Russell equity indices, seemed to be benefit greatly from The Fed’s Zero Interest Rate Policy and QE. Mortgage REITs, on the other hand, kind of died with the financial crisis and never recovered. The RCA CPPI commercial real estate index too off like a missile.

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Like in the Ambrose Bierce short story “An Occurrence At Owl Creek Bridge,” The Fed and other central banks are quitting any attempts at rate normalization (for fear that they might hear that dreaded “snap” at the end of the monetary rope].

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Did The Federal Reserve Kill Off 10-Year Swaption Volatility? (Lowest Since 2005)

10-year Swaption volatility has sunk to the lowest level since 2005. Did The Federal Reserve provide too much liquidity for too long, effectively drowning bond volatility?

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The Fed’s lingering Target Rate near zero and its three rounds of asset purchases helped kill of bond volatiilty. And with rising Fed Target rate and balance sheet unwind (removing liquidity from markets) has pushed bond volatility to 2006-2007 levels.

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So, the answer is … YES!

(Vol has been) shot through the heart and The Fed’s to blame! The Fed gives central banks a.bad name.

MOVE 3-month Option Volatility Index Hits All-time Low (Bond Market Bernanke’d!)

The  Merrill Lynch Option Volatility Estimate 3-Month has just hit an all-time low.

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The MOVE index is a yield curve weighted index of the normalized implied  volatility on 3-month Treasury options. It is the weighted average of volatilities on the CT2, CT5,  CT10, and CT30.

Even since Fed Chair Ben Bernanke started ZIRP and QE in 2008, continued by Janet Yellen, interest rate volatility has subsided to an all-time low under current Chairman Powell.

Not a great time for volatility traders!

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US New Home Sales Decline 4.1% YoY In January As Median Price Continues To Decline

Has. the US housing market peaked?

In terms of new home sales, perhaps. January new home sales declined 4.1% YoY and the downward trend continues.

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The median prices of one family houses declined once again as one family houses for sales increased.

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The new home sales figures are disturbing given the decline in the 30-year mortgage rate since November 2018.

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US Residential Construction Spending Slumps For 6th Straight Month As US Banks Report $251 Billion of “Unrealized Losses” On Securities Investments in 2018

Today is a double whammy for bad news for the US economy.

First, The Census Bureau monthly construction spending report reveals that highway and street spending rose 11.7% in January. The biggest decline was communication spending.

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BUT, US residential construction spending slumped for the 6th straight month. It is beginning to resemble “The Matterhorn” plunge of the 2000s.

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The second whammy is the FDIC report  revealing that US banks reported $251 billion of “unrealized losses” on securities investments in 2018, the most since 2008.

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For a less grim chart from The Federal Reserve (and a different metric), here is US Commercial Bank Liabilities Net Unrealized Gains (Losses) Available for Sale.

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Double whammy!

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Undun! S&P 500 Index Comes Undone From 10Y Treasury Yield As Term Premium Hits Low

The Treasury market has come undone (or undun as The Guess Who sang).

The S&P 500 index has come undone from the 10-year Treasury Note yield.

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Meanwhile, the 10-year term premium is at a new low, likely due to persistently low inflation.

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No sugar tonight?  Don’t worry! The probability of a Fed rate cut in 2019  is minimal.

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Alarm! Europe’s And US Bond Volatility Grinding To A Halt (Precursor To Recession)

European bond volatility (according to the Merrill Lynch 3-month EUR option volatility estimate) has plunged to the lowest level on record.

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A similar chart for the US bond market is the Merrill Lynch Option Volatility Estimate for 3-months shows exactly the same thing. The US bond market is grinding to a halt.

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Note that the US MOVE 3-month estimate hit a low in May 2007, just ahead of The Great Recession of 2007-2009.

Alarm!

 

The Mummy Returns! ECB’s Draghi Raises Their TLTRO Program From The Dead To Combat Weak Euro Area Growth

The ECB’s Mario Draghi has decided to raise the dead (as in Modern Monetary Theory) by reviving the ECB’s Targeted Longer-Term Refinancing Operations.

Mario Draghi revealed the biggest cut in the European Central Bank’s economic outlook since the advent of its quantitative-easing program as policy makers delivered a new round of stimulus to shore up growth. The ECB president said the euro-zone economy will expand just 1.1 percent this year, 0.6 percentage point less than forecast in December. 

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The central bank will revive its Targeted Longer-Term Refinancing Operations to encourage banks to provide credit to businesses and consumers, and will hold interest rates at current record-low levels at least through the end of the year, several months later than previously indicated.

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The Euro declined on Draghi’s announcement.

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And most Euro area 10 year sovereign yields are down 5 basis points or more.

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Draghi must not read from the Modern Monetary Theory (MMT) book!

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US Residential Construction Spending YoY Falls To Lowest Growth Rate -1.5% Since 2013 (Slippin’ Into Darkness)

Is housing slippin’ into darkness?

Perhaps. residential construction spending YoY fell in December to its lowest level since early 2013.

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Non-residential construction actually rose 4% YoY in December.

That’s not the way I like it.

 

Deja Vu? Bankers Get Creative to Offload CLO Risk in U.S. and Europe (Here We Are Again!)

Bankers dumping business loans and corporate debt in the forms of Collateralized Loan Obligations off on investors in the US and Europe? As New York Yankee legend Yogi Berra once said, “It’s déjà vu all over again.”

(Bloomberg Quint) — Arrangers of collateralized loan obligations are innovating their way through a tough market as they try to shift a stockpile of warehoused assets from their balance sheets.

The year’s first batch of new CLO issues to price in the U.S. includes two transactions with short maturities and one static deal, where the underlying pool of loans remains the same throughout its lifetime. These non-typical features are offered to draw in investors some of who have grown more cautious after leveraged-loan prices dropped and CLO funding costs rose at the end of last year.

Investors say similar structures are being touted in Europe as well. And it’s not the first time that more creative structures have appeared: short-dated deals emerged in 2015 and 2016 when market conditions deteriorated during the oil and gas crisis and liability spreads ballooned.   

Issuance of CLOs — bonds whose cashflows are provided by an underlying pool of loans — soared last year as investors wanted exposure to higher-yielding, floating-rate debt. The market stalled toward year end amid the broader market volatility and weaker sentiment. CLO managers are now trying to navigate the slow recovery in the market.

*Pine Bridge Capital has a nice “CLOs for Dummies” article.

Although CLOs are primarily bank and corporate loans, they can degrade quickly like the “subprime” loans in 2008/2009 (as discussed in The Big Short somewhat accurately).

CLO for dummies

And like the period of time discussed in The Big Short (and other lated books and movies), the “A” rated tranches are looking good in terms of impairment rates, but the “killler Bs” are looking stressed.

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The CLOs 2.0 average structures (aka, “Cov Lite” loans) have higher risk.

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While this is NOT a chart of CLOs, it does show the growth of corporate debt since the financial crisis, particularly at the A and BBB ratings.

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Makes one ponder holding a protective asset like … gold.

Gold

Here we are again!

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