Author Archives: Kevin

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.

Lately It Occurs to Me…


..What a long, strange trip its been.

Expansion-Graph-Corrected-2(click to make big like)

The graphic above comes to us from Forbes via the folks a NBER. For all the hand wringing, ranting and denials, the current expansion now ranks in the "Top 10" for duration dating from 1854. Modern Monetary Monkey-business clearly is stacking the deck against history. The credit super-cycle (and its bust clean up) run nearly double the duration of the historical mean and median.

A couple of thoughts: First, as James Burke points out in the still wonderful The Day the Universe Changed, Credit Where it Due 1985the production and acceptance of credit is the fundamental building block of expansion.

Second, expansions don't tend to dissolve of their own volition.

So, will the current expansion just call it quits, like The Grateful Dead in Soldier Field over the 4th of July, or will it Keep on Truckin' ? Enter Janet. The truth is the Fed has precipitated as many contractions as it has pumped up expansions. The "Soft Landing" has fewer economic sightings than the storied, dangerous "Bond Vigilante." The question remains how hard will the Fed be able to tug before called on again for support? As Fed Funds crossed 3.5% during the Greenspan incremental water boarding of the last cycle, a few radical thinkers conjectured that "the farther away from 1%, the more ammo to mop up with."  QE bond buying programs and Twisting Operations will certainly complicate the exit (if it even begins at all).

Here's our suggestion: Run it as hot as you can and provoke the Government to extend issuance now that overt Twist has ended. (A stealth-twist continues as long as maturities are re-invested). Our view of the curve is simple - Steep is good and we need to be much steeper before messing with the Overnight Funding Rate (so happy there's a new kid in town). When deflationary forces are running about the globe, being able to point at the curve horizon and say "There's the inflation" is a positive.

The recent argument in favor of snugging sees the economy as "Sweet Jane, living on reds, vitamin C and cocaine" in dire need of detox. I have to wonder if the next lyric isn't more appropriate : "set up like a bowling pin, knocked down, it gets to wearing thin" but here we go again.


Leaving Wonderland

Today's report on the Employment situation (and the deep sharp revisions) has renewed the repricing for leaving Wonderland. We cautioned at year end that the duration infatuation was a dangerous attraction. I compared the cornucopia of specious reasons for buying to Jerry Seinfeld's rental car agent: Good at buying the bonds but not very good at holding them.

Since Jan., the EDU16 has declined from 99.85 to 98.50. For the end of 2015, implied 3Mo money has gone from .62 to .86.   We were excited to hear from the Fed that they were not enamored with "meeting counting Fed Fund Futures" opinions and would be rolling out an Overnight Funding Rate that included Eurodollar/Libor transactions. The Greenspan mistake, hiking 25bp a meeting, would not be repeated.

In Treasuries, the complex had the worst week since the Taper Tantrum with barely a tremble. The "holding of the bonds" is getting tougher, however. Hooper tagged the downside in daily 5s and Classics. Interestingly, the 10 year  remains in an old pattern from the 10/15/14 crash up. The first objective down is 124.31. Weekly breakdowns target 145.12, 123.23 and 117.31 in Classics, Dimes and 5s respectively.

Leaving Wonderland will not be easy. No CB has ever pulled it off. The negative yields and monetary monkey business in Europe mean plenty of guests are still drinking tea at the Mad-hatter's Party. But attempt to leave, we must. Today, I heard comments from the peanut gallery that are a necessary prerequisite for trouble: "It's a good thing the Fed is going to start and reverse." Spoiler Alert: Its NOT. Here's something else to think about with the market so focused on Millenials - They've never seen a bond bear.


hat tip: Marcy Playground: Leaving Wonderland a Fit of Rage 2009

Farewell and Adieu

The only thing missing was Hawk singing "Turn out the lights...." I started to write a post about my Open Outcry days but I've decided against it. I made my peace with the old way almost 10 years ago now. I'll just say it was the greatest place to work ever and I wouldn't trade a day of it. It was "our thing." I'll remember my floor days for the characters and the experiences. When I look back, I see us all at the front lines of every significant historical event from Continental Illinois to Sept. 11. I view history through the "lens" of the Pit. It was awesome, you should have been there.