A Derivatives Bomb Exploded Within The Last Two Weeks, by Investment Research Dynamics

SLL recently published a guest post, “Is Deutsche Bank The Next Lehman?” (6/13/15). Along the same line is this post from Investment Research Dynamics, which raises the suspicion of a recent derivatives “accident” at Deutsche Bank. There is no smoking gun, just speculation, but Deutsche Banks huge derivatives book, recent developments at the bank detailed in the prior article, the turmoil in debt markets, and the Greek situation, lends some credence to the speculation. If Deutsche Bank is in trouble, most of us won’t know it until well after financial markets have reacted. From Investment Research Dynamics:

I’ve never seen so many sophisticated Wall Street’ers this scared in my entire career. – This comment comes from a very well-connected Wall Street/DC insider and is in reference to how illiquid the bond markets have become.

Something deep and dark has transpired behind the Orwellian “curtain” used by the elitists to hide the inner workings of the financial markets, especially with regard to big bank balance sheets and OTC derivatives. What’s happening right now reminds of the movie “Jurassic Park.” You can hear and feel the monster coming but you can’t see it yet and you don’t know it will pop up in your face or how big it is.

It was the sudden firing of Deutche Bank’s co-CEOs this past weekend – The Brown Stuff Is About To Hit The Fan – that prompted me to spend more time analyzing a sequence of events which indicate to me some sort of derivatives position, possibly at Deutsche Bank, has exploded. In addition, the stock and bond markets have been emitting some curious signals which reflect that fact that something happened in the global economic and financial system.

Let’s look at some charts first (click on any chart to enlarge). The first graph below shows a 1-yr plot Dow Jones Transportation Average vs. the S&P 500:

As you can see, the DJ Transports and the S&P 500 were tightly correlated until the end of April 2015. The Transports hit an all-time high on October 25, 2014, which is about when the Fed formally ended its QE program. The DJT began to underperform the S&P 500 at the end of April. Since then it began to diverge quite negatively from the S&P 500. The DJ Transports are largely made up of trucking, railroad and delivery services stocks. This sector of the market reflects the heart-beat of economic activity, especially as it relates to consumer spending in the United States. The Transports are down 9.4% from its all-time high. I wrote about the collapsing U.S. economy a week ago: LINK The behavior of the Dow Jones Transports is the market’s confirmation that the U.S. economy is contracting.

A collapsing global economic system will exert an unanticipated and extreme amount of stress on highly leveraged financial systems. This stress is “magnified” by the enormous amount of derivatives which are connected to the disastrous amount of global debt.

An even more curious chart is the relationship between the yield on the 10yr Treasury bond and the DJ Transports:

As you can see, the yield on the 10yr Treasury bond has been trending higher since the beginning of February while the DJ Transports has been trending lower. Notice a problem? In a “clean” market – i.e. a market free from Central Bank and Government interventions, interest rates and the DJ Transports should be positively correlated. If the economy is contracting, as reflected by the direction in the DJ Transports, the yield on the 10yr Treasury should be declining – not rising. You can see that when the DJ Transports ran up to an all-time high, the 10yr yield spiked up, reflecting the markets perception that the U.S. economy might be strengthening.

It does not make sense that the 10-yr Treasury yield is moving higher – quite rapidly – while the DJ Transports are tanking – quite rapidly. In the first week of June, the yield on the 10yr Treasury bond spiked up from 2.09 to 2.40, a 14.8% move. This is a big move for yields in just 5 trading days, especially in the context of a rapidly weakening economy. Worst case, 10yr yields should have remained flat.

I believe the illogical movement in 10yr Treasury yields reflects the fact the Fed is losing control of its tight grip on the bond market and longer term interest rates. Note that German bunds have also experienced a similar spike up in interest rates and volatilty. In the context of my view that there was a derivatives accident somewhere in the global banking system in the last two weeks, it could well have been an OTC interest rate swap bomb that detonated.

To continue reading: A Derivatives Bomb Exploded Within The Last Two Weeks

http://investmentresearchdynamics.com/a-derivatives-bomb-exploded-within-the-last-two-weeks/