Author Archives: Kevin

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.


After shooting well through the downside objective on the daily pattern yesterday--- Today's high is the exact Hooper sell point on the Weekly pattern.

It id interesting that for all the back and forth--the SP future has been moving sideways in a broad pattern since November. Tops tend to be long drawn out affairs. A sideways move from a lower level, and a narrower range is not uncommon during a monetary policy adjustment (hard to call it a tightening) like the Fed is outlining.


The Competitive Devaluation of a Meme

Today, in the most telegraphed CB move in history, the ECB outlined a 60B/m NCB bond buying program. The pending action quickly morphed into television and social media labeling of a "Competitive devaluation of the currencies." Say WHAT?

The topic could be expected by book selling "Quasi-conomists" and yellow metal hugging Chicken Little's, but even "veteran" currency anchor Sarah Eisen promulgated the myth. "Currency Wars" retweeted through "finance Twitter all day. That the most significant recent global Fiat event was last week's crash UP re-pricing in the Swiss Franc mattered not to the accepted theme.( A  policy of artificially lowering the Franc's value was aborted. ) If a 24 cent jump in the your currency is a competitive "devaluation", then we're in bigger trouble than I thought.

I could not help but wonder at the tons of luxury leather boots Italy would be dumping on Spain ! Except they won't be. Because, contrary to the phoned in pseudo-analysis of the day - There is Not a competitive currency devaluation going on. As for ECB QE, I'm lost to if it will help Europe. As I said to Lorcan Roche Kelly (who knows far more than me on this), since National CBs do the bidding it looks like PIK (payment in kind) bond buying to me. I am a tad nervous that such an obviously flawed narrative as "Currency Wars" goes unchallenged, however. Also, the Fed is still poised to attempt a dismount with a much higher difficulty factor than the ECB's highwire into LSAP. In fact, no one has ever "landed" it.

Several years ago,  @Fullcarry and I wondered what America would think of "looking like Japan." Contrary to the assumed slight, we focused on America's reaction to relatively low unemployment, a couple points of GDP growth and nary a glimpse of inflation. I guess the answer is totally confused and completely unacceptable.

The Trouble With Openness

Way back in 1996, when I contributed some of my radical notions to a mentor's bi-weekly called Grant's Interest Rate Observer, Jim wrote a wonderful book titled The Trouble with Prosperity (A Contrarian's guide to Boom, Bust and Speculation.) I would be fibbing if I didn't say that the book influenced me deeply. Jim and I don't talk much anymore but its a perfect day to acknowledge his spot on call last Autumn on the "white-flagging" by the SNB. Jim suggested buying 6 month option protection on a rising "Swissie" for cents on the dollar. For those not "ISDA members with a TBTF bank relationship" he liked - as is his thing - buying gold.

For delusional, older, semi-bitter futures traders, like moi, today's SNB action (and the probable action of Jan 22 at the ECB) is another glaring example of the Failure of Openness when implementing monetary policy. Today is a Euro-cross trader's Oct 15. Market participants are merely making logical large scale bets on the openly broadcast narrative of their respective CB. in the glory days gone by, a large Hedgie (say Soros) might have hastened the surrender with a brazen bet. No longer. Color coded Eurodollar players spent months last Summer adjusting to the Fed's nudging only to see the positioning "Crash up" in their collective gaping maws. Euro-crossers, verbally green-lighted by the powers that be, loaded up on inter-governmental sanctioned competitive monetary hot potato. And today? BOOM

Our suggestion has been, remains and hopes to become the abandonment of CB openness around the globe. Could this be the first step back to the old way? Maybe, doubtful. I still recall the dismissive look Andrew Ross Sorkin gave me during a commercial break when I voiced this opinion several years ago. The Fed Watching Community has not been thinned by the CBs statements and pressers. An army of reporters are at the ready to tell us what we've just been informed of. And yet....the losses and position blow ups continue to mount.

The diluted efficacy of policy action remains our biggest critique of "Openness." "Surprise and Do More" is "Shock and Awe" for central banking. The SNB stepped back in that direction today. We constantly remind our customers- "No one has EVER exited." Take heart in the notion - at least for now - that the Fed is still handing $!00B/quarter to the Treasury Dept. The red P/L at the SNB led to waving the white flag today.

Monday Musings

1. The US deficit, according to CBO estimates, declined from $1.4 trillion in 2009 to $506 billion in fiscal year 2014 and is projected to be even a bit lower in 2015. The change is nearly 1/3 of the Fed Balance Sheet and issuance cuts are an under stated part of the bond market "love in." The Parkhurst Corollary comes through again.  At the peak of the deficit/government spending hysteria I went on CNBC's Squawk Box and introduced the world to my mentor's teachings. The PC states- as readers here have heard before- "Economic knowledge is inversely proportional to concern for US public debt." As Bob Rubin pointed out to James Carville when bond vigilantes were still a thing- All you need to do is turn the trend and the economy will do the rest. The decrease in the rate of increase has been remarkable given the moderate pace of expansion. Imagine the impact if acceptance of our other Theory, that we are in a Structural not Liquidity, Trap had been addressed.

2. The Employment release failed to produce a linear day in bond futures. The 3 days to start the year and following concession absorbed most of the potential energy. Players moved into the Reds after several days of solid performance from 5s. I would watch this space closely as it is a battleground for the potential policy friction between the Fed and the ECB. The 2nd half of 2016 is roughly 1.5% and near the recent price high of the stability range. The Fed can reverse engineer a scenario: How do we get there, from here?