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.


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