Trouble with the Curve

Here we are a few hikes and a few holds down the "Exit" ramp and yield curve tourism is swinging into peak season. Having spent many now non-retrievable hours of my life lead timing and lagging various arcs of said curve into and out of the major economic events of my past life; I present a quick ditty for your dining and dancing pleasure.

I have learned that most curve tourism is focused on the easily digestible slope of the T-curve, a canary with little coal mine exit door location prowess. A small sample of the points from the last mistake and today:

2006 March, May, June FF - 4.75, 5.0, 5.25 (rapid eh?#GIK)

Model Equil FF Rate for same months - 3.95, 4.25, 4.47

That's approx 75bps of stringency the way I look at things and of course a year later the Fed was hacking the rate from 4.75 to 4.25 just as quickly - but far too late.

For reference the 5 yr T yield was between 4.95 and 5.10 over the time frame.

and this is quite jocular -

Presently, you could say the FF rate is 1.37 (right down the middle of the corridor) and the model determined equilibrium rate is 1.44.  Conservatively on the bright side of neutral but fold in a fairly aggressive tax cut and an historically low unemployment rate, and it actually tilts toward a tad "easy" still.

Having trouble with the curve? You're looking in the wrong place.


The New Face of Losses

Yesterday, buried on the back page of the B Section of the WSJ, there was a big dose of graphic eye candy under the heading : The New Face of Treasury Auctions. I highly suggest you give a lookie-loo.

Under the rose colored analysis - "Today, domestic bondholders account for greater than half of the more than $14T in marketable debt outstanding." Less than 15% of T purchases were by foreign investors, down from nearly 43% ! Yay Baby Boomers amiright? Um, NO.

For the 25 years prior to 2009, when the US citizen was less than interested in bonds and bond funds, real yields were higher and inflation was in the strong phase of a 30 year decline. The Street is less involved in Uncle Sam's IOUs than any time since modern financial deregulation. Secured lending is replacing LIBOR wholesale funding as trillions of notional  back month Gyros slowly melt off the expiry. All Bond desks to Janus.

As we have stated on this blog many times before, a seminal moment in markets is a page turn in a history book but years when unfolding. Deemed "Certificates of Confiscation" in the 80's at 5+% real yield and coveted by the public now, Bonds remain our favorite disdain. The WSJ may think its swell that John and Jane Boomer are plowing more money than ever into bond funds but we see it as the necessary action of the end.

Remember the Bond Trader's mantra : There are no bad bonds, just bad bond buyers.

The Structure of Scientific Revolutions – Redux

Living in the Age of Pre-conditioned Paradigm Fail

First, from Kuhn:

Chronologically, Kuhn distinguishes between various phases.

Phase 1- It exists only once and is the pre-paradigm phase, in which there is no consensus on any particular theory. This phase is characterized by several incompatible and incomplete theories. Consequently, most scientific inquiry takes the form of lengthy books, as there is no common body of facts that may be taken for granted. If the actors in the pre-paradigm community eventually gravitate to one of these conceptual frameworks and ultimately to a widespread consensus on the appropriate choice of methodsterminology and on the kinds of experiment that are likely to contribute to increased insights.[10]

Phase 2- Normal science begins, in which puzzles are solved within the context of the dominant paradigm. As long as there is consensus within the discipline, normal science continues. Over time, progress in normal science may reveal anomalies, facts that are difficult to explain within the context of the existing paradigm.[11] While usually these anomalies are resolved, in some cases they may accumulate to the point where normal science becomes difficult and where weaknesses in the old paradigm are revealed.[12]

Phase 3- If the paradigm proves chronically unable to account for anomalies, the community enters a crisis period. Crises are often resolved within the context of normal science. However, after significant efforts of normal science within a paradigm fail, science may enter the next phase.[13]

Phase 4- Paradigm shift, or scientific revolution, is the phase in which the underlying assumptions of the field are reexamined and a new paradigm is established.[14]

Phase 5- Post-Revolution, the new paradigm's dominance is established and so scientists return to normal science, solving puzzles within the new paradigm.[15]

Following the chronology from Reagan to Obama, our government (and thus aiding the learning curve of others) realized its utility expanded in the anomalies outlined above. In other words, policy implementation accelerated under 'crisis management.' This idea was then twisted by the out of power party (the Democrats) into a guidebook cloaked as a critique called The Shock Doctrine by Naomi Klein. Hence, institutions perpetuate a Phase 3 state, exiting the established paradigm but never solidifying the new.

The last year has brought the idea of living in the Paradigm Fail to clearer focus. Policies are cast aside for the casting not necessarily the replacing. The Fed has seen its policy implementation morph under the same Paradigm Fail Phase. The policy debate remains stuck on the actions taken over the last 8 years and now, their unwinding. Little discussion emerges on what the post- unwind structure will look like, nor what its guiding principles would be. Reloading before the next crisis appears to be a thought.

The next crisis will not require the same remedy. The series of events from 1983 to present that define the Age of Paradigm Fail did result in enormous and sometimes radical policy implementation in Monetary, Geo-political and Social arenas.

Kuhn did not see societies getting stuck in or between Phases.

A science may go through these cycles repeatedly, though Kuhn notes that it is a good thing for science that such shifts do not occur often or easily.

"A good thing?" That's a value judgement. The revolution is the status quo. The VIX is the anomaly and the screaming proof of getting stuck in a failed paradigm. When fear and chaos are the normality, their "gage" is calibrated too low.

Sept 7 Below

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. 

Sept 8 10 yr future - 12728

Oct 25 10 yr future - 124.06

and you're welcome. But remember, the fed buying less and less of said debt and rolling down its BS is not a negative...I heard everyone on TV tell me so !


Sons of 1984
Open your eyes and see
The world I couldn't change for you
Reach out your hand and take
The world that will belong to you
We were on our way to a better day
And the spirit was in us all
But as time went by we fell by the wayside
Maybe you'll be the last to fall
You are the only ones
There is nobody left but you
You are the chosen ones
There is nobody else to choose
Back when I was young, my hope was strong
But the time blew it all to hell
If I thought I knew what was good for you
I would have gone and done it for myself
Worlds of tomorrow
Life without sorrow
Take it because it's yours
Sons of 1984
I can still see the great panorama of hate
Being cleansed by our loving hands
But the brothers broke stride, the sisters cried
Now you have to start all over again
Songwriters: Todd Rundgren
Sons of 1984 lyrics © Warner/Chappell Music, Inc

The Wildfire of the Humanity

With due respect to Tom Wolfe.

I phased myself out of day trading and micro-bracket analysis several years ago. It was a long a gradual process - there is no methadone for generational animals like me, only isolation and rehab. Now and then, I feel drawn back into the muck to weigh in on the "sitch" .

The current social fragmentation was forecast years ago by numerous commentators. I recall being on CNBC with none other than Mr. Art Cashin when the growing wealth gap was discussed in terms of "ripping at the fabric of society." The shocking aspect is the fragmentation - now called tribalism - is occurring in the long upswing of economic activity and employment. If you hearken back to the financial crisis, many pedestrian thinkers voiced optimism that the financial destruction was occurring with LOW unemployment rates. In actuality, this proved to be no buffer as the socio-economic costs would be heaped on the already fractured financial system. (As opposed to a normal cycle in reverse order.)

Today, as everyday, the level of "the market" is pointed to in a variety of "sounds good" analysis indicating - simultaneously - the strength and impending implosion of said market, The 30th anniversary of "The Crash of 87" (once called just The Crash, but now merely a top 5-er) is a good time for perspective: What did "the market" tell us about the world when it strted to ripple that August? Nothing. What about Continental Illinois 3 YEARS EARLIER ?!![ Actually was the largest bank failure in US history, and my first FTQ.] A surprise? Nope, my Economics professor, Dr. Frank Navratil, had laid out exactly how it would occur almost 2 years prior.  NADA. Worshipers from a host of ideological and graphic religions will sermonize their Nostradomic  warnings of the events. It changes nothing. The gyrations of the mid-80s are significant only because they ushered in the era of activist central banking - often derogatorily, sometimes factually called "bailouts" - that dominates policy today.

The latest risk to that 30 year evolution is the potential nomination of John Taylor to the Fed Chair. The greatest asset in the modern CB tool box has been flexibility. The Greenspan/Bernanke Feds should not - and I believe will not - be judged on the actuality of their policies but on their willingness (mistakenly by AG and presciently by BB imo) to explore the social boundaries of the institution. Taylor would attempt to revert the CB to a rudder steerer, most dangerously navigating by a seriously flawed compass, The Taylor Rule.

My worthless opinion from here among the vines is the potential for screwing it up at the Fed has risen significantly. I have long argued there is no hybrid ground between a rates regime and a quantitative regime that many subscribe to now. Mr Market will judge Taylor to be the rates line in the sand. The curve is as flat as its been in a decade already. My advice would be to concentrate on the BS and let the curve run wild, free and steep. An economic downturn, even a marginal one, with the country this frayed could morph into  social collapse.

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?