Author Archives: Kevin

The Known Unknowns


Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don't know we don't know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.[1]

Sec. of Defense Donald Rumsfeld

I was thinking about the SOMA account today; because, you know, that's what you do on a beautiful Friday morning in wine country, and concluded we are going to be hearing a lot more about this in the months ahead. I put in a call to @interestarb to flesh out some ideas and, as always, the conversation was enlightening.

here's the standard op boiler plate from the NY Fed:

and here's the meaty quote : Under this distribution, the Desk anticipates that the assets purchased will have an average duration of between 5 and 6 years. The distribution of purchases could change if market conditions warrant, but such changes would be designed to not significantly alter the average duration of the assets purchased.

SO, the Fed will see 212 B in maturities over the next year representing the apex of re-investment activities. As @groditi has posted about at various times earlier, the Fed has essentially continued a "stealth twist" on the term structure because of their activities. Their hefty (we have called them "just another big clumsy player" for years now) presence is already a concern as to deliverable supply and squeezes on the contract.

The "known unknown" is the possible change to the investment buckets as a way to pre-pave the road to halting re-investment. I have made peace with the reality that my preferred action would be balance sheet first, then rates but the Cognoscenti do not agree. If they continue to act in the present fashion then curve flattening could accelerate after the initial hike or two bumps into a couple hundred billion in buying. If they shorten the duration bucket - another idea I would be in favor of - then the rising funding rate further works against their own portfolio. A third idea, deemed most attractive by @interestarb and myself, ( thus almost certain to NOT be followed !) would be to stop telling participants where and how much they will be buying.

If they shorten the bucket by announcement, then they would spend countless mind numbing speeches proclaiming the adjustment as "technical" and not a "policy adjustment." But If the go silent, and let the Bid to Covers do the talking for them, a refreshing market price discovery for new Treasury issues could emerge. One can still hope. The distrust of market participants (and thus market prices) runs deep at government operations. Our track record gives them decent right to be wary. However, the still significant (212B this year 180B-ish next) FOMC sloshing around in debt obligations is the prima facie case against sound monetary policy by the most powerful economic force on the planet. The time has come to set a better example.

B.H. – Before Hilsenrath

Greek Crisis Highlights Euro Paradox at Heart of Eurozone’s Plight
Common currency fuels imbalances while curtailing member countries’ ability to address them

Before there was Jon "Jon is it?" Hilsenrath, there was Greg Ip. If an Ip article appeared in the right hand column of the WSJ under his byline, the "sources" were believed to be Greenspan himself. And markets responded aggressively.  I'm very glad to see Mr. Ip back at the Journal where his information can be utilized more quickly than the Economist.

The above quote comes from today's article about the fundamental flaws in the single currency concept that is the Euro. The article is a must read, not just because we have held many of the same critical views here, but because Mr. Ip's by-line tells me participants high in the EZ food chain are questioning the Euro's core mission.

We highlighted some similar views last week here:



Animal House

We haven't weighed in on the Greece situation in a long time for 2 reasons:

1. Its political and outside our core competency.

2, I'm not sure it matters as much as day trading hype believes.

Greece seems to have reached its Eric Stratton moment. The Dean Wermers at the IMF, European Commission and ECB  have already exhausted their 'double secret probation" ploy. Tsipras is left to argue that "although they broke a few rules and took a few liberties with the female party guests, he isn't going to stand back and have them bad mouth the country."

The truth is Greece is not and never was Germany. That they were able to borrow as if they were under the blanket of false hope that was the Maastricht Treaty could not change the reality. All Lagarde's horses and all Junker's men will never put Humpty together again. My only early comment on the "crisis" was and remains, default.

The cognoscenti have pointed to "exit" as if this alternative is the Lehman Moment for Europe. Doubtful. The vast majority of the obligations now reside in various quasi-governmental accounts where bonds go to die. The short term would be difficult and chaotic for locals but survivable. The land mass would remain in the Mediterranean Sea between Italy and Turkey.

All of the bickering has masked the base flaw in the charade. A currency without a country cannot survive. Something more than an idea and good will must stand behind the fiat. The Greek Animal House, slowly spiraling toward 10,000 marbles and a Death Mobile, was doomed since inception. 22 years of college, down the drain.


Last week we opened the door on the anecdotal evidence narrative. (a computer glitch wiped the post out if you missed it) Today's WSj reads like a primer for Yellen and Co. to up their game:

1. Hidden Costs Frustrate Fuel Sector.

Speculators in the RIN are ginning up the price of Federal bio-fuel credits. Forcing foodstuffs into fuels (especially when glutted) always sounded idiotic to us. The story is a classic case of the unintended consequences of good intentions and what the WSJ cooly calls "hidden currency" trading.

2. Black Pepper

About a decade ago, Jim Rogers announced the onset of the "new inflation" and made a large physical bet on pepper. The ins and outs of the pepper market are nothing to sneeze at (ya, I went there) on the colorful drying fields of Madagascar, but McCormick calls the pricing shots. Today's Journal highlighted the "weight-out" case against the spice giant. Basically, the iconic red and white tin was reduced to 3 oz. from 4, which in days gone by was called 25% inflation

3. Mortgage Rates

Tipping back above 4%, the rate structure saw levels not posted since the Taper Tantrum.

In the Piketty-loving section called Mansion; really its called Mansion !, we learn Dr. McDreamy's Malibu Frank Gehry "pad" sold above ask in a bidding war for $15 million. Mr. Dempsey paid a paltry $7M in the blissful market of 2009 !

4. Salt

Chinese state owned monopolies continue to explore busting up inefficient and overpriced commodity industries. It all sounds good, but sugar tells us its not as easy as keeping the prices artificially jacked up.

5. Labor

We made a hypothetical "paired trade" call on Long labor, Short Capital about 6 months ago. In an article that must have Peter Schiff doing an extra stand up set at the Comedy Store Open Mic night, Gold producers are inking wage increases and cutting production. The article shows a Gold Field 3 year contract included a 21% pay raise. In the lower corner of the page, "Activist investors striking back at Executive pay"

We have not abandoned the "Too Much Everything" tilt that dominated the great credit super-cycle and post-meltdown denouement. But cycles have phases and inevitably begin to arc. As Isak Denisen wrote, "Perhaps he knew, as I did not, the Earth was made round so we never see too far down the road" The anecdotal case for higher rates continues to grow.

Pluralitas non

Pluralitas non est potenda sine neccessitate

Get offed by the Black Death and a few hundred years later people will remember what you said, like William of Occam.

Thus 200 years after Occam, Tycho Brahe, benefiting from the highest percentage of GNP ever (still) allocated to scientific research (5%), at the behest of King Frederick II of Denmark, built Uraniborg. Loosely translated as Castle of the Heavens, Tycho over saw an observatory research lab of unmatched status.

Less well known was the excessive amounts of alcohol consumption and binge partying that went on at the site. Tycho was usually in the company of a clairvoyant story telling dwarf named Jepp. Brahe's pet elk died from an intoxicated fall down the castle steps.

Why do we bring up this history lesson? To review our now nearly 2 year disdain for the FI market. In case you've been in a coma, We don't like Notes. Like Tycho, we are happy to wait until the rest catch up to our views of the universe rather than adjust to theirs.

So, from the Sun soaked vineyards of the North Bay, and the clairvoyant musings of a gin soaked dwarf named Hooper, we reiterate: When confronted with 2 competing theories, all else equal, the simpler one is more likely correct. Bonds are going down.

Do Not Bend, Mutilate or Fuld

I woke up today to discover a vigorous "hindsight" understanding of the financial crisis and the fall of Lehman. A mini-Christmas for a left-coast, semi-recluse, front line survivor. The disdain for Fuld (he gave a talk today somewhere) remains high but I was amused by the pedestrian lens that this critical slice of history is being viewed through.

Let's reset the table, shall we?

The big I-banks and the morphing hybrid bank/security firms were all riding the crest of the long credit super-cycle. Securitized mortgages (anything with a time-able cash flow really) were flowing through the system like high octane gasoline. The manufacturing, rating and adjusting anchor to these "things" - it was well known and turned out to be - was completely corrupt on many levels. (Note WSJ article today showing Bcc emails on LIBOR manipulation going to the BOE trade desk !)

These institutions, representing a huge chunk of the SP, were gearing their activities at double digit speeds in recognition that; contrary to the prevailing wisdom that US manufacturing was dead, the business of America was the creation, distribution and accumulation of promised payments. When the music stopped, the regulatory arbitrage that smoke screened the illusion went all the way to the Fed.

MS and GS quickly asked for, and were granted, status as "banks." This allowed the Fed to help them along with the other now exploding giants. Lehman found itself in a tricky spot. Levered up at a higher gear to keep up with its beefier friends, the wholesale funding lock out had them hemorrhaging cash like oil from the Exxon Valdez (#GIK). Unsure of who was to listen to whom, Treasury and the Fed showed a unified voice : We will cover it, but we want the gearing ratios down first. This reality led to the part of the chaos I like to call Fuld's Gambit.

As the others - yeah we're looking at you Merrill - tagged out billions to 22 cent bid lists, Fuld held back, and continued to fund daily in a variety of  common yet sketchy and increasingly difficult ways (Repo 105, nice to see you old friend). This did not sit well with the schphitzing government suits, nor the falling in line competitors. After a few harrowing days, Fuld's tower of promises remained heavily levered as the others had recognized some Costanza-sized shrinkage. The bid would be 45 cents soon, but Lehman had to go for not playing along.

I say, good on you, Dick. You went down with the ship. The others, most now heavily fined, some still revered, remain on the thrones of their hypocritical kingdoms.  TBTF? I'm pretty sure it failed. You might even say..EPIC.

It’s Not Me, It’s You

Madame Chair spoke again today and finally floated a view over the marketplace we fully endorse : She'll adjust official funding rates when Mr. Market tells her, not the other way around.

Rather than join "the bond market is manipulated by the Fed," and "the stock market is just addicted to free money" ranters, we have argued (for some time) that the primary missing ingredient to Fed action has been the prevailing term structure of rates. We put it this way, "Show me the place in color coded Eurodollars that is demanding the Fed to act?" Crickets.

Last week, Matt Boesler of Bloomberg  emailed me a chart of my equilibrium FF model over the actual2015-05-22-ktf-rule

The Fed's aggressively easy stance in 2011 and 2012 are the foundation of the expansion. The more recent readings of sluggishness align with the NEUTRAL policy stance of 2013 and 2014. Policy lags of 9 to 18 months are fairly common historically. I'm of the opinion the Yellen Fed would like to know if Mr. Market is up to doing the heavy lifting, as opposed to the plethora of participants mapping their course the other way around. (i.e. the Fed will raise rates on X date at Y time by Z much and it'll be bullish)

So, on this Memorial Day we not only remember our fallen service men and women but take a minute to reflect on something encouraging, a return to the way things used to be.

Piketty, Mao and Wine


Today from Bloomberg Business "Hong Kong executive makes $22B and this week loses most of it."

So what is Goldin Financial really worth? In his capacious Hong Kong office, furnished with generous touches of faux Louis XV marble and gold, Pan pauses from a game of solitaire and explains.

“It is important to understand the business behind it,” he says. First, the Hong Kong office tower will start generating cash next year, he says. Second, Pan has notified the stock exchange about plans to inject two massive wine storage facilities located in free trade zones of Tianjin and Guangzhou into the company, whose inventories will steadily increase in value as bottles in the cellars age.

“Goldin Financial wants to be the king of the wine business,” he says.

Third, is a factoring arm, which involves buying receivables from manufacturers at a discount. The business, which Pan describes as low risk and low return, will put the firm “into a different playing field,” he says, once it obtains a license to operate in Shanghai’s free-trade zone.

What's that? Wine ? Storage facilities? I'm  listening.

The anger and trepidation that attach themselves to the US expansion like Remora pale in comparison to the realities of the Chinese credit super cycle. Every day, I negotiate sales of library wine to Asian customers. The stock of late-80s to mid-90s vintages is being hoarded up like copper several years ago. The Government has opened up some licencing in the free trade zones for distribution and  wine shops. Wealthy (on paper) Chinese come to the valley to "Make business with" people like me.

The concept is simple: They want me (and other wine producers) to sell them moderate quantities at significant discount so they can ship it back to themselves and mark it back up. I have come to two understandings from the process:

1. The distrust of  government induced wealth creation runs very deep. The objective is to convert Renminbi into anything else as rapidly as it is acquired.

2. After a generation of Communist price controls the concept of "market price discovery" does not yet exist in "modern" China. (Amazingly, discussing this topic with a younger employee last week, the Millenial admitted he had never heard of "The Little Red Book or Mao !" [ #GIK its available on Amazon] Price is "discovered" in accordance with unspoken deals avoiding tax and government officials. Often, customers demanding deeper discounts bolster their terms with, "I pay cash." An homage to the grey market economy they know as capitalism.

The Bloomberg article is a keeper. This individual's massive wealth swing is not the story. The story is a nation creating a credit induced wealth gap of Grand Canyon proportion. The off-loading of the US credit super-cycle to the East will have far darker consequence than the much feared US Government debt "problem." The Piketty Moment will erupt - someday - over there. Until then? Sure, i make business with you, and I don't care how you pay, the tax is on top!


For What Its Worth

"There's nothing happening here, What its not ain't exactly clear. There's a man with a mic over there, telling me I've got to beware."

with apologies to Steven Stills

The bond market has settled back to the levels of March after another period of stretched reasoning as to why you should own it. The SP is also bouncing around levels routinely traded as March came in like a lion and left like a lamb.

Here on the Left Coast prices, wages and especially real estate are all extremely tight. We cannot find workers and Temp Agencies are offering $500.00 bonuses for referrals. This situation clearly does not extend across the country. As we have contended from 2010 on, QE elasticizes the relationship between asset prices and economic activity. The consequence is a rupturing of the belief system that "The markets are telling us something about the future."

For what its worth, what does waffling around  the same place for an extended period of time mean?



So There’s This…

At the beginning of the month everyone was wondering how high the government obligations of respected nations could go. Their ascension has come with an under current of foreboding warnings of "shortage" and "hoarding." Long ago, we posited that the concept of "too few bonds (usually promoted because a CB was buying them)" was a meta-issue. A classic case of "sounds right economics."We have, on the other hand, been a bit of a worry wart about liquidity. Any C Team player now understands that Volume is not Liquidity, so now we can look at the issue more clearly.

And David Schawel pinged this:

"Definitely the first to highlight this issue…

(Twitter confessions). I'm so tired of the bond market liquidity story. Been hearing and writing about it for 3 years"

Tracy is a respected journo and David is a sharp player. I'm not convinced that just because the negative impact of the liquidity change hasn't manifested itself we should be writing it off. PDs have decimated their FI desks, especially in Govies. FF transactions have fallen off a cliff. A whole generation of "T Traders" experience now revolves around bidding a dutch auction and pitching your allotment to the Fed. Not exactly Mensa candidate work. Few have EVER had to actively participate in a Bear. The Taper Tantrum did kinda - sorta happen.

There was an old expression in the Eurodollar Pit (yes, I'm that old); where volume seemed to increase no matter what and then a crisis would pop up, "There's plenty of liquidity until you need to tap it." Then, things just reprice. Bond shortage? i still say "Challenge." Aunt Janet could help you out with a few trillion if you ever freaked hard enough for them. Bond liquidity? Color me skeptical. There may not be "bad bonds, just bad prices" but those prices can get thin and wide on the way down.