NFP day

NFP Friday Tuesday was today, we saw a print of 148k on estimates of 18k, nowhere near good enough (~200k) change needed to spur on tapering at the moment. On the plus side the Unemployment rate dropped to 7.2% but the headline Sep NFP number was the key, and that came in weak.

The reaction across the markets was entirely predictable, stocks traded higher, bonds traded higher and the USD got slammed across the board.

But, soon after the reading, cross asset correlations started to break down considerably. One of the key determinants of the USDJPY pair is the Interest rate differential between UST's and JGB's. As JGBs are shut, USTs drive the USDJPY price action through the US session.

we can see here the clear divergence post-NFP and we can see my tweet suggesting shorting USDJPY and hedging short USTs

We can see the USDJPY is purple and the US 10 year futures contract (ZN_F) inverted to represent yield, the correlation is normally clear but the divergence was shocking to me.

So as tweeted so shorting both (when weighted properly) would result in a tidy convergence trade, resulting in a 0.3% return, but the advantage here is that this was well hedged against market volatility and represented a great risk-adjusted return.

I suppose the moral here is to follow me on twitter for more simple trades like this :)

Trade updates

So my outstanding trades are as followed

Short GBP at 1.6190

Short EUR at 1.3595

Long US-DE 2 yr spread

As of today I've covered the Short GBP to mitigate too much USD risk. And while I'm bearish still, I think taking some off here is decent.

covering at about 1.5920 (horizontal fib level / triple bottom support) resulting in a trade profit of 270 pip profit.

The second trade can be seen here

Entering a "long" spread trade at -0.38 with it now trading at close to -0.25 is working very well, so is the EURUSD which is up about 100 pips currently. And looks like it could go much lower given the right circumstances from Washington

Market update 8th October 2013

So today was interesting, at least on the very short end of the yield curve, 1-month T-Bills rocketed as high as as 0.355%, while many are saying this is a rather insignificant move (and it kinda is) it shows how quickly the front end can move, the 1 month benchmark has been stuck to 0% since 2009, and barely budged throughout the European Crisis (ofc) and were only a little weaker during the "fiscal cliff" so in contrast it is quite big.

MTD US 1 month Benchmark yield. Reuters

Notably, the front end of the curve inverted up until about 1Y 9M (the 2yr-1m reached 2bps at one point though!)

US yield curve - Tradeweb

Here we can see the bills yields, the benchmark was up 17bps when this screenshot was taken

UST bills Quote screen. Bloomberg

Furthermore, for the first time, the yield on the US 1 month was > than the 1 Month LIBOR

US 1M TED spread

But these moves higher in US interest rates should be impacting the USD after all interest rate differentials have widened and the 2 Year Soverign spread has moved to 20bps from 12 or so a few days ago. To consider this, the last time the 2 yr spread was at 20 bps the EURUSD traded at 1.3150

EURUSD vs US-DE 2 YR spread

Divergences like this don't tend to last long, and either the US yield is going to drop suddenly(tightening the spread), or the EURUSD is going to drop. Hard.

So here is another look but considering the 2 Yr futures so we can see trade potential

EURUSD vs Bond futures

So here we have the US 2 YR futures contract and the German Schatz future (2yr ish) nominal spread overlayed in green. below we can see a visual representation of the spread by having them overlayed on the same axis.

At a current nominal spread of 0.38 points we are looking to buy US 2's and Short DE 2's. This sythetically puts us "long" the green line.

Simultaneously by shorting the EURUSD we would be hedged against interest rate risk and we would then need to wait for them to converge.

In terms of my weighting I haven't made it a perfect hedge as I have a personal downside bias in the EURUSD. So lets consider how to enter this trade.

Long  1000 TUc1 (US 2 YR) at 110.015

Short 1000 FGBSc1 (DE 2yr) at 110.395

Short EURUSD 1.3595 (Yellen just hit the wires)

Positioned like this, a tightening to 0.20 points would result in profit ~ £201.71 (at GBPUSD 1.6083 and EURGBP 0.8438) , at 0.30 points it would be £128.21

Now we need to consider the EURUSD position at this point a €10,000 notional short from mkt (#spot ref 1.3570) , yielding $1 (0.62.2p) per pip would result in a profit of $300 (~£190) if/when the EURUSD dropped to 1.3295.

If the trade worked perfectly then I believe as opposed to a simple meet-in-the-middle idea the EURUSD drops to catch up with yields then the rough area of conjoining would be ~ 1.327 or 0.30 points at this scale. 

Resulting in a profit or £390 or so depending on GBPUSD fx rate. This is a simple look using 1 contract in the future and a 10k short in the EURUSD but can easily be scaled up and adjusted depending on bias.

Worst case, the spread between the EUR and the 2Yr sov spread widens. 

Roughly speaking if it widens to 0.5 points then the potential loss is ~£150 although this would imply a EURUSD of 1.2970, the EURUSD needs to be below 1.3345 for the trade to BE, so it can be seen that I've quite substantially weighted towards the EURUSD as opposed to the spread. 

Short GBP?

The UK macro picture has improved hugely in the past 6 months, forcing interest rate expectations up hugely as shown by the shift in 3M LIBOR expectations.

UK historical STIR curve from Jan vs real time and spread in red.

This view is supported by the very strong PMI readings and decent labour market readings, all in all the near 10% rally in the GBPUSD over the past 2.5 months has had a strong macro footing, However I see it unlikely to keep pace and there are starting to be signs from the Credit markets that this is the case.

GBP technical view, Citi Macro surprise middle pane, Stochastics bottom.

Here we can see that the GBP is running into 5 year resistance and strong supply above 1.62 through 1.6250 and this will definitely slow progress higher, this combined with overbought stochastics suggest upside is limited for now.

There was also very large volumes in GBP today (possible distribution top?)

Reuters Matching relative volume

This week we have important PMIs and I have a feeling that they'll disappoint, especially considering their strength of recent months that sort of momentum will be hard to keep.

Furthermore the aforementioned Credit view is seen here, the GBP vs (UK vs. US) yield curve spreads

GBP vs GBP model, large divergence occurring now

As we can see there is a lot of resistance for the GBP and the path of least resistance is lower - plus I don't mind holding long USD at this point, so that's why I'm in GBPUSD shorts as opposed to EURGBP longs.

Here is a quote from a Goldman Trader on today's Moves

"The most widely telegraphed flow of the year later this afternoon and no surprise cross trades softly - aided by the general risk off tone and political instability (although hardly new) in Italy over the weekend. My inclination tells me cross won't collapse from here and if anything we should be looking to reduce longs in sterling at these levels - cable should struggle to break 1.62 while EURGBP, although technically looking vulnerable below 0.8350 has severe snap back risk later today with month end also confusing the issue. We still like sterling but not at these levels and the easiest trade right now feels to observe and wait but risk reward here and now is to be short sterling tactically."

My trade is as follows - Short GBPUSD at market 1.6190. SL on a close above 1.63 with targets around 1.59

In other news.... BTPs had an exciting day lol

Big moves in the Fixed income markets

So the headlines were as follows from the FOMC

*FED SAYS ASSET PURCHASES ARE NOT ON A PRESET COURSE AND FED DECISION ABOUT THEIR PACE REMAINS CONTINGENT ON ITS ECONOMIC OUTLOOK, LIKELY EFFICACY AND COSTS

*FED SAYS TO KEEP BUYING $85 BILLION IN BONDS PER MONTH, SPLIT AS $40 BLN MBS AND $45 BLN TREASURIES

* FED SAYS TO KEEP FED FUNDS 0-0.25 PCT AS LONG AS JOBLESS RATE ABOVE 6.5 PCT

*FED SAYS RECOGNIZES INFLATION PERSISTENTLY BELOW 2 PCT COULD POSE RISKS TO ECONOMIC PERFORMANCE, BUT ANTICIPATES INFLATION WILL MOVE TOWARD OBJECTIVE OVER MEDIUM TERM  // hints of Japan?

Either way - what we got here was far wide of consensus which was for a $10bn cut in tapering split equally through MBS' and UST's. But this is clearly not going to be considered until December now.

First off, clearly UST's were going to benefit hugely and we saw the 5's yield drop the most (in terms of bps) since March 2009

And, in my opinion, more importantly the US 2s10s tightened from ~250bps down to 235bps on the news as the long end was heavily bought, but at the same time the US 5s30s steepened considereably from 218bps to over 232bps

Furthermore in terms of inflation protected bonds - these were very sought after with the 10's ending up over 2%, pushing the yield down from 0.72% to 0.49%

Overall, it's been a big day and in all honesty, with 2 months to go before the next taper consideration, we could very easily see the 10Y benchmark trade lower towards 2.5%

Charts that make you go hmm...???

First of here is an almost 20 year look at the Nikkei vs the 10Y Japanese IRS

As we can see, for the past 4 attempt of this downtrend, the IRS (red) has stayed low while equity prices have rocketed up. Is this time different?

Now we can consider the US 10's vs the Dow 30. Makes you think...

On a smaller timeframe - here is the Dow today, vs the Dow of July/August 2011, a very similar H&S pattern forming. Coincidentally both around important Fed moves (2011 was QE2 ending) and we are facing FOMC tapering potential tomorrow so who knows??

2 Year bond yields

The importance of short term interest rates on the FX rates is undeniable and quite clear. Below is a YTD chart of the yield differential between the Us and German 2 Years vs. the EURUSD

EURUSD white, USDE2 spread Purple. Thomson Reuters

But we are at a very important point in the yields as we go into possibly the most important NFP of recent times. The consensus is a strong NFP (>175k) will be met with a guarantee of tapering in September as opposed to later on. 

But where does this put the Yield spread as this will have enormous influence on the FX rate, as we can see the US 2's broke above the two key levels approximately at 0.44%.

Us 2 year yield. Bloomberg

As we can see, there is definitely potential for the the yield to move higher, possibly to 0.5% and even higher.

But when we consider the Germans then it seems the ECB is the limiting factor for now

EUR EONIA 1Y1Y forwards. Bloomberg - H/T Nordea research.

As we can see by the EONIA forward, the ECB refi rate seems to be capping any further advances and this has a clear impact on the German 2 year yield as we can see below

German 2 year yield. Thomson Reuters

So what we can conclude is that from this is that we can see the German yields will struggle to move higher (although if tapering does occur I expect it to still break higher, just with more momentum).

And so if we get a much higher Us 2 yr yield ~0.6% by October is entirely possible. This, given recent correlation would imply a EUR/USD of approximately 1.2750.

As it stands I'll go into the "Septaper" event Long Schatz and short US 2's. As it stands now, the "price differential" on the futures is 0.3766. I am looking for a widening to 0.65 differential.

By buying FGBSc1 at 110.27 and shorting TUc1 at 109.89 (decimalized ofc) 

At the same one could consider hedging by buying EURUSD