Author Archives: Kevin

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?

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.

Equity Futures

Yesterday, the NQ hit a downside pattern and the Dow future tagged an upside pattern. The SP held in above a big weekly level for us. The long stability run may be starting to weaken. A new high will most likely be accompanied by a bearish divergence. We are watching 1964 on the weekly. The daily pattern recalculates on a 1980 trade (almost this morning).

Day traders are packing it in in droves. The Stability has frustrated many. The media is groping for a story and incoherent reporter tirades are going viral. The change is getting close.

These are not the Fed Funds you’ve been looking for

The minutes produced a wave of short covering in color coded Eurodollar strips well beyond the notion of “dovish.” Practitioners were forced to adjust the term structure as Fed staff hinted at revamping the calculation for the Fed Effective Rate. In simple terms, The Committee desires to keep FF an important signaling tool and thus MUST solidify the Death Star spread to ensure that result.

I have been of the camp that FF role could be diminished and replaced by the RRP. The Fed has now made clear that they are NOT going to head in that direction unless forced. Instead, tweaking the Fed Effective calculation to include “other” money market TRANSACTIONS (direct hit to “old” LIBOR) will allow the S/T rate known as FF to maintain its place in the hierarchy of policy change shifts.

In practice, the management of the balance sheet will become more cumbersome. The Minutes entrench a “wide spread” between the Death Star rate and the IOER rate. The testing has run at about 20bp. Our usual radically delusional opinion has been to move the D-Star rate toward 12bp and CUT IOER toward that level. The Fed has now confirmed that they are content to solidify the spread, re-enforce FF effective and create a “sub-floor”. The trick will be inducing participants to utilize the RRP facility to the tune of oh, lets say $400B/day with the spread structurally wide.

My jaded view comes down to this:

1) The Fed was mistrustful of participant and public understanding of the revamped Money System with the Fed now a long(er) term large B/S player in it.

2) They have opted to give a face lift to an old friend, Fed Funds, rather than replace it with a new and potentially nasty toy that is the RRP.

3) Back month Eurodollars (and the Tar Pit of FF futures) are adjusting and being diminished to bland consensus reflections of FOMC forward guidance with little feedback loop input.

4) The shifting, when it eventually unfolds, will not be as benign as the Fed (or its band of subsidized constituents) hopes.



The number one topic since Thursday’s Employment Report has been inflation. Depending on who you listen to, the US is either about to, or already experiencing an inflationary cycle. The idea of inflation – rather than the actuality – is easily attached to in “Sounds right Macro” as virtually everyone can point to something that’s price is higher than before as evidence. The truth is creating inflation is much harder than most think.

In the developed market space, disinflation (and even flashes of deflation) have been far more common over the last 30 years. Asset price inflation has filled the void and created a safe harbor for the Neo-inflationists. The recent drop in the Unemployment rate has sparked a flurry of inflation sightings.

Although we believe this cycle will be scored nominally, we are not convinced a general inflation cycle has emerged. Central Bank(er) focus and QE have promulgated the impending inflation story. Remember the “Dollar crashing” hype of 2010? The reality is the widespread development of derivative contracts act as a huge impediment to a CB that wants more inflation. Consider the economic blowback to the Taper last Spring. Futures markets were able to fast forward to multiple tightenings at the first hint of Fed adjustment.

Volcker showed incredible resolve in cracking the 70′s inflation spiral. His success is highly correlated – but rarely linked to – the invention and use of financial futures. The ability to create inflation in the developed world since the use of these products has become widespread has been spotty, at best.

Even after last week’s solid report, FI futures have rebounded into the growing inflation meme. The energy complex retreated sharply. If and when inflation gains some traction in the US, we fully expect the Bond Vigilantes to ride into town “a whoopin’ and a hollerin’ ” as Slim Pickens used to say, and scare the daylights out of the citizens of Rock Ridge. (#GIK)

All You Need to Know

As readers are well aware, I’ve been fixated on the development of the Fed’s Death Star (and Term Deposit Facility TDF). I have tried to push back against “other” more respected bloggers as to the sanguine nature of these NEW tools. I continue to believe that many analysts are still calibrating their prognostications to a financial system plumbing that died with the credit super cycle,

Here’s a Primer: CBs that “offer” IOER are -by definition- impaired or beholden to systemically important entrenched interests. The Death Star is a Financial System 2.0 operation to help manage big number “on balance sheet” assets. The D-Star and thus, the TDF ,need to be primed beyond OMD “call-arounds” for participating counterparties to play along. Academic side line Pollyanna’s have been telling you the rate should be even with IOER and little collateral damage would occur.

We believed the rate would need to be slightly ABOVE IOER for participants to play along. Others we have respect for have felt the spread could be closer to 15bps. Meanwhile, media pundits yammer on about the Funds Rate and FF futures concept of “the first rate hike.” Dino….meet the Tar Pit.

Here’s the latest from long time market watcher Ray Stone of Stone McCarthy fame (#GIK): The Fed did just shy of $125B in 7 day TDF yesterday at 29bps (4 over IOER) to 58 counter-parties (read minions). The levels needed for sufficient Death Star efficacy is more like 400 to 500B. Remember, the Fed has “electronically produced” nearly $2.7T in balances. Cut to Mr. Stone’s analysis: ”

At some point, the premium will serve to distort the money
    market yield curve, a development that may have adverse
    implications for CP issuers, and ultimately macroeconomic

Don’t listen to me, I’m just a dog watching TV, maybe you should listen to him.

On the Next Day

You make money 364 days, and on the next day you go broke.

- Old Vol selling strategy line

The Central Bank “stability mandate” is starting to give people the willies. Bill Gross extols the virtues of picking up nickles in front of steamrollers at the Morningstar Conference.  The IMF responds with a warning today. Basic market dis-function is apparent with the recent spate of 5 Year specials and creeping increase in “fails.”

Jim Grant wrote a book on the subject in 1996 called The Trouble with Prosperity. On Dec 5 of that year, Greenspan gave the infamous “irrational exuberance” speech (wow even that needs a #GIK now):

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?

Mr. Bubble himself was worried about a bubble.
I feel the problem is seeded in the false goal of “stability”. There is a critical difference
between low volatility resulting from well calibrated policy and policies designed to
suppress volatility, compress credit spreads and guide the duration of those activities.
Someday, the capital markets will break loose of these CB objectives. There will be a
 of pundocats “Nailing it.” The reality will be that significant players will be caught out by the
adjustment. I am not convinced “Day 365″ is upon us but we are certainly long in the count.

Paid With What?

Yesterday, the WSJ posted an article on the pending BNP Paribas “deal” to settle US sanctions. The fines could amount to $9B and a guilty plea is attached. A temporary ban on clearing “certain dollar denominated transactions” is a possibility. Deutche Bank, Credit Ag and Unicredit are watching closely. That BofA and JPM have already forked over $12 to $13B here at home is a shockingly under analyzed fact.

The “fines” are “paid” through a little sleight of hand known as QE/IOER. As Bernanke openly stated in the historic 60 Minutes interview of the crisis, “We just electronically mark up the balances.” In a closed loop silliness only Rube Goldberg could love, EU officials now worry that the fines could endanger the capital and operations of the institutions the largess was designed to help. A frank threat to the US by French Economics Minister Montebourg mentioned “economic warfare” and said, according to the WSJ, “Maybe we should imitate them (USA).” Get ready for EU regulatory pushback while foreigners amount to over half of the reserves on the Fed’s balance sheet.

This, ladies and gentlemen,  THIS is what a Structural Trap  looks like from the inside. Inefficient, entrenched and lax industries are propped up by government subsidy then publicly dressed down. The quip that the Obama Administration’s economic plan was “Full Employment for Lawyers” proves un-funnily true.