Looks like "The Basis Trade" (this time) is really an uberhedged, multilegged "Relative Value" spread (might be ratioed, still sifting...). EU vs US. Seems to be the successor, London based, trade that blew up under Truss from Carney's New Rules at the BoE. (Yes, THAT Carney.*)
More on it, and ZH has been trying to keep up on this outsized whale of a trade that a LOT of people piled into, on the erroneous assumptions of "He won't tariff!" and "They'll just have to keep issuing!", and lastly "JPow will have to cut!".
Side note: Spread between GLD and physical showing a LOT of stress, IMo
Now where'd I put my helmet....and this is EXACTLY what the floors handled, lived for actually, in guts and sweat.
*If you want to see just how munificent Canadian "PM" Mike Carney is, look no further than the politically connected "deals" landed by his Brookfield Asset Management.
All day, everyday, as markets move, traders and pundits look for the underlying reasons. Heck, we have no less than three financial news channels dedicated to those discussions. However, news in itself doesn't actually cause price fluctuations, buyers and sellers cause fluctuations. So, in reality, we're really asking, what was the catalyst for buyers or sellers to act with such force that values changed. In fixed income and FOREX, those questions can have ambiguous answers. To wit: In short order, we've had a collapse in asset prices, the first monthly CPI decline in nearly half a decade, a sharp drop in the Federal government's monthly deficit figures and a bona-fide crash in energy prices. Normally, any one of those fundamentals would cause buyers to madly bid up the price of long dated debt instruments. Instead, Bonds have been crushed over the past week.
So, how could that be? Well, as Jeff asked, "who knows how many Global Central Banks, Chinese or otherwise are selling, despite bullish fundamentals?" Clearly, those massive players who're selling are motivated by reasons far different than those who're buying based on what are historically bull items and their selling far, far out numbers the amount of dollars being invested by bulls. Some of my worst days in the pit occured when I was fading a move based on the "odds play." I remember once getting destroyed as a long because despite a bunch of bullish stuff on the tape, Lehman Brothers sold 25,000 bond futures to hedge a big corporate bond offering that they were underwriting. Sure, prices came back in subsequent days but that was too late for yours truly who was carried out before the market woke up to reality.
Here's an interesting aside Jeff, about notional value. Back in 1977 when the Bond contract was designed by the CBOT, $100,000 per one lot was a fair amount of money. A thousand lot equals $100mil and back then, how many developers etc had more than $100mil of interest rate exposure? The entire National Debt didn't reach $1 trillion until 1982. Now, billions are like candy and the government borrows a new trillion dollars every several months. SoFi Stadium cost $5bil to construct. If Rams owner Stan Kroenke wanted to hedge his interest rate exposure (assuming he had a variable rate loan) he'd need to sell FIFTY THOUSAND ten year contracts. We've been conditioned to assume liquidity is always present but as trading veterans are well aware, liquidity can be both transitory and illusionary.
one thing I liked about the bond contract size was when you put it into 32nds, it had volatility. I advocated for a $5MM notional Eurodollar which would have made it more whippy (but obviously would have decreased the volume traded!)
So the Chinese retaliated further and increased their Tariffs as well other non tariffs protection polices (ie rare earth elements). I think the next step in this economic war should be the delisting of all Chinese owned companies on our exchanges. The last bullet in the chamber we are reserving for when they invade Taiwan is to take them off the SWIFT banking system. They will no longer have accesss western banking systems at that point.
What annoys me about Trump and the Republicans is they don't push for budget cuts / government shutdown because they are supposedly afraid of the political fallout from a market sell off. And now we still get the market sell off and we don't get any budget cuts!
So now everything financial is going against Trump and the Republicans. Stocks are down and bond yields are up. People are taking losses in their 401Ks and they are not getting any hope in lowering their borrowing costs. And as far as I'm concerned this is the slap in the face Trump and the GOP deserve. They refuse to face economic reality and so the market is punching them in the face. Will Trump wake up?
I'm sure Trump sees himself as Reagan in 1982 when bond yields turned down despite an increase in government spending. But Reagan wasn't doing the tariff trick that Trump is trying.
Soon, I expect, long yields will turn down again. Trump needs lower yields. Trump needs a lower Fed discount rate. Trump would really benefit from QE. But Trump is not helping himself by refusing to demand real cuts in Federal spending.
China has another Achilles Heel on par with food. Their oil imports. No one ever brings up this strategic point. China imports 11 million barrels of oil per day. Much of it first passes through the Hormuz Strait and then through the Malacca Strait (72% per AI). These two narrow choke points could be easily blockaded by the US Navy, as China needs 5-6 supertankers *per day* to meet their oil needs. Also note that China, for all its shipbuilding, does not have a blue water navy. They cannot project power with their navy like the US can.
Oil production comparisons with the US: China only domestically produces 4 million barrels per day, the US produces 13 million. China imports 11 million barrels per day, the US only 6 million.
I would point out that blockading straits is tantamount- no - is an act of war. Start digging.
And "blue water" navies are quickly becoming a thing of the past what with hypersonic missles and "drone swarms" and such other things that we can only guess at. The last place I'd want to be is on a floating island carrying lots of short range planes. Go ahead, call me a "chickenshit", but also call me a realist.
Many years ago, I believe it was Brian Monieson who reminded me that:"the bond market is quintuple the size of the stock market and the foreign Exchange market is quintuple the size of the bond market". That stated I have always paid attention to fixed income and foreign exchange markets, but the Big kahuna, because that is what fund managers are measured against, is and always has been, the S&P 500 and I've never considered the term "the market" to be the Dow Jones, it's always the S&P 500. Traded all of them so of course I paid attention and studied all of them.
Probably the most important point that 99% of the world's population is missing on all of this is we are at a point where we are just entering the middle of the beginning of the overall trade and balance of world power strategically, economically, militarily and politically, and the tariffs, while not secondary, are not primary, the primary purpose being to address those things that Jeffrey Minch wrote in his Big Red Car commentary the other day about all the unfair Trade practices China has been getting away with for multiple decades and not been held accountable to adhering by the World Trade Organization, which is one of the reasons why Trump pulled us out of that feckless and inept(likely corrupt)organization.
We still have a long way to go. China is a bully and a dishonest one at that, who consistently lies about their economy.
One of the biggest advantages we have is that this is an Administration that has more transparency than any Administration before it in the history of our nation, that will continue to build trust. You touched on that in your article and that's so important, because nobody I know around the world trusts China more than they trust America.
Great analytical discussion. I'll confess that I understand the political economy strategy better than the financial market mechanisms and implications, but I'm trying to learn. Thanks for breaking these less straightforward parts down a bit for your readers. I'm sure I'm still missing a lot of nuance & detail, but it helps.
China will get what they deserve. Would you rather trade with the strongest and best economy in the world or the other countries that have problems of their own. China is built on a house of cars that is ready to collapse. And the EU has their own problems. Trump is right 90% of the time. Let things play out. MAGA
Communist China has been a house of cards for a long time yet its (likely inevitable) collapse has held off for many decades. I would not bet the ranch on pinpointing the moment. I've been arguing for decades that ultimately their apparent strength is a figment of reputation, extremely difficult if not impossible to mobilize strategically to achieve a specific desired impact. I can know that to be true by the facts without any confidence they cannot weather this storm as they have others.
Frankly even if Xi's domestic power base does falter or evaporate in the near-ish term, a regime re-org and/or the sheer reverberations of a new disequilibrium would include high risk ramifications and potentially crippling damage on the downward journey.
He does have options domestically other than being overthrown, some of them brutal (as Mao said, political power grows out of the barrel of a gun). China would need less food if the military killed a few million civilians, for instance.
"Communist China" is just the latest iteration of a long. long history of autocratic rule. China is an ancient civilization existing for more than 5000 years. It has had 13 major dynasties and as many as 83 minor ones in that time (google search). None of them have been "democratic" in any form. It is only my opinion that "communism" is only the latest dynastic form. How long it lasts we'll have to wait and see. If you are waiting for the Chinese to rise up and embrace democracy in any form you have a long wait in my opinion.
The problem of interest on the national debt can be easily solved, as Congress has the power "To coin Money, regulate the Value thereof." (US Constitution Article I Section 8). This money can be used to pay off the national debt. Of course excessive coinage would result in inflation, but at least the problem of interest would be solved.
No, I am quite serious, and not alone. Dennis Kucinich, Steven Zarlenga, numerous others better informed than I have endorsed similar plans.
"the NEED Act, introduced in 112th Congress, HR 2990: Pays off the national debt as it comes due, if necessary by creating the money to pay for Bonds coming due, rather than rolling them over with new borrowing" (https://monetary.org/pdfs/home/32-page-Monetary-Reform-Manual.pdf).
That "Monetary Reform Manual" provides much background, and there are additional resources at monetary.org.
"Modern Monetary Theory" is somewhat similar tho it seems to come with a lot of baggage.
Thanks for your response. I guess you and I have different understandings of how markets work. As I see it, issuing a lot of debt to fund government deficits leads to inflation, which worsens as debts increase. Printing money to pay off debt might initially have a similar effect, but after a few years the debt, and debt payments, will have declined so inflation pressure will be less.
Market is NEWS DRIVEN not DATA driven
There's a GREAT "Floorism" In this very, very thorough, pre-US open piece.
"Narrative follows price."
Wish I'd thought of that one, I'd learn to needlepoint and put it on a couch cushion in my office.
https://thebondbeat.substack.com/p/while-we-slept-usts-muted-on-in-response
Great post, and a great explainer. Thank you!
Looks like "The Basis Trade" (this time) is really an uberhedged, multilegged "Relative Value" spread (might be ratioed, still sifting...). EU vs US. Seems to be the successor, London based, trade that blew up under Truss from Carney's New Rules at the BoE. (Yes, THAT Carney.*)
More on it, and ZH has been trying to keep up on this outsized whale of a trade that a LOT of people piled into, on the erroneous assumptions of "He won't tariff!" and "They'll just have to keep issuing!", and lastly "JPow will have to cut!".
More here, and this is a very complex trade, plus optioning off of it, for the ATM factor: https://traderscommunity.com/portable-alpha-is-the-basis-and-carry-trade-sustainable/
Side note: Spread between GLD and physical showing a LOT of stress, IMo
Now where'd I put my helmet....and this is EXACTLY what the floors handled, lived for actually, in guts and sweat.
*If you want to see just how munificent Canadian "PM" Mike Carney is, look no further than the politically connected "deals" landed by his Brookfield Asset Management.
Great comment. Be nimble. No marriages. Just tentals
All day, everyday, as markets move, traders and pundits look for the underlying reasons. Heck, we have no less than three financial news channels dedicated to those discussions. However, news in itself doesn't actually cause price fluctuations, buyers and sellers cause fluctuations. So, in reality, we're really asking, what was the catalyst for buyers or sellers to act with such force that values changed. In fixed income and FOREX, those questions can have ambiguous answers. To wit: In short order, we've had a collapse in asset prices, the first monthly CPI decline in nearly half a decade, a sharp drop in the Federal government's monthly deficit figures and a bona-fide crash in energy prices. Normally, any one of those fundamentals would cause buyers to madly bid up the price of long dated debt instruments. Instead, Bonds have been crushed over the past week.
So, how could that be? Well, as Jeff asked, "who knows how many Global Central Banks, Chinese or otherwise are selling, despite bullish fundamentals?" Clearly, those massive players who're selling are motivated by reasons far different than those who're buying based on what are historically bull items and their selling far, far out numbers the amount of dollars being invested by bulls. Some of my worst days in the pit occured when I was fading a move based on the "odds play." I remember once getting destroyed as a long because despite a bunch of bullish stuff on the tape, Lehman Brothers sold 25,000 bond futures to hedge a big corporate bond offering that they were underwriting. Sure, prices came back in subsequent days but that was too late for yours truly who was carried out before the market woke up to reality.
Here's an interesting aside Jeff, about notional value. Back in 1977 when the Bond contract was designed by the CBOT, $100,000 per one lot was a fair amount of money. A thousand lot equals $100mil and back then, how many developers etc had more than $100mil of interest rate exposure? The entire National Debt didn't reach $1 trillion until 1982. Now, billions are like candy and the government borrows a new trillion dollars every several months. SoFi Stadium cost $5bil to construct. If Rams owner Stan Kroenke wanted to hedge his interest rate exposure (assuming he had a variable rate loan) he'd need to sell FIFTY THOUSAND ten year contracts. We've been conditioned to assume liquidity is always present but as trading veterans are well aware, liquidity can be both transitory and illusionary.
one thing I liked about the bond contract size was when you put it into 32nds, it had volatility. I advocated for a $5MM notional Eurodollar which would have made it more whippy (but obviously would have decreased the volume traded!)
So the Chinese retaliated further and increased their Tariffs as well other non tariffs protection polices (ie rare earth elements). I think the next step in this economic war should be the delisting of all Chinese owned companies on our exchanges. The last bullet in the chamber we are reserving for when they invade Taiwan is to take them off the SWIFT banking system. They will no longer have accesss western banking systems at that point.
Or not letting Chinese come to school here unless they burn boats
Going to be hard here in CA as I think San Francisco is basically China owned now.
Terrific commentary today, Jeff.
Linking to a helpful chart showing yuan/$$ exchange rates (obviously there is manipulation in this market, probably why the trade range is narrow)
This one is for the last week.
https://www.xe.com/currencycharts/?from=USD&to=CNY&view=1W
Recall that China manages 4 currencies, not just one. Slippery biz, that FX.
OK, I recall there is RMB (renminbi). What are the other two?
HKY, HK$, CNH, CNY, those are the External currencies, plus Renminbi, which Only trades within China.
Great chart thanks!
What annoys me about Trump and the Republicans is they don't push for budget cuts / government shutdown because they are supposedly afraid of the political fallout from a market sell off. And now we still get the market sell off and we don't get any budget cuts!
So now everything financial is going against Trump and the Republicans. Stocks are down and bond yields are up. People are taking losses in their 401Ks and they are not getting any hope in lowering their borrowing costs. And as far as I'm concerned this is the slap in the face Trump and the GOP deserve. They refuse to face economic reality and so the market is punching them in the face. Will Trump wake up?
I'm sure Trump sees himself as Reagan in 1982 when bond yields turned down despite an increase in government spending. But Reagan wasn't doing the tariff trick that Trump is trying.
Soon, I expect, long yields will turn down again. Trump needs lower yields. Trump needs a lower Fed discount rate. Trump would really benefit from QE. But Trump is not helping himself by refusing to demand real cuts in Federal spending.
China has another Achilles Heel on par with food. Their oil imports. No one ever brings up this strategic point. China imports 11 million barrels of oil per day. Much of it first passes through the Hormuz Strait and then through the Malacca Strait (72% per AI). These two narrow choke points could be easily blockaded by the US Navy, as China needs 5-6 supertankers *per day* to meet their oil needs. Also note that China, for all its shipbuilding, does not have a blue water navy. They cannot project power with their navy like the US can.
Oil production comparisons with the US: China only domestically produces 4 million barrels per day, the US produces 13 million. China imports 11 million barrels per day, the US only 6 million.
I would point out that blockading straits is tantamount- no - is an act of war. Start digging.
And "blue water" navies are quickly becoming a thing of the past what with hypersonic missles and "drone swarms" and such other things that we can only guess at. The last place I'd want to be is on a floating island carrying lots of short range planes. Go ahead, call me a "chickenshit", but also call me a realist.
All true, but my point is what the US could do if China started a war. I’m anti war.
Hence their dedication to coal. Link below to a piece (focused on carbon, but there is good data)
https://www.carbonbrief.org/chinas-construction-of-new-coal-power-plants-reached-10-year-high-in-2024/
Not sure where they stand re. power production vs. demand from AI for power.
Great point on oil. Aren't they building nuclear reactors like crazy?
Perplexity just told me they have 30 reactors under construction and intend to build 150 by 2035.
Many years ago, I believe it was Brian Monieson who reminded me that:"the bond market is quintuple the size of the stock market and the foreign Exchange market is quintuple the size of the bond market". That stated I have always paid attention to fixed income and foreign exchange markets, but the Big kahuna, because that is what fund managers are measured against, is and always has been, the S&P 500 and I've never considered the term "the market" to be the Dow Jones, it's always the S&P 500. Traded all of them so of course I paid attention and studied all of them.
Probably the most important point that 99% of the world's population is missing on all of this is we are at a point where we are just entering the middle of the beginning of the overall trade and balance of world power strategically, economically, militarily and politically, and the tariffs, while not secondary, are not primary, the primary purpose being to address those things that Jeffrey Minch wrote in his Big Red Car commentary the other day about all the unfair Trade practices China has been getting away with for multiple decades and not been held accountable to adhering by the World Trade Organization, which is one of the reasons why Trump pulled us out of that feckless and inept(likely corrupt)organization.
We still have a long way to go. China is a bully and a dishonest one at that, who consistently lies about their economy.
One of the biggest advantages we have is that this is an Administration that has more transparency than any Administration before it in the history of our nation, that will continue to build trust. You touched on that in your article and that's so important, because nobody I know around the world trusts China more than they trust America.
Great article and thank you.
Great analytical discussion. I'll confess that I understand the political economy strategy better than the financial market mechanisms and implications, but I'm trying to learn. Thanks for breaking these less straightforward parts down a bit for your readers. I'm sure I'm still missing a lot of nuance & detail, but it helps.
China will get what they deserve. Would you rather trade with the strongest and best economy in the world or the other countries that have problems of their own. China is built on a house of cars that is ready to collapse. And the EU has their own problems. Trump is right 90% of the time. Let things play out. MAGA
Or maybe not. Do not underestimate them.
Communist China has been a house of cards for a long time yet its (likely inevitable) collapse has held off for many decades. I would not bet the ranch on pinpointing the moment. I've been arguing for decades that ultimately their apparent strength is a figment of reputation, extremely difficult if not impossible to mobilize strategically to achieve a specific desired impact. I can know that to be true by the facts without any confidence they cannot weather this storm as they have others.
Frankly even if Xi's domestic power base does falter or evaporate in the near-ish term, a regime re-org and/or the sheer reverberations of a new disequilibrium would include high risk ramifications and potentially crippling damage on the downward journey.
He does have options domestically other than being overthrown, some of them brutal (as Mao said, political power grows out of the barrel of a gun). China would need less food if the military killed a few million civilians, for instance.
"Communist China" is just the latest iteration of a long. long history of autocratic rule. China is an ancient civilization existing for more than 5000 years. It has had 13 major dynasties and as many as 83 minor ones in that time (google search). None of them have been "democratic" in any form. It is only my opinion that "communism" is only the latest dynastic form. How long it lasts we'll have to wait and see. If you are waiting for the Chinese to rise up and embrace democracy in any form you have a long wait in my opinion.
Great post and discussion though Jeff. Thanks.
Game Theory is not solitaire. The other players always get a vote on the outcome, and the game never ends. (plus bots)
The problem of interest on the national debt can be easily solved, as Congress has the power "To coin Money, regulate the Value thereof." (US Constitution Article I Section 8). This money can be used to pay off the national debt. Of course excessive coinage would result in inflation, but at least the problem of interest would be solved.
I'm hoping this was tongue in cheek.
No, I am quite serious, and not alone. Dennis Kucinich, Steven Zarlenga, numerous others better informed than I have endorsed similar plans.
"the NEED Act, introduced in 112th Congress, HR 2990: Pays off the national debt as it comes due, if necessary by creating the money to pay for Bonds coming due, rather than rolling them over with new borrowing" (https://monetary.org/pdfs/home/32-page-Monetary-Reform-Manual.pdf).
That "Monetary Reform Manual" provides much background, and there are additional resources at monetary.org.
"Modern Monetary Theory" is somewhat similar tho it seems to come with a lot of baggage.
That is a terrible idea.
Please say more about why it is a terrible idea.
Summming up succinctly, your idea would bring hyperinflation.
Thanks for your response. I guess you and I have different understandings of how markets work. As I see it, issuing a lot of debt to fund government deficits leads to inflation, which worsens as debts increase. Printing money to pay off debt might initially have a similar effect, but after a few years the debt, and debt payments, will have declined so inflation pressure will be less.
I don’t think it is accurate to say the Covid vaccine was not effective. And DOGE has not discovered fraud and waste at levels the boys are claiming.
Oh, it's accurate. You got the vaccine, you could still get Covid. DOGE has uncovered billions in waste and fraud. Just the NGO stuff was quite a bit.