My Dog He Looked at Me..

....And he said, "You better get back to Tennessee Jed."

  1. The Summer added more weight to our old belief that what was "wrong" with the narrative of Fed hikes and "normalization" was the calibration of neutral/normal. Foolish metrics like the Taylor Rule and post 70's history have continued to destroy P/L's .
  2. Our model has put the neutral FF rate at about 1.10% and the recent prevailing effective has been 1.16% ( slightly North of where we think it should be, and recent data has been soft-ish)
  3. Labor situation is beyond tight. Case Study - The consequences of legalized Pot. Experienced field workers are being pulled into the Emerald Triangle (in Ca.) in a ramp up to legalization. Hourly rates are floating between $25.00 and $30.00. The Administration's border policy is keeping workers from moving around freely.
  4. The Fall, with debt supply and widespread material rebuilding, should provide plenty of opportunities to once again short the obligations of the government, a favorite non-grape based pastime.

Dog Watching TV

Chart full term

The Ultra-Bond, an oddly named product for those uninterested in the TLT, rallied 11.5 points from mid -H to mid-J. Over the past few sessions it has retreated about 3 points. The chart above saw an un-remarkable 3.5 BP drop over that period. The blip out of the quarter does not show on the long trend picture.

The relationship between EDZ7 and EDZ8 has collapsed to 39 BP over the rally. Also, during this time the Fed has shifted its policy meme from rate hikes to balance sheet reduction. We have long questioned the concept of raising the operational cost of an unprecedented policy adjustment but will leave the debate alone for now. The "signaling" and "de-leveraging" tactics will be graded by Mr. Market over the Summer. The 39bp spread mentioned above seems far too narrow for even a modest BS drop. Something around 3x wider feels right to me.

Purple Hayes

The Spider Network by David Enrich is a book on the LIBOR scandal set for release on Tuesday. The WSJ posted a tease this weekend. The long title is "The Wild Story of a Math Genius, a Gang of Backstabbing Bankers, and One of the Greatest Scams in Financial History." WOW that's a mouthful ! The story focuses on Tom Hayes as the protagonist villain, a scapegoat for a twisted system-wide farce facilitated by ignorant regulators, powerful banking interests and short attention spans. I know, because I operated as an institutional futures broker on the front lines of the "scam."

Long before the financial crisis, I had prodded the idea of a systemic deceit in the money market in periodic appearances on CNBC's Squawk Box. I would dare say I coined the term "LIE-BOR. The eye glazing and subject changing was as rapid as the producer's jump to the next commercial. But let's not get too far ahead, first some background.

The system was a "faith based" system. This structure filtered far deeper and wider than the yellow metal adoring critics cared to explore. "Money", whether geared up as Dollars, Euros or Yen was not constrained to a printing press and colored ink but free to expand into  financially engineered shadows and shared hallucinations. A kind of reverse Cardinal John Henry Newman - "Out of the world of truth and into shadows and images." (#GIK Ex Umbris et veritatem in imaginibus" !) And it all started with a simple request from the bankers.

LIBOR sets were posted by the BBA after a morning polling that originally asked, "Where would you OFFER money to a like participant for a given tenor." Bid ask spreads being sometimes wide (but rapidly closing) and transactions hypothetical to the poll not the actuality, banks and their lobbyists requested that the language be adjusted to "Where do you believe you could BORROW money from a like participant for a given tenor." When the regulators agreed I am sure those players in the room had to strain not to chuckle out loud. The rest as they say is history, or as the only accurate part of the book's title puts it: One of the greatest scams in financial history.

The public would love to believe that a "socially awkward" Asperger -touched "math genius" led a global team of crooks on an international caper of  'bending a few rules and taking a few liberties with their swapping party guests' but it just ain't so. They, We, I were all involved. The structure and older managers unwilling or unable to question the ever expanding -literal - money making machine gave us free reign to lie away. Like all faith based systems, once the lie was exposed  - that one could not actually borrow at the rate submitted - the system collapsed under the weight of the ugly truth. Tom Hayes is a legal convenience.

So, after all the QE, all the Dodd-Franking, all the LSAP-ing and Twisting, what system am I allegedly believing in now?

2 Charts

Chart last year

Chart full term

Here's 2 charts - Peeps love charts - I check at least once a week. Note the chart on left since July of last year. Despite several bouts of TLT loving hype, the unmistakable direction of this benchmark rate has been ? UP.

My friend @Conorsen has attempted to keep Fin Twitter abreast of these developments.

The chart on the left appears to be approaching the downward slide trend of the last 25 YEARS !

Now, I don't know much about charts as I never learned the language; however, I suspect some dark arts voodoo-ist might be conjuring an If/Then statement something like this: "If level X is taken out, then rates are going up to level Y."

From where I sit, its been happening for almost a year.

Big Hitter the Lama…LONG

An omen that the long dirge of low volatility may be ending is the recent interest of the general public in the mundane operations of Treasury Dept. issuance decisions.  Larry Kudlow began floating the balloon in December and Sec Mnuchin gave the meme a boost by saying, "Treasury was looking into the concept." (Spoiler Alert- TBAC has been "looking into" it for years) The pedestrian argument for issuing 50 and/or 100 year bonds will be played by Dorothy's favorite walking companion thusly:

Rates are low, the duration of government issuance is barely over 5 years, "lock in" low rates now. Oh, and asset/liability maturity matching, but we are losing you, so, the first things.

Here's my longstanding argument for devoting time to more important issues:

The shorter duration of the T pool helps grease the gearing of the financial system through its REFUNDING. The key characteristics to refunding are that the secondary market for the issues is DEEP, WIDE and RESILIENT (the decline in this 3rd characteristic to be picked up later).

To promulgate the vitality of the process, Treasury MANDATES that the issuance schedule will be "regular and predictable". When the duration of the pool began to slide toward 4 years, the IR risk was deemed substantial enough that extending duration became a stated, incremental goal of the department. Then, this little hiccup called the complete meltdown of the financial system scared the bejeezus out of everyone and T-Bills were deemed in short supply. The Fed (the guys that get all the attention) then embarked on a once taboo activity for CBs of buying Yucca Mountain amounts of Ts and such also in "regular and predictable" arrangements and doing a little number called Twist. To avoid getting looked at like a sick patient with his hospital gown open, Treasury back burner-ed the duration extension concept. Translation: The Treasury wisely opted to not appear a TACTICAL issuer, a stigma with possible negative signaling to markets.

Kudlow likes to drop this nugget in his pitch for 50s or Centuries, "Ts held by the public have grown from 32% in 2008 to 74% in 2016." I'm yet to figure out what that means except that it would behoove the Gov. to inflate away those debts more rapidly -if it could, it's harder than textbooks would have you believe -since the holders are increasingly it own citizens, but wait, I heard China might own a fair amount of these babies too ! Let's scrap that idea ! FI practitioners (of which I once was and am considering again) compute a thing we call DV01 - dollar value of a 1 bp change in yield. The beauty in the Eurodollar contract was/is the $1million dollar size (if invented today I bet it would be 5 or 10m) and the constant "always and everywhere" $25.00 DV01. (Think of back month Eurodollars -colored Gyros in Dog-speak- as strings of zero coupons) The DV01 of $1million in 50 year bonds, let alone Century, is roughly a messy couple thousand ! The CME Group would come up with a "Super -Ultra " contract to help the hedging but the development would be hindered by the original mandate issues. And here's the problem that relates back to the RESILIENT characteristic - very few people/institutions remain in the business of making markets and gearing these securities. In fact, if the public knew the small cartel of extremely large players inter-acting with themselves, they would become uncomfortable. The Taper Tantrum and 2014 "Melt-Up" were glaring examples of fissures in the most important debt market in the world.

Here's my advice to Mnuchin and the Trump administration: Concentrate on something more important, like a regulatory environment that promotes more participation in the process.


Unenjoyment Day

4.7% and 235,000 never looked so average. I got up early to watch the talking heads spin their political views all over the number. To think hiring managers have ramped up their actions in a policy environment that has been thrown into flux is new wave economic thinking devoid of foundation.

The focus should have moved away from the Employment data several years ago. Retail Sales should be the market blistering data drop of the month. And yet. Our warning over the last month has been the abrupt drop in retail activity. The sector posted a glaring negative in the otherwise standard advance. The "late tax return" meme holds a tad of water but should be gone by the March print and then, well some peeps may actually owe.

The cognoscenti wasted no time in tossing off rate levels 100s of bips higher than the prevailing. FI practitioners were once again portrayed as hapless rubes mesmerized by the Fed's sleight of hand. Equity boys, on the other hand, are brilz. The incredible heavy force of Europe that has been weighing on the term structure, and is now shifting, was never mentioned. The Fed, of course, was "behind" the "curve."

We still contend it is the SHAPE of that curve that needs adjusting more than the LEVEL of rates. The ghost of the 70s/80s  rates anomaly still haunts people's views 2 generations later. Low does not mean "easy" and Higher does not automatically equate to tighter.

I Bid 43 No Trump

The stock market continued to post new highs last week and the chattering classes battled over politically biased ownership claims. I enjoyed the silliness sipping a Crozes-Hermitage GSM, as my dog had predicted the increase months ago without political affiliation.

First, a few data points: Jan 2015 12 M LIBOR = .63 and EFF = .12

Jan 2016 the sets were 1.169 and .38. and Jan 2017 was 1.689 and .66 and March/April should be interesting.

As we suggested a year ago, the calibration of monetary policy, provided an exogenous mishap could be avoided, would become more powerful over the ensuing months. The beneficiaries of said calibration would be "anything but Treasuries and the economy" in decreasing connection. With the Taylor Rule finally being disparaged publicly by more respected talking heads than mine (@TheStalwart had me on WDYM twice over the past 2 years discussing its flaws), we will continue to monitor policy through our historically more accurate and market profitable metric.

Looking at the simple Jan samples above, we can see that Zirp 2015 was an "equilibrium calibration at best. (FF "should" have been slightly negative) in Jan of last year the metric moved to +.16 and in Jan 2017, +.43. (The higher the number the higher the loose policy efficacy. There is a whip crack effect and a lag, obviously) In  Q3 2015 we suggested that the effects should manifest themselves 6 to 9 months hence.

The SP has roughly crawled from 2000 to 2360 over that long dirge span. About 200 of those points were scored since Nov, more an indication of election resolution than dog whistled victor administration policy possibilities. More importantly, the real economy metrics behind the stock market scoreboard are spotting up after nearly 18 months of positive cluster.

March looks to come in like a Lamb around 1.75 but could go out like a Lion if European pressures that have aided the positive calibration impact here were to abate abate. A steadying, or decline, from the prevailing .43 spread would be a tell. However, spreads of 100 + or - are not uncommon in cycles hitting on more cylinders. Then, historically, the Fed screws it up.

(See Countdown to Liftoff March 2015 in the archive.)

In Other News

--The massive Pilot Whale grounding bolstered the correlation to earthquakes.

-- The 220% increase in Northern Ca. rainfall has caused an emergency spillway breach and evacuation below the nation's tallest dam. Prices for wine have been pushed "sticky" in a post-harvest attempt to curb widespread discounting. The problem is another massive harvest and large increases from non-Napa/Sonoma regions. The dam is not in danger of structural failure, but more rain is on the way. The "heads -up" is for Central Valley growing regions (Spring should be under way) where most bulk grape and large volume fruits and vegetables are produced. (The other place being Mexico, the place on the other side of the wall)

--The shift in winter weather from the plains to the coasts connects to the potential Omega block this Summer in grain growing regions. We will be keeping an eye out for rain at Riviera CC as the PGA rolls in. Also, Titans of Maverick's was canned when Red Bull pulled out but record-breaking waves have been reported.

-- You can see where we are going with this: We outlined earlier our belief that the new administration was policy tilted toward price increases. A supply oriented policy mistake(s) is fundamental to gaining price traction in a world awash in everything. A weather market would ignite the process. Corn for Dec is up 25 cents this year and 20 cents over the front month.

We are not crazy about heavy things that hurt when Garts drops them on his foot. We do think financial assets have been force-fed and stuffed like a Hudson Valley duck during the monetary experiment euphemistically called QE. Any incremental shift into the tiny commodity markets for food would bring limit moves. Craft beer chasing millennial traders would experience their first grain Summer.

We're your Pilot Whale.