Author Archives: Kevin

Here’s the Thing

Greg Ip is wrong.

Yesterday, veteran economics reporter and former Greenspan mouthpiece (he was Jon Hilsenrath before Hilsenrath #GIK) Greg Ip penned a story explaining that the Fed had already tightened. A litany of anecdotal evidence was presented to support the theory. The base idea was: By vocalizing their intent, the Fed had nudged markets to the future event pricing and done the Fed's lifting for them. If only.

In fact, beyond Treasury/Corp spreads widening, there is scant evidence of market "tightening." Futures prices (forward forwards) have been wary to stray far from the well advertised Fed exit plan. Consider a path with NO Fed jawboning - the way things used to be . Markets would have dropped bond prices, widened spreads and flattened the curve. As Europe crumbled for the umpteenth time, oil prices collapsed (because there's too much of it) [causing the large amount of speculative notes issued in the space to falter] and the US data slipped, rates would adjust lower some until a clearer view of the future emerged.

Well I'll be damned. That's exactly what transpired. Never mind that the most basic gauge of "tightening" - the Bank Lending Survey - continued to show accommodative tilt throughout the zigging and zagging. No, Mr. Ip, the Fed has not already tightened by flapping at the lip. Markets have not done the heavy lifting for them. Our core theme of a Structurally Trapped economy continues to evolve as the Liquidity Trapp-ers change their story. And some start to make things up.

Martini Musings

Last week, I posted some thoughts on the Minutes that provoked some debate about Fed Exit Sequencing (a fancy way of saying "stuff"). The post led to some exchanges from fun follows like Boes and Klein and "the K." One of the more lucid stances comes from my friend (yes friends have different opinions) Mark Dow, here in his tumbler, Behavioral Macro

Mark and I became friends exchanging ideas over Twitter and martinis at Nobu in New York. Although our conversations are more about dogs and the beach these days, he's a brilliant thinker and brings an incredible experience to the table. That said, I see Fed Sequencing risks in a different light.

In the protracted advertised hikes leading up to the Financial meltdown, we (and others) railed against the Greenspan experiment. Bernanke, you may recall, was practically cornered into hiking to start his tenure or risk the Dove label. This hike took place despite high real rates, an inverting yield curve and spiking oil. Because the increment and timing of adjustments had been predetermined, the system was able to avoid de-leveraging despite the above mentioned characteristics. This is key. Although the ghosts of LTCM floated about, the financial institutions were the real geared monsters. Morgan Stanley and Goldman were running at least 15x. Lehman was well north of that. Citi? Well, they were insolvent by many measures. Fast forward to today:

Regulatory changes have plopped assets on the balance sheets of the system. IOER (the Advil of damaged banking systems) has replaced the wholesale funding operations of Fin System 1.0. As Jamie Dimon (and his CFO) have pointed out, these Fed created "assets" are unwanted and relatively useless beyond regulatory filings. What is the logical reaction to raising the funding cost of an unwanted asset? Correct, it is to purge it, and shrink the system by design.

Thus, inching up the Funds Rate faces 2 conflicting pressures not relevant to the old system. On one hand, funds outside the Fed accounts can cap over the raise. On the other, The Death Star, Term Facility and internal term structure funding positioning, could lock up the new system much quicker than the days of the off balance sheet wholesale funded credit orgy. Although, I respect the "risk diffusion" argument, I am skeptical the risks are identical to the last experience. And again, the worst offenders were the system anchors themselves.

I continue to advocate a balance sheet approach to Leaving Wonderland. A quantitative regime needs to operate with quantitative tools. Applying Interest Rate Targeting Regime blunt instruments to multi-trillion dollar balance sheets reeks of Mid-evil Tonsorial blood letting to me.  As I stated last week, Fed flexibility has been their finest attribute. Let's hope the haven't lost it. And keeping reading and listening to the heavily armed Bonobo (Mark Dow) after all, I'm just a dog watching TV.

Got a Minute ?

The Fed Minutes once again provided some interesting substance to the over analyzing and parsing of statements that "Fed Watching" has devolved into. None other than Jon Hilsenrath (Last Board's "IT" Journo ) weighed in with a great piece this morning.

Last year, when many of us still held lollipop dreams of rate hikes and Death Star firings, we suggested tweaking the balance sheet and reserves was a more practical place to start than adjusting the funding rate. We were quickly brushed back by a plethora of younger (and obviously wiser) practitioners copying and pasting Fed statements on the order of exit.

Yesterday's Minutes showed several (many?) FOMC-ers with similar concerns to ours.

From Hilzy himself today:


"In March they agreed they might need to ignore their own cap, according to the minutes.
Fed officials also entertained ways to eliminate reserves more quickly than planned, including by selling some securities before they mature or allowing some to mature without reinvesting the proceeds. It is striking that they discussed new strategies for eliminating reserves at the March meeting"

What's that you say? "Striking"? Well, yes and no. What's striking is the modern incarnation of a Fed Watcher is someone who can read. What's striking is that despite a very solid track record of ingenuity and FLEXIBILITY, the populist view of the FOMC is that of a gaggle of clowns.  In fact, since the halcyon days of TARP, Fed Flexibility has been its strongest trump card. Considering alternative routes (1 that we advocated) down an exit path NEVER successfully navigated in modern Central Banking is reassuring. The mantra of a quality Fed Watcher remains "watch what they DO, not what they SAY."

Countdown to Liftoff

According to the talking box in my living room, the Fed is going to raise the overnight funding rate and (insert thinly developed quasi-logical market reaction here).

Yesterday on Rapido the always refreshingly frank Josh Brown of Ritholtz Wealth Management responded to a condescending anchor inquiry with, "How could I know what the market will do? It might go up it might go down." The producers don't like it (I know from experience) but the answer is honest and accurate.

Here's a brief history from our data base:

Jan 2011 -- .78

Jan 2012-- 1.13 (Arab Spring, Hungary, EU debt mess)

Jan 2013 -- .84

Jan 2014 -- .58

Jan 2015 -- .63 Today .713

In Jan of 2012 Germany had the lowest unemployment since 1991 and Spain had the highest ever recorded. The data set show that the only "rate rise" feedback from the money market over the last 5 years has been crisis induced. Our model suggests an equilibrium level of FF (Fed neither easy nor tight) of .11 today. Hmmm, the actual rate is 12-11.

If the FF window goes up to .12 to .37 and settles quietly around 25, then the money rate will need to go to AT LEAST .85 (given a first move, several more should filter in suggesting a rate over 1%). If not, the Fed moves to a "tight" calibration too quickly. The like rate for funding Euros is a paltry .21  ! This dislocation will increase the difficulty of "flooring" the Funds rate and - wait for it - possibly force the firing of the Death Star in real time.

The SP has been +1.25% down .6%, up 1.35% and down .45% in the last 4 sessions. What's it going to do tomorrow afternoon? Pulleeeease !

We’re All Free Riders Now

Melvyn Krauss wrote an interesting piece in the Weekend WSJ on "QE Could Spur Reform in the Eurozone." Its worth a read.

The article points out the "skepticism" of QE "centered on the free-rider problem - that the more heavy lifting ECB does, the less European politicians will do to promote stuctural reforms." Krauss makes an argument that Fed detractors and "QE_Birthers" here at home should consider: Deflation and harsh economic conditions have not pressured periphery governments into reform, as many have advocated here in the US.

The example does not hold much beyond the surface as most recognize the European situation is flawed at its core arrangement and the debt and interest rate differentials are more realistic than the pre-crisis fantasy that all the Euro parts are equal. In the US the narrative remains stuck in evaluating the Fed in terms of the stock market and dollar exchange rate fluctuations. This is a pedestrian view of Quantitative Monetary Policy.

The question Fed members will be addressing this week is "What are the consequences of lifting the floor on the funding rate of the post crisis financial system." In the old days the system wholesale funded itself (much off balance sheet) with non-securitized non-collateralized transactions linked to the lie called LIBOR. Not anymore. The system funds itself through securities funded with the collateral of other securities. The Fed has created a massive bank asset called excess reserves. Structurally, banks do not, will not, need not ever bid for deposits through the rate channel. In fact, as JPM indicated last week, they don't even want the deposits the Fed has hoisted upon them. (A brief chat with Matt Boesler last week, @boes_  , made my day when he concluded "Everything you've been saying is happening in a widespread and profound way." Thanks Matt ! ) So the question of raising the Overnight Funding Rate Range" is more complex than under a rates regime.

What benefit (against what cost) can be isolated by lifting the transaction expense (Floor) of the system plumbing? That a large dislocation between us and Europe will grow larger is only part of the puzzle. The flow will increase the difficulty of lifting the floor rate. An under appreciated reason for attempting the lift is the expansion is now of normal duration and creating the ability to cut (later) is essential. Parsing the statement is a convenient diversion from the critical truth that we have no experience with non-zirp QE regimes sufficiently supporting their economic systems. NONE. The Fed finds itself on a precipice contemplating a leap of faith : "We need to find out if we can do this"

But Then Again…This

The first Friday of the month arrived with the usual combo-platter of noisy data, thin economic assumptions and perma-pessimistic detractors. We believe a fundamental observation is being overlooked.

The Federal Reserve's central policy calibration remains QUANTITATIVE. The news feed is a steady stream of "Fed hikes here" scenarios and "This is good because stocks go up when the Fed hikes" mumbo jumbo. (The latter being a Michael Jordan can fly "truth"...i.e. For a little while)

To begin, NO Central Bank has EVER exited a Quantitative Regime. The Fed is advertising something called "Lift Off" but that is a euphemism for "We are going to change the funding rate of the Regime Operation." Long time readers will note that we believe this is a mistake but the key point here is, because of re-investment and balance sheet size; the quantitative central tendency remains in place. "Rate-Normalization" predisposes an abnormal state now, an assumption even bond bears like us have questioned.

The rapidly developing disconnect is the application of Rates Regime targeting to the well advertised pending change. Policy makers and market participants are taking an optimistic view of transitioning the Hillary Step of monetary policy. (#GIK- the Hillary Step - make it or die) Given the disastrous results of the Greenspan rate targeting, open incremental adjustment cycle, (when Fed Bal Sheet size was puny) a more robust debate about Fed orientation and intention should be taking place. The Death Star and development of the Overnight Funding Rate may turn out to be new tools for the wrong job. Electronically marking up the balances of accounts at a faster pace with Trillions in stock means we're not out of Wonderland, yet.

Monetary Policy Forum

The Chicago Booth School held its annual Monetary Policy Forum ( Hey they use my book there !) today featured a panel on the Equilibrium Fed Funds Rate. Long time readers know this is a topic near and dear to me, as I have been a vocal anti-Taylor Rule instigator and have had my own "model" since the early 1990's.

Steven Beckner summarized the panel views in a long BBG piece earlier today. The key take away being:  "If the "equilibrium" interest rate has fallen somewhat,the Federal Reserve might need to delay raising interest rates, but if it does the Fed will likely need to raise rates "more steeply" later."

The panel disputed the Larry Summers' promulgated view of a secular decline in growth rates. Here's my view from the Left Coast:

Skipping past the math that led to my neutral rate calculation, a simple way to consider my view goes like this - If you start to build from the FF rate you don't get "clean" feedback because the first input may not be in the "appropriate" place. ( The Taylor Rule is built on inputs that are subject to huge revision and time delay making it useless from a policy steering standpoint.) Thus, I use a rate that is influenced both by the Fed's present rate stance AND market participant pricing -  12 month LIBOR. [ IMPORTANT: These metrics assume a return to a Rate Regime - a primary orientation NOT yet achieved by the Fed.]

So, looking at just the recent past, we see:

This date last year; .56

Last month: .62

Today ; .67 ---

Subtract the constant of 60 bp and voila, you have the Equilibrium Funds Rate or, roughly the prevailing rate 7-12. (smart guys like @groditi can build you all sorts of cool graphs if you ask nicely) Point of parliamentary procedure - By equilibrium we mean the rate at which the Fed stance is neither stimulating nor inhibiting growth. The "neutral" rate, a monetary policy maker's nirvana. In our brief snapshot we can determine that the Fed was "assisting" the negative neutral rate with LSAP. As the rate adjusted up, (no change to official FF rate) policymakers tapered the buying. As we've stated numerous times prior, contrary to popular delusion, the Fed was not/ nor could be as aggressively stimulative as many concluded simply because the official rate was "ZIRP." In a post credit super cycle burst, the equilibrium rate fell to zero/negative. Despite heated ranting from famous detractors, if the market was left to determine the rate it would have eventually found the zero bound, according to our work.

Suspending your disbelief for a second, I would pose this question: Given the prevailing "Neutral Stance" and the observable data inputs (inputs that as a cluster support the equilibrium view btw- moderate growth/ low inflation) Why should the Fed need/want to raise the rate? In fact, despite all the jawboning, if the Fed were to act under the present term structure, we would deem the action PREEMPTIVE. With debt deflation still a real concern for much of the developed world, preemptive rate hikes seem dangerous to us. The long lead time to action is a function of the market's inability to adjust away from ZLB as much as policy makers FG promises- which have faded without violent market rate upward adjustments.

Conclusion: The Fed has time to wait on raising the rate because Mr Market says so. When/if the market rate is able to stretch from the ZLB, the then "behind" Fed stance will become temporarily MORE stimulative, advancing late cycle positive consequences suggested by @ivantheK in yesterday's stream. (Example: 12 month rate rises to 100bp on improving outlook and Fed official rate moves to 25 -50 window. Market prices middle at .37 -still pretty neutral (100 - 60 = 40) ! If 12 month money continues to rise, a big if given the world, the pace and strength of Fed adjustments should adjust accordingly behind it.



Selling the Storyline

"In general we look for a new law by the following process. First, you guess. Don't laugh, this is the most important step. Then you compute the consequences. Compare the consequences to experience. If it disagrees with experience, the guess is wrong. In that simple statement is the key to science (and for me, trading) It doesn't matter how beautiful your guess is or how smart you are or what your name is. If it disagrees with experience, it's WRONG. That's all there is."

Richard Feynman

Mute the Fed

The hue and cry from the "protectors" of citizen's rights to "Audit the Fed" is trending faster than NPH in tighty-whitey's. Here's a better idea - Mute the Fed and reboot the concepts of consequence and loss to the capital structure.

I received an email from an old friend and mentor the other day that was a stream of consciousness series of questions. Most, I and he, had long ago formulated the answers to. One, stood out in the "choir-preaching" however: When did the divorce between faulty thinking/poor decision making and negative consequences take place? The answer, in my mind, is shortly after the Fed decided to tell you what they were doing.

The Fed Chair is now just the Mayor of Lake Wobegon, were everyone wins and all the market participants are above average.  The near month long retreat in bond prices is only the latest example. After spending the first month of the year listening to a Whitman's Sampler of convoluted and hack reasons for owning long dated securities, the 3 week (and longest since Taper Tantrum) slip has - we are to believe - harmed no one. I have one word to interject : CHALLENGE.

Maybe, just maybe, what Ms Yellen was trying to say today - in between the moronic "Audit" theme - was someday soon market participants will need to think for themselves again. That the concept of price discovery will provide policy makers with needed feedback on the state of the world. That you, young Titan of the Universe, will be introduced for the first time in your vaulted career to a little ditty called LOSS.