Bond Fire: Santa Ana Winds Deal Another Blow to US Economy

Published by Matt Warder on December 4, 2020

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California firefighters have been incredibly busy this year.

Back in August, lightning from the remnants of Tropical Storm Fausto ignited roughly 600 fires across the northern part of the state. The blazes burned somewhere between 1.5 million and 2.1 million acres to the ground… all in the span of just 2-3 weeks.

Beating back the flames was made complicated by both an incredibly strong heat wave and the COVID-19 pandemic. To give you an idea of just how difficult conditions have been, three fires – Rattlesnake, the North Complex, and the SQF Complex – are still active.

And Mother Nature hasn’t stopped, either.

At this very moment, more than 500 firefighters are actively battling a new set of fires in Southern California, after the Santa Ana Winds rose up to spread a small residential blaze over to some nearby brush just last night. The combination of dry air, warm temperatures, drought and strong winds have literally added fuel to the fire, which has grown to cover more than 11 square miles and caused power outages and mass evacuations.

The Bond Fire, as it has been named, is yet another setback to California’s economy, which had already been in steep decline due to a COVID-related lockdown in March. Consumer activity has remained comparably lower there, with Google’s Mobility Data for the state showing a 31% reduction in activity around retail locations compared to last year’s baseline.

Source: Google

Making matters worse, just a few minutes ago Governor Gavin Newsom issued a second stay-at-home order as hospitals in several areas across the state approach patient capacity limitations. Combined with the ongoing wildfire, the twin emergencies are almost certain to drag consumer spending down further.

And given that California itself comprises 15% of US Gross Domestic Product, it means that by the by the transitive property, US GDP is unlikely to bounce back in Q4.

Congress, if you’re listening, we sure could use some stimulus right about now…

Speaking of Shutdowns…

Fortunately, there has been a little movement on the stimulus front.

A bipartisan US$900 million package was introduced yesterday by my home state’s (hometown, in fact!) senior Senator Joe Manchin that called for smaller $300/week supplemental unemployment benefits and $180 billion to be distributed to state and local government relief. And although the bill doesn’t include another direct payment to Americans, it does provide temporary relief from COVID-related lawsuits.

Unfortunately, that plan was almost immediately shot down by Senate Majority Leader and part-time TWD extra Mitch McConnell who is advocating for an even smaller, more targeted relief bill. He and House Speaker Nancy Pelosi resumed negotiation efforts today, as there is one truly bipartisan motivation to get some kind of a deal done soon.

A complete government shutdown.

Unless the two parties pass some kind of spending bill by December 11^th, Congress’s short-term spending bill will expire. And the dysfunctional relationship between the two polarized parties in power means that it a long-term spending bill is almost entirely out of the question.

A best-case scenario at this point might be just to extend current spending levels by another month to kick the can down the road. But that’s no guarantee either, as there are obstacles in that path as well.

The primary obstacle in question is President Trump, who has been a combative negotiator in each of the past budgetary negotiations. He has gone so far as to shut down the government once before, so the odds he’ll play nice this time around were pretty low to begin with. Add in the fact that he has openly threatened to veto the Department of Defense budget unless lawmakers revoke “Section 230” and those odds go down to zero.

The President’s motivation here is to eliminate the protection to private businesses against being held liable for content posted by their users, most likely so he can sue the large tech companies for censoring him.

But as time marches on, the probable outcome here appears to be that Trump’s scorched Earth political strategy will light a “Bond Fire” of his own doing…only this time it might be in the actual bond market.

Yields on the 10-year bond fell slightly this morning, despite weekly unemployment numbers that were better than expected. Lower yields mean higher bond prices, and without any fiscal stimulus coming from Congress, that leaves the Federal Reserve as the only actor that could possibly step in.

What could go wrong?

Speaking of Things Going Wrong…

The last time that happened at scale – back on March 15^th, due to COVID – came after two weeks of constant selling. Ironically, at the beginning of that stretch of dates, coinciding with the February option expiry, the ratio of puts to calls in the options market was at an all-time low.

Source: The Market Ear

Leading up to the March option expiry date (March 20^th), that reversed dramatically.

And this time around, we actually have a similar pattern setting up, with COVID surging, the European Central Bank set to meet on December 10^th, followed by a possible government shutdown on December 11^th, followed by the December option expiry on the 18^th.

Except the put-call ratio is even lower now.

If bearish interim news keeps the market from melting up and market makers no longer have to cover their shares, they’ll start selling them just like they did in March.

Source: Bloomberg

When the put/call ratio is that low, volatility becomes cheap. And just like I wrote back in September, when that happens in a time of heightened uncertainty, the iPath Series B S&P 500 VIX Short-Term Futures ETN (BATS – VXX) is our friend. Adding ¼ tranche to that position here seems prudent, as downside appears limited for the VIX, and upside appears limited for the S&P 500.