Author Archives: Kevin

Buy Bonds, They Said

The recent new highs in the Bond Classic and Ultra contracts came with a host of “this time is different” and war fear mongering explanations. The truth is the Note market was skeptical of these claims. We looked for divergences as the long weekend started. The most glaring warning sign was the dis-interest of the belly as long bonds spiked higher.

This morning, the world is still a complicated orb but the manufacturing news is robust. The contract roll is over. The “owners” look more like “renters”. Bonds may garner all the attention but keep your focus on the belly.

Trouble with the Curve

Everyone continues to talk about when the Fed will “raise rates.” The interesting fact is that the market is unwilling or unable to raise rates despite the heavy Fed-timing focus. A few years ago, Europe came to the harsh conclusion that Greece (and then every other EU country) was not Germany. This led to a blow out in spread relationships and even chatter of countries opting out of the monetary alliance.

Today the German government term looks like this: 2 year -.03, 5 yr .18 and Bund .94. These rates have pushed peripheral Europe borrowing costs back down to historical lows. The Spanish 10 year is floating around 2.28, or 10bp UNDER the US. Thus, although a wide spread still exists between Germany and the “others” (we’re an “other” now) the rates are inordinately low and still falling.

So, why is the topic still, “When will the Fed raise – the anchor – rate?” Forward guidance has crafted a tight relationship between out years in Eurodollars. Flat curves are only visible inside the country. The new wides between the US and Germany indicate stress beyond the calibration of monetary policies. As we saw here in Napa, when the stress builds up, things begin to shake.

10 Yr weekly

The 10 year ran at the weekly upside objective on the Aug, 8 pattern last Friday. The market stopped short of the 127.10 objective. This week has seen a slow grind down into the weekly trap gap Of 126.02 to 125.28. The short base took a licking last week as war news went viral.

The POC (point of control) for the long side is 125.22. A settle below there on Friday would be significant given the “soft” J-Hole tilt being floated over the market. A hold and breach early next week seems more likely.

Acceptance

The Kubler-Ross Model of the 5 Stages of Grief apply to the post-crisis recovery. Denial, Anger, Bargaining, Depression..Acceptance. It appears we have finally moved toward acceptance.

The WSj and BBG have picked up on the dramatic regulatory changes shaping the new financial network plumbing. The prevailing sound bite is “collateral shortage.” This is a prime example of what we call “sounds good macro”.  Ultimately, the system will adjust to the needed capital/collateral capacity to fulfill its economic role. The concept of shortage is a calibration to the credit super cycle apex of the old money system.

The Fed’s recent apprehension of excessive RRF usage is another example of moving toward acceptance. PDs are pulling away from repo funding operations at a steady pace. Yellen’s late night “dovish” comments align with the limited demand for credit and the collateral adjustment to its creation. If this is all there is, there’s something to be said for Denial.

Sp Future

Hooper hit the downside objective of 1895.92 on the daily pattern. We pointed out yesterday in a tweet that we saw 1893 as a target. That number is 1 number down on the weekly break that created a new pattern on Aug 1. The reversal pattern increases with the daily objective tag. Standard op on lowering the stop to 1 number down and new pattern after the close.

The Wrong Topic

The big topic in financial markets continues to be, when will the Fed hike the rate? We believe this meme is a feint, a diversion, an homage to a regime long gone and possibly not returning for years. Long time readers know that we consider “quantitative regimes” to be proper CB orientations in times of unacceptable inflation or disinflation (de). When metrics are moving around in acceptable parameters, a rates regime is proper calibration.

The transition back from Q to R can be a drawn out affair. Coming out of the Volcker Q-Regime, the Fed had (secretly then) begun the shift several years before Greenspan openly discussed targeting the Funds rate. An entire generation of traders had, in fact, never been exposed to the concept. Returning to a rates target is trickier from the other side of the spectrum, the side we are on now. The Fed balance sheet, and thus the balance sheets of the Fed’s biggest constituents, is the issue.

Beyond a signaling device, why would the Fed raise the rate (what rate ?) while the system is loaded up with QE balance sheet accounting? More importantly, why would the Funds rate be the instrument chosen to send that signal? An IOER rate hike amounts to an increase in the “electronic marking up of balances” on Fed accounts. The FOMC and Staff are quick to warn, “Please don’t call this a subsidy.” Institutionalizing a spread, or soft floor, between IOER, Fed Effective and the RRF is an admission of uncertainty with regard to regime change.

We believe the balance sheet should be left to fall by default by a significant amount before anything beyond a symbolic small rate adjustment occurs. Stopping reinvestment is a critical first move.  Time is the second. A CB wishing to return to a rates regime cannot simply ask market participants to ignore the nearly 3T elephant in the room. The post crisis regulatory changes are sweeping. The rates regime officials hope to return to is NOT the regime of the LIBOR based money system of the great credit cycle.

Here’s a simple exercise. Look at the Fed’s balance sheet. Look at the balance sheets of the biggest US and Euro banks. Now ask yourself, why are they talking about raising the rate?

Why do it at all?

We received some interesting feedback on our FOMC choices. Sources tell us the “higher ups” on the Committee are skeptical of actions less than 25bps. The panel doesn’t believe smaller moves can/will make proper condition changes in the economy.

This begs the question : Then why raise rates at all? We were laying out a possible path to normalization. If the concern of the FOMC is slowing credit and thus economic  activity, then raising rates is a moot point. We believe our method would increase confidence and facilitate credit by signaling the end of ZIRP on a “principles” basis. The source information also means the first move will be even more attenuated.

Will It Float?

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David Lettermen has a running bit where he drops various objects into a pool of water and asks “Will it float?” After yesterday’s chat with Michael Sedacca and Vince Foster for Minyanville, I decided to run an experimental matrix of what FOMC movements may attempt next year. Spoiler Alert: It doesn’t look like it floats.

The problem comes from the flood of international cash and low demand for dollar borrowings in the unsecuritized/uncollateralized interbank market. Despite myriad regulatory changes the “old rule” (more like a guideline) that 3 month LIBOR is/should be 14bps over FF continues to calibrate in times of stability. However, as rates are moved upward – in my example with 2 small moves before a 25bp move – Interbank will price in multiple moves (denoted by ++ on chart)…PROVIDED DEMAND INCREASES as we move off ZIRP (a theory we have but could be wrong)

Also, it is reasonable to suspect that Fed attempts to create a soft floor would not be any better with a hard FF target (as before) rather than a range that I suggest here. The range essentially gives cover for the probable consistent downward pressure on FF from “other” sources.
Two possible unwanted outcomes are steady pressure that suppresses interbank rates lower and longer than desired OR a significant jump up in money rate term structures more accurately reflecting the new regulatory environment and the hash reality of the end of “free money.”
GC could continue to trade as if in shortage -like now – in either scenario and there is little support for the notion that heavy Death Star participation will change this.
No CB has successfully exited itself from QE. We are going to give it a go…cue Paul and the band for a drum role….Will it float???

On to the Next

David Kotok of Cumberland Advisors (and his Chief Economist Bob Eisenbies) are friends of mine. Bob and I met at a meeting with Sec. Geithner and he introduced me to David. They are both class acts and their notes are regular reading for me. David has just penned a missive on a shift in Tapering as Tightening. I have a slightly different view but the details are important.

As we know, the pace of Fed buying continues to drop toward a goal of zero by Fall. The size has now crossed under the net new issuance of the shrinking deficit creating “free radical” Treasuries for the first time in quite awhile. Also, and more importantly in our opinion, the duration of the Fed’s balance sheet has approached 6 years. This was the target bucket of QE and longer than I was comfortable with (see older rants). Cumberland’s conclusion is these factors will amount to a shift in rates that results in the initial “tightening phase.”

I may agree with that idea in theory. However, I believe the significant event upon us is/will be the coming market shift to these new realities. The calibration of monetary policy is not adjusting, yet. In a cycle a violent correction after a long trend ,that fades back to trend is a common pattern. The taper tantrum was that event for us. Tops are long protracted frustrating affairs, unlike market bottoms. That a significant community has embraced fanciful new age thinking to justify their lengthy holdings makes us happy.

Thus, the question for us is not whether Tapering (or halting LSAP) is Tightening, or whether or not rates will rise – they will. The focus should be on the fashion in which the shift manifests itself on the curve. The Fed, to the extent they will matter at all, will be an observer of those shifts. We believe the curve is too flat now. We also think the initial adjustment will be embedded in a higher medium term nominal growth path. We continue to believe the 30 year bull market in Treasuries ended 2 years ago and a generational top is being formed.