The Precise Take – Equities post new highs overnight into massive Treasury auction week

Medium to Long Term Analysis:  As we have been writing over the past few months, we believe the 30 Year T-Bond futures contract is key to monitoring the health of the long term Treasury market.  When it approaches important technical levels, big things usually happen.  Most recently, last Friday, the 30 Year reversed off strong resistance and equities posted sizable gains.  With the $197 B in Treasury auctions this week, the 30 Year will be even more important to watch.  The first technical support level that could provide major support is the confluence of the 61.8% retracement from the Aug 09 range (117’03) and the Anchored VWAP line from the June 11 09 low (117’13).  When and if that area is reached this week, we would monitor equities longs very closely looking for signs of weakness.

Last month during the similar auction week, Monday was an interim high in equities and an interim low in the 30 Year.  The 2 Year and 5 Year auctions on Tues and Wed went poorly but the 30 Year held its ground and equities were not able to advance.  The 7 Year auction on Thursday last month went very well, allowing the 30 Year to recover a bit as equities advanced the following week and Treasuries again tested critical support, eventually recovering as equities corrected a bit.

For the current month, we doubt things will play out exactly the same, but the result will be similar—at the end of the week, demand for long term Treasuries will be gauged to be healthy, but not so much that they take too much money from equities.  The game that has been played to date—ramp equities, then Treasuries—has so far succeeded.  However, while equities have clearly trended up, the same daily and weekly charts of the leaders we look to in gold, the EuroYen forex cross, crude and the 30 Year yield (inverse to the 30 Year futures contract) have formed consolidating bull flags.  This could continue for perhaps another month or two, but eventually, the consolidation must give way to breakout.  Eventually, either we will have a huge inflationary bullish equities run, with gold finally breaking over 1000 decisively and other commodities following suit.  Or, we will have a deflationary equities correction with long term Treasuries finally breaking resistance (and yields headed downward again.  Neither scenario is good for the economy because, in the former case, long term yields eventually rise to unmanageable levels and, in the latter, the risk of another stock market crash is high.  As always, we will monitor all of this on a daily basis but, if we had to pick a scenario, history says that governments ultimately choose inflation at their own peril.  Until a scenario ultimately shakes out, trading with longer than a few days to a week’s time horizon will be very difficult.

Time Profile:  Today the FRNY conducts permanent open market operations (POMO) and it is the day after options expiration Friday.  This has only happened twice, once on May 18 09 (a large up day) and June 22 09(a large down day).  As the Time Profile for these two dates yields no useful information, the individual Time Profiles for POMO Mondays and Post OpEx Mondays are posted on page 2.  Between the two, there a bearish bias in the morning and early afternoon and a bullish bias in the late afternoon into the close. 

Trading Today:  Only the 3 and 6 Month auctions today at 1:00 pm are scheduled news and they are very likely to go well.  Tomorrow begins a strong news day that could reverse markets.  Given the Time Profiles for today, we would see a retracement to the 1021.50 to 1023.00 area as a buying opportunity, but would not attempt longs below…

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11:11 am EDT:  Per our morning report, see Wall St. Cheat Sheet’s Chart Junkie page for the 30 Year T-Bond chart created earlier this morning.  With the 10:00 am Existing Home Sales greatly exceeding expectations (ours included) and breakout of the S&P 500 through resistance, the final bar on the 30 Year has now reversed nearly the entire week’s gains.  It will now likely head down into lower support as equities continue to climb into early next week, even if today’s move is largely over.  In the ES, we would expect some consolidation now and perhaps another late day surge.  We remain intraday bullish as long as the ES holds 1014.00.

The Precise Take – Can overnight gains extend, or will typical OpEx choppiness reverse them?

Treasury Analysis:  The 30 Year T-Bond has hit the lower end of a very strong resistance area that extends from 120’30 to 122’03.  Please visit Wall St. Cheat Sheet’s Chart Junkie page about mid-day for the chart and explanation of the forms of resistance we’re seeing.  The auction amounts for next week as released yesterday will be for slightly less than last month’s (see below), with the trend of increase in the longer dated auction amounts halted (at least temporarily).  With equities also retesting highs and a new “moderating” tone at the Treasury, the 30 Year will be key next week to confirm a breakout or double top in equities.   

Time Profile:  See page 2 for historical Time Profiles of options expiration day.  Notable is that from the 2001 bear market until the end of 2004, there was a strong initial bearish bias in the first hour, which gave way to an initial bullish bias that has increased since about August 2007 (not shown).  Derivatives (including options) trading has changed so much since 2001, that we don’t place too much importance on the direction of the bias, so much as tendency of it not to continue (and indeed often be reversed) early in the day.  As the Time Profile measures the net change from the prior period’s close, the first hour includes any opening gaps.  This means, any overnight gains are likely to not extend materially in the opening 60 minutes, and have a tendency to be reversed slightly in the 10:30 am to 11:00 am period.  The rest of the day tends to be choppy with the final hour having a bullish bias and the final 15 minutes after 4:00 pm (in the futures) tending to reverse.

Trading Today:  As of yesterday, 995.25 is the new highest volume market profile point of control for the life of the September 09 ES contract, having overtaken the 913.00 level that held for so long.  This will make the 995.25 level the key level to watch going forward.  We become intraday bullish above overnight highs (as we write) of 1011.75, but would be surprised if the ES were able to…

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We will cover this more thoroughly in tomorrow’s report with greater resolution and history.  For now, there is a clearly bullish bias in the first hour of trading on option expirations day going back two years, which becomes mildly bearish the second hour of trading.  For the eMini S&P 500:

The Precise Take – Equities rebound smartly into options expiration Friday

Treasury Analysis:  With the overbought condition of equities having been relieved and a decent turnaround yesterday to reverse a poor opening on Monday, the markets appear more or less neutral.  The 30 year T-Bond future that we monitor as a barometer of the health of long term Treasuries hit resistance earlier in the week, but has not sold off much in light of yesterday’s equities gains.  At 11:00 am today, the Treasury will announce the auction amounts for the slew of auctions that will occur next week to finish the month’s borrowing needs.  The trend has been for one record breaking month after another and we expect no less to be announced today.  It will be important for the 2, 5 and 7 year auctions to go well next week, especially after last month’s poor showing.  But, with the strength of the recent 30 year auction and recent equities correction, long term Treasuries are in a good position to weather a few hiccups.

Time Profile:  Today is the day after the FRNY’s permanent open market operations (POMO) and has typically had a slightly bullish edge into midday and a bearish edge thereafter, accelerating into the close.  Because the two POMO auctions this week on Monday and Wednesday have not produced the typical tape-the-paint closes (yesterday was simply up from the beginning), we are suspect of the pattern for the post POMO day (today) holding.  Rather, we believe it is likely the markets will consolidate yesterday’s action with a nominal new weekly high possible, but a strong directional movement in either direction unlikely.  Existing Home sales and options expiration tomorrow should be market movers and we will post the Time Profile pattern for OpEx days later today.  Thanks to Billy O’Nair for updating us on the upcoming POMO days—there are two next week on Monday and Wednesday and only one the following week.  Ironically, POMO was intended to support longer dated Treasuries, but has also allowed for the large equities run-ups.  With POMO winding down into October, further gains in the stock market will increasingly need to be made on strong fundamentals rather liquidity injections (that is, unless the FRNY comes up with something else in the interim).

Trading Today:  We don’t have a strong directional bias and would merely suggest longs be cognizant of the tendency of a bearish close after two POMO days in the week.  We are intraday bullish above…

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The Precise Take – Consolidation yesterday and overnight

The ES has found support at the upper end of the next lower market profile value area, the point of control of which is 973.25.  Today’s Time Profile is a bit flat and not indicating a significant edge.  Housing Starts and PPI at 8:30 am today are the only major news items, and tomorrow is a flat news day.  Accordingly, we have no directional bias into Thursday and expect some more back and fill into options expiration on Friday.  Today, we become intraday bullish above 990.00 and intraday bearish below 979.50. 

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12:17 pm EDT:  The low of the day was exceeded by one tick and price quickly reversed to the upside, which is the first condition of a bear trap.  If the ES can get over 985.00 on volume (2nd condition), we could see a pretty strong short covering rally, especially if it happens during midday here.  We will likely sit out until 977 or 985 is broken.

The likelihood of further downside action is increasing and we will still watch 973.25 as a potential reversal area, but are not as enthusiastic about fading long there as downside momentum could develop.  Nor will we short a retracement until the low is taken out at 977.50.  970.50 and 964.75 are the next downside targets after 973.25.  We won’t try to get long unless and until the market gets back above 985.00, with the possible exception of playing the POMO-close long in the late afternoon.

 The Precise Take – Asian-lead selloff–can a POMO close save the day?

Leaders:  Because 30 Year T-bond futures held support last week and advanced as equities held their ground, it is in very good shape to weather next week’s (likely) record breaking auctions.  We wanted to see a close above 119’08.5 in the 30 Year this weak and, after poking above it Friday, we could get it today.  The announcement of next week’s auction amounts will be this Thursday at 11:00 am.  At 9:00 am today, we will get a look at the monthly Treasury Int’l Capital report to gauge continuing foreign interest in the US’ long term Treasuries.  The data will be six weeks old, but it is important nonetheless.  On the overnight weakness, gold has broken last week’s lows and the EuroYen forex cross is down sharply as well.

Time Profile:  Similar to our comments from Friday, today’s time profile suggests that we could have another strong close, despite likely being net down for the day.  Strong closes on POMO days have historically been reversed the following day.  The July rally erased this edge temporarily with several strong follow up days.  However, with renewed weakness in equities, it may be time to revisit these plays and short weak issues on a strong POMO close.  If the close is weak instead of strong, we would want to see other reasons to short.

Trading Today–Putting it all together:  We do not get intraday bullish unless and until the ES can climb over the 995.50 market profile point of control from Friday.  Below that and we’re primarily looking for shorting opportunities, though we would fade long at the next lower long term point of control at 973.25, if we saw buying come in.  Overnight, the combined day and night session daily S2 has provided support and shorts will want to break this area early to continue the directional move.  Assuming no major disturbances in the 9:00 am TIC report noted above, the key news item for the day will be

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We hinted at some Fed charts yesterday, but have yet to finish the heavy lifting, so we willfully admit to bait and switch and hope the following has some interest to our readers.

First, let’s revisit a statement from the Aug 4 2009 minutes of the Treasury Borrowing Advisory Committee, as it pondered the future of the Treasury, both in debt raising and governmental financial “innovation”.  From the Minutes, verbatim (emphasis ours throughout this post):

 The presenting member then discussed interest-rate volatility. Both realized and implied volatility remained at elevated levels relative to historical norms, with long-term rate volatility significantly higher than front-end rate volatility. The negative convexity profile of the mortgage market has increased with the QE purchases but it is difficult to hedge the convexity in the current market. This is because there are no natural sellers of volatility left in the market, following the collapse of hedge-fund capital, despite overwhelming demand for volatility from mortgage servicers and originators; this has created a chronic structural net short position in the market place. The presenting member suggested that Treasury, if it wanted to be opportunistic, could potentially benefit from this demand for volatility by offering putable issues.

It bothered us at the time that the Treasury would be so cavalier at throwing out the possibility of assuming the traditional risk taking functions of the private market, and we pondered aloud that it might be a bit jealous of the Federal Reserve, which has become the word’s largest de facto hedge fund. 

So, what is the Treasury’s role?  According to its Congressional mandate issued Sep 2 1789:

Section 2. And be it further enacted, That it shall be the duty of the Secretary of the Treasury to digest and prepare plans for the improvement and management of the revenue, and for the support of public credit; to prepare and report estimates of the public revenue, and the public expenditures; to superintend the collection of revenue; to decide on the forms of keeping and stating accounts and making returns, and to grant under the limitations herein established, or to be hereafter provided, all warrants for monies to be issued from the Treasury, in pursuance of appropriations by law; to execute such services relative to the sale of the lands belonging to the United States, as may be by law required of him; (b) to make report, and give information to either bra[n]ch of the legislature, in person or in writing (as he may be required), respecting all matters referred to him by the Senate or House of Representatives, or which shall appertain to his office; and generally to perform all such services relative to the finances, as he shall be directed to perform.

This is a bit broad and the assumption of hedge fund roles are not mentioned, per se.  However, we’ll give the Founding Fathers the benefit of the doubt and believe that they did not intend such.  The next question is, what is the Treasury’s own view of being “opportunistic”?

From the Mar 6 1998 address of Assistant Secretary for Financial Markets Gary Gensler:

Second is maintaining the consistency and predictability in our financing program. Treasury issues securities on a regular schedule with set auction procedures. This reduces uncertainty and helps minimize our overall cost of borrowing. Related to this principle, Treasury does not seek to time markets. Our sheer size does not practically permit an opportunistic approach. Over the long run, moreover, it is unlikely that we could consistently and successfully time markets.

Gensler (former Goldman partner and now Chairman of the CFTC) admits that Treasury opportunism (at least from the perspective of attempting to time Treasury auctions) is impractical.

From the Oct 30 2002 TBAC minutes:

The question on performance measures generated some debate among Committee members about both the feasibility and desirability of quantifying debt management performance.  Some members felt that this issue required more preparation than the current meeting format permitted. Treasury’s efforts to reduce auction release times was cited as one area where quantification is beneficial, but some Committee members were skeptical that Treasury would be able to identify other quantifiable performance measures.  Part of this skepticism stems from Treasury’s issuance approach as a non-opportunistic issuer. 

The Committee identified some measures relating to debt management that may form part of a larger package of performance indicators: bid volumes, auction tails, bid-to-cover ratios, persistence of fails in the financing market, pricing relative to a curve (spline, LIBOR or RP-adjusted swaps, or G3 funding), and turnover or volume in secondary market.  Any performance measures will need to be adjusted for economic and market conditions.  Some Committee members argued that debt management is inherently subjective given the enormous range of uncertainty associated with fiscal forecasts and the dependence on current conditions.   The Committee also noted the unique difficulties faced by the U.S. Treasury which cannot use another issuer as a benchmark.

As to the first bolded statement, the Treasury again states its role as non-opportunistic.  As to the second,  we note only the ominous nature of the “difficulties” that can only be remedied by the US Dollar being replaced as the world’s reserve currency. 

From the Dec 5 2002 remarks of Treasury Deputy Assistant Secretary for Federal Finance, in a speech titled “Treasury is Committed to Inflation Indexed Securities [TIPS]“:

Good morning. It is a pleasure to have the opportunity to speak with you again. Yesterday, I tried to give you a feel for debt management at Treasury as well as our position in the marketplace. We talked about the regularity and predictability of Treasury debt management. I stressed that Treasury is not an opportunistic borrower. We believe a regular auction calendar will provide investors with certainty. That certainty will help translate into broader investor participation which will then help lower Treasury’s borrowing costs.

Ditto.

From the June 26, 2003 Presentation of Deputy Assistant Secretary for Federal Finance Timothy S. Bitsberger to the Bond Market Association’s Inflation-Linked Securities Conference New York, NY:

Why Treasury Issues TIPS

As the primary seller of TIPS, I am frustrated where I talk to private and public funds that view TIPS as the long-term panacea for their ills, but then trade them with a short-term, opportunistic bias. Growth depends on long-term commitment to this market; arbitraging break-evens and carry versus nominals increases one-way liquidity and does nothing to create long-term sponsorship.

Here, the Treasury (at least when being channeled through Mr. Bitsberger) views short term opportunism as a negative.  Interestingly, the very same TBAC minutes from August 2009 that we first quoted in this post, where opportunism is casually bandied about, discusses the negatives of the TIPS (inflation protected government debt) program:

…much of the criticism of TIPS has been based on ex-post cost measures which have shown a high cost.

i.e., inflation makes TIPS a clear loser to the US Treasury, even with gamed CPI–surprise.

From the Sep 15 2008 Treasury Office of Debt Management Director Karthik Ramanathan
Remarks at Real Return USA:

Given the extensive uncertainty Treasury faces, debt management requires considerable flexibility. The recent fiscal stimulus package, in which rebates were literally place into the hands of Americans just 20 weeks after enactment, shows such a need for adapting to rapidly changing conditions. At the same time, our large size makes behaving opportunistically impractical. Moreover, it would not necessarily lower borrowing costs. Financial market participants would likely model our interest rate objectives and anticipate our debt issuance behavior, limiting any potential gains we might hope to achieve.

In addition, opportunistic behavior would increase investor uncertainty and could limit demand for our securities. Therefore, in order to ensure ready market access, we issue debt regularly and in predictable amounts. Our set of instruments consists of 8 nominal issues and 3 inflation indexed issues – a very simple, liquid set of benchmarks which investors can tailor to their needs.

So, until as recently as Sep 15 2008, the Treasury viewed itself as non-opportunistic and did not want to issue exotic debt (e.g., putable issues?).  What a difference six weeks makes.   From the TBAC minutes of Nov 4 2008:

One member pointed out that the reopening was not executed well but that it did help to fix fails, and that Treasury should consider being more opportunistic to take advantage of rich issues. Being opportunistic in this manner may help Treasury fund at low costs while also addressing the fails situation. Other members stated that certainty of supply was a hallmark of Treasury policy. A few members stated that such reopenings however would create a premium on Treasuries due to uncertainty of supply.

Since then, the Treasury has indeed reopened longer dated issues (i.e., issued more of them).  However, the recent wording in the August 2009 TBAC minutes suggests that there may be more than simple “reopenings” in the pipeline. 

One wonders if the “one member” from above is the same as the “presenting member” from the Aug 4 2009 minutes.  Comparing the then members of TBAC to now, there are a few commonalities.  Notably, 

1. Keith T. Anderson (now Chief Investment Officer of Soros Fund Management; then Chief Investment Officer – Fixed Income, Vice Chairman, BlackRock)
2. Goldman, Sachs & Co.  (now represented by Ashok Varadhan, Managing Director; then represented by Gary Cohn, President & Co-Chief Operating Officer)
3. Richard A. Axilrod (now and then Managing Director, Moore Capital Management, Inc.)
4. Ian G. Banwell (now & then Chief Executive Officer, Roundtable IMC, located at Bank of America Corporate Center)

One also wonders if the “short-term, opportunistic bias”, once derided by the Treasury is on the verge of being self- institutionalized.   Part 2 will take a deeper look at the players involved and a Treasury-cum-wannabe-hedge-fund.