Monthly Archives: March 2011

The Post 4-1 8:31am World

Sometime between a minute and a month after Friday's unemployment report, capital markets will need to adjust to the macro landscape. Margins remain robust despite input increases hoped to be temporary. Profits generated from the rest of the world and a high weighting for financials won't pull the load for the rest of 2011.  Structural global re-balancing has moved DM and EM economies farther apart in Q1. A stark example is the futures curve term structure into 2012 between the US and the EU. Into March, Euribor is 97.68 (2.32) vs 99.15 (85).

The silent "default" that US policy has engineered through growth, inflation and issuance has received incredible criticism culminating with PIMCOs vocal buyer's strike. In fact, it is the process that has kept us from the ash heap of history, so far. The European experience is a text book case of not being afforded this luxurious deceit by the capital markets. We are of the opinion that a messy budget process has heightened the Fed's desire to get out of the Treasury's business with commodity prices flying.

One thing we are confident about: The post 4-1 8:30 world is not the world most have become comfortable with.

 

In Like Chaos – Out Like Complacency

A wild month of economic inputs and global mayhem has essentially left the US rates market unchanged on the month. The SP responded in near identical fashion from the St Patrick's day turn. As readers know, we felt European regional financial stress would have demanded action by that date. EU inflation data at 2.6 has recharged rate hike fears and the Euro is near the high at 142. More craziness in the last session cannot be ruled out.

Fed activity gets a huge amount of criticism both from the outside and. lately, from within. Analyzing the capital market opinion shows that QE remains a significant pressure on negative real rates. The results are most evident when improving economic outcomes manifest themselves in equity prices. We are neither blessing or denying this process, merely observing the market's position. The regional Supply Management survey has been (and remains ) the key data set for us this year. In a rare double bill, the national survey posts 90 minutes after the Unenjoyment Report on April Fool's day. The Fed OMO schedule is conveniently blank.

We closed the last unit core short in the rates complex yesterday and are resisting the siren song of going long. An exploratory short in the SP yesterday morning was also closed as the calendar buttressed prices. We will take another look at 1329.00. The 5 year - our Treasury fave even though 10's and Bonds get the attention - struggles below 116.22. A settle above 116.30 TOMORROW would confirm a "weekly up" (lower low than prior week and close up on week) and pressure structural shorts. In Masters parlance, today is "moving day." You can't win it today, put yourself in position and don't take yourself out before tomorrow.

Automatic Refresher

Futures performance for March is led by Silver, Cattle and Crude. The big losers are OJ, Wheat, Cocoa and the Nikkei 225. The big names in trading - the Buck, Bond, Note and S&P are flopping around + or - .5%.

Doleman Securities in Ireland rates Irish Life and Perm and Bank of Ireland a "sell." They trade at 40 cents and 22.3 cents, respectively.

Month, Quarter and Japanese year end gets a lot of chatter for window dressing. Balance Sheet availability should be equally important given "Refresher #1

Dagong Credit Ratings, a company thrown together to do what the official Chinese government cannot do without hurting itself, bitch slapped the US in its latest report.( Zerohedge has the report on line for a full reading.) Calling US Fed policy an "escalation" in the global credit war that will need to be addressed, a "turning point" is the warning. That China had been propping up the stellar credit nations of Europe was not mentioned.

Mercury retrograde starts today and lasts until April 13. Trends should not be trusted. The alignment is characteristic of choppy range trading.  The SP is patterned for higher first (it is) then lower in this session.

Some tightening in the relationship between data inputs and net change in the capital markets should emerge. The ISMs have been a far more accurate compass than the over-hyped employment situation. The breakdown inside the regional reports has filtered straight to Fed District outlooks.

Do These Guys Even Talk?

The EU is an example of the difficulty of  effective financial reform when core problems remain unaddressed. Reconstructing asset/liability mismatches can be tricky when the "assets" are the liabilities. The US situation is messy but not the same. The political players shows an incredible lack of maturity on the subject. The banks are effectively pushing back exemptions and restrictions on "skin in the game" while relying on Fan/Fred to take the paper. At the same time, no less than 5 proposals are on the table right now to shut down the mortgage giants. The budget process, or more directly the lack there of, is the input that has moved the Fed away from QE.

Despite floating reasons that are more palatable than true, QE is a process of pressuring negative real rates when the zero bound is hit. It is an inefficient process that throws off several types of shrapnel deemed positive (asset class inflation) in the short term. The ridiculous reliance on Stop-Gap Funding has bolstered the restraint camp at the Fed. A budget that is passed and on the table can be evaluated by the Fed. A political football being kicked around government shutdown and the debt limit cannot include the Fed. Certain prominent bond market participants see this loss of a consistent buyer as the primary threat to prices. Expectations management on the inflation front is the other tricky tweak. For all the bashing, the Fed's dilemma is now the result of their own "success"  at monetary pornography.

Finally, the Chinese are going to take another swing at a bond contract. Shelved since 1995 after an influx of insider trading and problems, the product is a necessary addition. The contract can help inflation fighting in a more efficient manner than credit quotas and reserve requirements. They are late to the party. The global paradox grows. The West continues to lurch toward central planning as distrust of free markets and men remains high. The East, from regulation to revolution (to wealth), yields to the force of the Invisible Hand. The US needs to penance our sins and move on, or we will find ourselves on the wrong side of history.

Worse Now

Now that Q 1 2011 is wrapping up, the data on Q4 2010 is accurate enough to analyze. Corporate profit margins were running about 8.2%. The Fed data suggest profits as a percentage of national income was 12.7%. Both numbers are near record results.  Corporate profits were driven by financial firms. Non-financial firms experienced a $10B drop.  The compression that corporate America was under in Q4 must be heavier in 2011 given commodity and energy inputs. More importantly, as the Fed is now fretting, the expectation of prices staying high or going higher is becoming embedded in the public's psyche. From a political standpoint, the results show the effectiveness of Herculean Fed support  for their constituents.

We actually saw Japanese buying in the T complex last night, although prices remain marginally weaker today. Shuffling supply among a host of data this week has been of greater concern to traders than FOMC blustering. A flurry of interest in long end flatteners has popped onto the research screens. The Street remains overwhelmingly positioned long 2s and under and oriented to the near record slope. Hence paragraph 1. The direction of Eurodollars for 2012 from these levels will help shed light on the debate. Having been short for 2 weeks we stated our considerable reduction in exposure on Friday.

Finally, a focused reading of Plosser's "exit strategy" over the weekend resulted in depressing feelings about people in high places. Under Plosser's rigid and predetermined plan, EVERY 25 bp hike in the FF rate would trigger 125B of automatic asset sales. A consistent rise would put the rate at 2.5% and the balance sheet down to "quasi-normal" in 1 year, from start. Market participants are viewed as a polite and docile crowd throughout the process. I could not help but picture Mr. Plosser as the Kevin Bacon character in Animal House during the riot scene. Bottom line, I would put chances of the exit strategy described Friday (and alleged cause for rate movement) being implemented at slim to none.

 

Outside the Fed Tool Box

There are six - count them 6- Fed speakers today. Somehow the focus is on the Chairman's new schedule of periodic appearances after meetings starting on April 27. "Jawboning", "Steering" and "Talkin' about it" are the new wrenches in the Fed tool box. All of this, and virtually everything else, is done for STABILITY. There are 36,000 Google News stories hitting on "stability" and her twin sister "transparency" is trending right behind.

Let's reverse engineer the concept. The transparency objective has been rolling along at least since LTCM. Has the move toward openness ( in the market, or at the Fed ) resulted in less scandal? Fewer crises? A more productive Fed? The Volcker regime was extremely closed and abrupt with its market associations and policy was very effective. In fact, the St. Louis Fed did an extensive study PRIOR to the Greenspan quarter point telegraphed hiking disaster that showed surprising the market expectation was the most effective signaling method. The Fed is slogging through the regulatory landscape in hopes of energizing a weak weapon.

Stability, disambiguation, represents permanence of condition. Markets exist to deal with the paucity of the former. Resiliency  and robustness are far better objectives for policy than openness and stability. The 2008 crisis showed that big markets are not necessarily liquid or flexible. Volume, for the day or for a nano-second on the offer, is a poor metric of robustness.

Our key take away from the Fed Presser announcement is that another swap is being negotiated. The Fed is glacially moving to a phase of doing less and jawboning more. We think the concept has merit because right now they are doing too much. After LSAP ends policy will not be far from neutral based on our model. We expect a lot of chatter to fill the void. In a world oriented toward "buying things", we are contrary because we look to sell. (Chauncy Gardinier likes to watch, we like to sell. It's our nature) I have a feeling the Fed is going on a publicity tour aimed at keeping people like us at bay.

 

 

 

The Deficit – In Practice

Back in the pre-crisis days of 2006, after staring slack jawed at GSE balance sheets for over a year, we penned a semi-tongue in cheek missive titled "In Defense of Deficits." Tracking back to the Clinton administration, we looked at the promulgated "fear" that the surplus was gone forever and a shortage of regular liquid high grade issuance would disrupt bond markets.The 30 year was discontinued and even the 5 year was falling off the screen. So sprouted the credit cycle that culminated with "rolling the dice with sub-prime." (Sub-Prime far too small sector for all the hatred it gets BTW)

In 2007 the Bush administration deficit was a paltry 160B and 1.2% of GDP.  (http://www.bloomberg.com/apps/news?pid=newsarchive&sid=abGA3.0koGV4&refer=us )

The Fed was approaching 14 well telegraphed hikes of the Fed Funds rate and the curve had been flat for months. As Warren Mosler points out in his latest, "the system had insufficient equity to support the credit structure."  Fast forward to yesterday and the Fed's slap down on BAC's penny dividend can be viewed in softer light.

The futility of deficit discussions today is they cannot get past the size of the number. Low is "good" and high is "bad" comes pre-packaged into the debate. The EU situation should be a catalyst to frame the issue differently. CDS is just another trading product dressed up in benchmark clothing. The Fed and their activities should not be excluded from the conversation. The famous Helicopter Speech actually said that setting the rate would be the preferred method of transmission. QE is a much less efficient activity because an IOER regime does not create a new conduit for reserves to flow into the real economy. In fact it creates a repository where the can fester. The $90B interest payment from Fed to Treasury takes place completely inside the government. That 1 payment is $90B that the private sector could not obtain.

The problem is not the deficit (s). The problem is that all debts are viewed as sacrosanct and elaborate shell games are created to perpetrate that myth.  That 10 year yields inside the EU  can be so far from each other while extrapolating 1 year rates geared from the same central bank is a glaring sign of stress.  "Other" sources of funding will either become permanent or collapse, or both. The US term structure indicates a belief that the deficit- to a large degree- will be inflated away. The time to worry will come if and when that belief system breaks down.

The Ceiling and the Floor

As I listen to Laszlo Birinyi  hype irrelevant SP targets for Sept. 2013 (2854 ), the remaining 99.99% of the trading community will try and guess where it will be at 3pm ET. The target is silly only because the capital markets are now about the journey not the destination. In 3 weeks we will hit a different target, well in front of Laszlo's. The floating of 2 week band aids will no longer be tolerated. The debt ceiling is roughly 3 weeks away. The Treasury's deck shuffling will provide a few months of buffer after mid-April. The inability to focus on important domestic issues cannot be dismissed as global crisis triage. Crisis Management for everything is myopic policy and promulgates crises.

I have stated before that I learned economics from Dr. Kenneth Parkhurst and he taught the "Parkhurst Corollary": Concern for public debt is inversely proportional to economic knowledge. The deficit, and thus the budget, is a different animal. With rate structures morphing from "emergency" to "permanent" and QE winding down, the budget should be all over the headlines. The jambalaya of crazy global events has punted this annual political  football right off the page. Prepare for the calendar to force the issue back into the spotlight.

Finally, given the large declines in certain bond markets, US term structures have remained amazingly resilient.  Exploring the short side since Sunday night, the decline is a rounding error in the context of the risks. Relative value trading in the curve and through the stack remains the dominant theme.