Futures portfolio update
The 10 year note futures (ZN_F) got stopped out this morning. I ended up giving back a little over half my gains, netting 39 ticks overall.
Note that volatility hasn't picked up even as the CCI has swung from positive to negative territory.
The weakness in rates markets is across the board - 2Y, 5Y, 10Y, 30Y, and even investment grade corporate bonds (AGG, LQD). However, junk bonds (HYG, JNK) are holding up well, as are financials (XLF). Financials and regional banks are poles apart, as can be seen when observing the on-balance volume.
Financials (XLF)
Regional banks (KRE)
So Mr. Market doesn't want to risk owning safer credits or riskier banks, but is happy to party on with financial institutions that are guaranteed to get a bailout, and low quality corporate bonds.
That's puzzling.
But that's macro for you. It doesn't always make sense. I will be watching for the CCI on the 10Y to turn higher, or for some news that explains the price action. Until then, I'm staying neutral.
Excerpts from the FDIC's quarterly banking profile:
"Unrealized losses on available-for-sale and held-to-maturity securities increased by $39 billion to $517 billion in the first quarter. Higher unrealized losses on residential mortgage-backed securities, resulting from higher mortgage rates in the first quarter, drove the overall increase. This is the ninth straight quarter of unusually high unrealized losses since the Federal Reserve began to raise interest rates in first quarter 2022. Driven by write-downs on credit cards, the industry’s quarterly net charge-off rate remained at 0.65 percent for the second straight quarter, 24 basis points higher than the prior year’s rate. The current net charge-off rate is 17 basis points higher than the pre-pandemic average. The credit card net charge-off rate was the highest rate since third quarter 2011. Looking more closely at CRE portfolios, the upward trend in past due and nonaccrual non-owner-occupied property loans continued in the first quarter. The industry’s volume of past due and nonaccrual (PDNA) non-owner occupied CRE loans increased by $1.8 billion, or 9.0 percent, quarter over quarter. As seen in this chart, deterioration is concentrated in the largest banks, which reported a PDNA rate of 4.48 percent, well above their pre-pandemic average rate of 0.59 percent. The next tier of banks, those with between $10 billion and $250 billion in assets, is also showing some stress in non-owner-occupied property loans. This cohort’s PDNA rate was 1.47 percent in the first quarter, up from 1.35 percent in the fourth quarter and above its pre-pandemic rate of 0.66 percent".
You can read the whole thing here FDIC Quarterly Banking Profile First Quarter 2024
The banking industry remains in crisis, bonds are selling off like there's no tomorrow, and the market thinks there won't be a Fed rate cut in June. In an election year. There's a growing cohort of macro commentators calling for a rate cut, from the CIO of Blackrock fixed income to Josh Brown of Ritholtz Wealth Management to Julian Brigden of MI2 Partners. There's even evidence pointing to how higher rates are exacerbating wealth inequality: US consumers show the Fed its backward problem with high rates: Morning Brief
None of that matters right now. The market is convinced we should all just buy Nvidia and ignore the pain in CRE, credit card borrowings, and regional banks, because the macro doesn't matter.
That will change when the Fed is forced to cut rates. There's still a couple of weeks to go for the next FOMC.
I bought the regional banks (KRE) at $48.14 on May 1, as part of my overall yen trade:
I exited my position today at $47.23, for a loss of 1.9%. I haven't soured on the trade idea, but as with the 10Y, I think it's prudent to wait for a show of strength.
High interest rates haven't stopped the rally in commodities or stocks. Nor has it brought about credit contraction - bank deposits are up from the Silly-con Valley lows. By making major parts of the market uninvestable, it has in fact fueled the FOMO into tech, since these companies have cash-rich balance sheets and are profiting off the high rate environment.
Stagflation is already here and isn't going away. Not cutting rates will only make it worse. The Fed is being stubborn for no reason.
The beauty of the rates market is that interest rates trend. The first cut will be followed by the next cut. The first QE with more QE, and so on. Even the current Fed won't be so wrong headed as to follow a path of hike-cut-hike-cut-cut-hike-hike... you get the point.
When the market indicates interest rate cuts and QE are at hand, it'll be time to buy bonds and banks and ride them for a long time. I think that day is coming soon but I'm not front running the trade.
I'm still long the 2Y September futures (which I bought instead of rolling over the 5Y) and am planning to let it ride, but I won't be re-entering any of the other positions.
Good Trading!
Kashyap