Monthly Archives: July 2011

Us and Them

The European session has pushed the US circus act into ring two this morning. The Bond Vigilantes are alive and well and rough riding allover the BTP. German Bunds continue to anchor the "quality" side of what appears to be capital flight concentration in the EU.

The US situation is a self inflicted wound. The Nattering Na-Bobs were quick to grade the 5 year auction a C- on a 2bp tail. The real take away is the incredible lack of liquidity in the complex given the constant drum beat of supply. A sloppy placement of real magnitude looks to be on the horizon but not the 7 year today.

The key distinction, for all the ugly politics here, remains refunding over rescheduling. The measures of the ECB and EFSF are merely precursors to an eventual default/reschedule. Greece has played the game wisely, go big and go early. The US should be utilizing the chaos to refund as much term debt as possible, as smoothly as possible.

Finally, the cognoscenti continue to be of the view that a move to AA in the US is a non-event. The short lived spikes in Japan dominate the data. Upon closer review the debt of Portugal, Ireland and Greece also conform to the SHORT time frame concept of post-downgrade stability. No one can argue that downgrades didn't matter, or came to late, in those countries now.

Ben Affleck – tea party icon?

The low point in American political debate took place last night when Tea Partiers used a clip from The Town to somehow bolster their resolve. Never saw it. I would also add that I think Casey's work is better. If this doesn't mark the official "shark jump" of the debt ceiling - budget fiasco, I don't know what will.

I continue to avoid the Pavlovian "buy something/anything" conclusions of the chattering class. Markets are washing aimlessly through old Hooper patterns and no longer term conclusions should be made. Once the budget emerges, austerity measures will have to align themselves with still optimistic predictions of second half growth.

How the Fed Fits In

Thinking back to Spring when the data began to slide in earnest, the Fed began to publicly extricate itself from the Treasury. The mess that has erupted shows the Fed's move was a smart one. The extreme balance sheet holdings do have some unintended consequences, however. The open promise to do more if the economy drops out has clearly emboldened Congressional game playing. The Fed is wise to be as close to the sidelines as possible with no budget to evaluate but negotiators on both sides must feel The Bernank will monetize their mistakes.

The largest holder of US Treasury debt is now ourselves. That large position has helped mitigate what would have been THE debt ceiling/budget scare tactic. With all he press conferences and fear mongering, few have turned the China card. Japan would have little reason to sell. China, however, is already diversifying its reserve balances and could be far more vocal in their displeasure. Culturally, I would suggest decreased participation is more likely than dumping. I  keep coming back to a rare interview from 2 years ago with the Managing Director of the China  holdings: "America must learn to be nicer to the people that lend it money."

Systemic Disfunction

Whom the gods would destroy, they first call promising.


We are all being forced to follow the budget mess hour by hour. The process has now morphed into a sick hope that markets will collapse and demand action. That a "scorched Earth" gambit is being played out at 15% unemployment is shocking. The air is being sucked out of the room and markets are not levitating as many has predicted last week.

The circus is going to pack up and move on. The only upside is this freak show has an expiration date. The slew of Treasury paper the system has to digest this week should be messy. Europe remains on the brink of managed default. The lack of growth has put State budgets back on the radar. None of this makes us start a discussion with, "We  should buy...:

Perpetuating a Myth

The Age of Activist Central Banking is in its zenith. The calls for fiscal austerity around the globe are underpinned by the belief that CBs will do anything to support the system. Monetary policy as a tool has morphed into a Mulligatawny of facilities, activities and  charades all designed to perpetuate a myth. The myth being their own significance. Forget hyperbolic rants for the Fed's dissolution. Central Banks do have a simple necessary  purpose. The Fed and the ECB are losing efficacy because of classic mission creep.

The reality, coming to the capital markets near you soon, is the disappointment that results when the myth explodes. Never in history has so much chaos been heaped upon the world all in the name of "stability." Stability is a condition not a policy objective. The clamor for austerity should include Central Bank interventionist ka-noodling. As monopolists in moolah, they can target price or quantity. The Fed moves to "quantity" at interest rate extremes. The ECB clings to a price target while running a closeted quantitative mess. Expect less from your Central Bank and they will disappoint you less often.

The financial crisis allowed a misconception to solidify as a "given" : Markets are evil and destructive and thus, must be ring fenced. I don't subscribe to the premise, so I cannot advocate  for the present  "solution."

No Matter What

No matter what happens in the world, or here at home, buy bonds. This is the predominant view being spouted as Europe comes to terms with its haircuts and we do what we were always going to do, roll over our debt. Eat your peas and buy those bonds. I don"t subscribe to the view.

There is an event that needs to occur to solidify the end of the Great Bond Bull Market. After 30 years of denial, everyone finally has to like them. The all time low yields were tagged during the crisis so never fit the bill for a blow out "love affair." That classic mistake is transpiring right now. When I got out of college in 1983, 10 year yields were 11% down from a whopping 14% in 1981. The unemployment rate was 10.2%. Over the next year, notes fell back to a 12.4% marker. The "certificates of confiscation" issued by the US government decided to give everyone a last flyover. They were universally hated.

Today, a preponderance of pundits will tell you to own the paper at sub-3 interest. This is where the ride ends. A long time to experience but a blip in a history book from the all time low. In a world where the long term is a trading session and a flip is 400 milliseconds, secular cycles are hard to fathom. I'll make a little prediction: They'll change their minds before I will.


The Treasury yield should be regaining traction as positively attached to growth. A "hedged" position from unemployment day remains, short Treasury and short SP. The "pro-growth" position is long SP and long Ts.. A debt situation resolution that does not engender better growth prospects could be the developing outcome. The most common position, long Ts and short SP has been a pure alpha trade on both ends and thus, neither a spread nor a hedge. The system is "riskier" yet the prospects for reward are diminishing, not a good development.

On the Slope

Many are taking the view that low rates are the result of virtually any debt/deficit scenario. The slope of the forward curves has been our focus over the paltry yields. Although the Treasury curve remains steep in the US, the money market futures curve has flattened markedly. (The EDZ11 - EDZ12 spread hit a new low this a.m. at 29bp) Bond curves in Europe are dangerously twisted from the crisis.
This situation indicates to us that the growth prospects over the medium term have deteriorated. The big investment banks continue to reduce their GDP forecasts down toward our nominal 5 year Treasury indicator. The obvious risk is in the continued anticipation of second half pick up. Futures relationships now price that event as low probability (and thus are good sell bets for those who still look for a growth pop). We are not convinced, as yet. After a long period of skepticism, the concept of "extended period" has manifested itself in term structures under the cloud of an attenuated malaise.