Monthly Archives: October 2011

OWS as Jihad

In 1995 Benjamen Barber wrote Jihad vs. McWorld. I was please to find out I had read it before President Bill Clinton and he kept a copy in the oval office. An updated version is a must read for those of us that are not pre-aligned to the left or the right. (It is important to note that "Jihad" is a much broader term than the commonly used "holy war") One of the important facets of the book is that democracy produced capitalism not the reverse. Thus, Occupy Wall St. is a jihadi movement as it attempts to push back on the advancing Western ideology and endorse a more traditionalist social state.

"In America, with people so cynical about their own democratic institutions to recommend democracy to transitional states...is problematic at best." China holds on to a mercantile regime in response. Europe is a case study in nationalist push back to a Supra-Sovereign market infrastructure. Civil society lies between government and the private sector. OWS should, eventually, open up in Washington DC. That event, should it occur, will define the movement as citizen Jihad.

I advise an open minded reading of the book. An important conclusion shows that neither "Jihad" nor McWorld have any intrinsic interest in fairness. The focus on fairness, or social justice, in the election year is dangerous. The middle, the citizens, tend to suffer when fairness is pitted against the institutions of capitalism.

The Stimulus Worked

The election sniping is heating up both inside and between the parties. The Tea Party has lost the spot light to OWS but look for a bounce back. Here's the hard truth: the stimulus plan worked. In fact, it worked to historical proportion. The massive hoard of corporate profits is the result. My friend Gerard Minack at MS Asia has shown that transfer payments are running high enough to bring disposable income back to peak, while ex TP only 50% has been recovered. The implications are huge.

First, the global anti-deficit shift will be a significant headwind to growth, not a supply side positive. The second, and more complicated, aspect is do corporate profits matter? Extreme cost cutting during the crisis set the foundation for bottom up benefits that accelerated in the recovery, now what? The profits have not morphed into a self sustaining expansion and heavier cost cutting in a stall will be difficult. Only government is up for cutting.

OWS has yet to realize the paradox in their message. Likewise, the neo-free marketers have not come to terms with who (what) actually made them profitable. After spending the majority of the year tossing around with international headlines, the US capital markets will wind down 2011 contemplating their own navel. Corporate profits have been driven by the stimulus. The stimulus has been vilified as a mistake and a failure. Corporate profits will be the consequence in 2012.

Back in the USA

The Super Committee is bogged down. The ratings agencies are working overtime. A floating rate Treasury could muddy the dirty water more. The 1.65% yield on the 10 year everyone keeps telling me about sure looks like 2.25%. A significant number of bond bulls this summer were right for the wrong reason. Most argued that debt limit debacle was bullish. The truth is the global economy was stalling harshly. Japan, China and Europe are all now moving toward monetary accommodation. Spread product has improved as Op Twist has rolled out. (That, not lower long term yields, is the objective). Now comes the real test for US capital markets.

It’s Unfortunate

“It’s unfortunate handling by the Polish presidency, and bad news because the markets have tanked,” the diplomat said on condition of anonymity because of the delicacy of the subject. But the diplomat said the summit meeting should not be affected.

“We have created a world that is noncomputable because it is too complex,” said Fredmund Malik, chairman of Malik Management, a consultancy in St. Gallen, Switzerland.

 

Unfortunate ? That's what it is? The Great Differentiation proceeds despite  the EU's bureaucratic unfortunate-ness.  The White pack is trading 99.39+ with LIBOR at 42+. The volume is the lowest I've seen in decades. Yesterday, with another unfortunate EU member comment, the system teetered on the abyss and was able to find a toe hold. Out of nowhere, the Polish are the spanner in the works?

The quote at top is telling. They are tossing air balls and watching the ticker. The negotiations are not about loss recognition and moving toward reality. The charade is performed for the benefit of net change on the day. I'm not sure exactly what it is.....but its far more than unfortunate.

Reality Distortion Field

People close to the great Steve Jobs say he emitted a "reality distortion field." Taken from Gene Roddenberry's Star Trek, the term means the individual operates outside the constraints of the rest of us. For Jobs it was a management style that forced those around him to great things by his gravitational pull. For Europe, it is a dangerous game.

The capital markets continue to be tossed around by the empty headlines on the EZ plan. Wednesday is now the day of the rapture for Europe. The problem is only a very strong leader can produce a reality distortion field with enough heft to create positive results. The Germans are clearly the boss economically but have been reduced to last minute obstructionists. The majority of the tab is coming to their citizens and they can't distort that reality.

The US entities have had better success with the distortion. On some levels, Fed policy is a massive Reality Distortion Field. Games, like Op Twist, require participants to suspend disbelief and play along. If we get past Wednesday, watch for a trial balloon from Treasury on Friday. The Treasury Dept. is considering issuing a floating rate note (most likely a 3 year.) This would be the first new product since the introduction of the TIPS. After nearly 30 years of falling rates and FF at zero, the reality needs no distortion.

Op Twist Update

The lead time and trial balloon nature of a "transparent" Fed will keep History writers busy adjusting the inside/outside policy lags for analysis. Since the operation began, 10 year yields are up 50 bp and the interest cost on 2 year notes has doubled. Obviously, context is everything.

Another, possibly more important activity has popped up. Goldman Sachs issued 50 year debt at 6.5% (callable). THE Ohio State University issued 100 year debt at 4.85 (taxable). The knee-jerk response is usually, "Why isn't the US Gov. issuing longer dated paper?" The Treasury was moving the duration of the debt out structurally. Given the delicate nature of the system and the large amounts, they opted to NOT be a counter influence to the Fed's Twisting. Strong opinions will remain about the decisions from both agencies.

The side effect could prove to be more beneficial. T+ issuers are stepping into the void. A successful Twist, one that narrows spreads rather than lowers T rates, would open the door for more corporations to secure generational low long term financing. Roll over risk for Uncle Sam will provide plenty of heated discussion down the road. You know, that road with the can getting kicked down.

In Defense of Chaos

This morning, an economist from Nomura on CNBC’s Worldwide Exchange made several very good points on the state of the economy. Then she said this, “The VIX shows, against virtually any other measure, that financial market volatility causes economic retrenchment.” I understood where she was going but an hour of work with Hooper didn’t yield the same conclusion. Keith McCullough, of Hedgeye Risk Management says, “Government intervention 1) shortens economic cycles 2) increases volatility.” Again, a pertinent point well worth looking into.

My experience in the market has led me to a slightly different take. Stability, or more accurately, policy enhanced spread compression, causes economic disruption. From Fannie and Freddie to peripheral Europe, the problem is the ability of lesser credits to borrow at narrow spreads to benchmarks. A huge amount of government intervention and policy is oriented toward the false stability of spread compression. The history of the Greenspan Fed is a road map of the dangers of the artificial  socialization of credit. The problem with Greece (and now Italy and Spain) is not that their borrowing cost is wide to Germany, its that they were permitted to borrow so much as if they were the same.

The economy stumbled in early Spring and Treasury yields moved down. The VIX did not break out to the upside until August contingent with equity index declines. Swaps, TEDs and other spread metrics had moved out well in advance. A bumpy ride to nowhere since has seen the VIX remain elevated, yet economic activity appears to have held on at a moderate pace. Put simply, the benchmark for financial market volatility is a lagging indicator at best. “Volatile” is the natural order of markets,  “stability” is a false god and terrible metric of reality.

Eurodollars (full disclosure, I grew up with the product) and packages of futures contracts offer a unique look at the mayhem. Settled to the rate formerly known as LIBOR, most would contend they are “cheap” at the present 99.40 ish prices and the set at 40bp. I believe LIBOR and Eurodollars are attempting to reflect a new (actually original) structure that more distinctly shows their difference to Treasuries. An entire generation of traders and quants have come of age under the false constant of FF + 14bp = LIBOR.  I don’t worry about a credit world that distinguishes between borrowers and counter-parties. I worry about what happens when policy and players treat all credits the same.

In Defense of Chaos

This morning, an economist from Nomura on CNBC's Worldwide Exchange made several very good points on the state of the economy. Then she said this, "The VIX shows, against virtually any other measure, that financial market volatility causes economic retrenchment." I understood where she was going but an hour of work with Hooper didn't yield the same conclusion. Keith McCullough, of Hedgeye Risk Management says, "Government intervention 1) shortens economic cycles 2) increases volatility." Again, a pertinent point well worth looking into.

My experience in the market has led me to a slightly different take. Stability, or more accurately, policy enhanced spread compression, causes economic disruption. From Fannie and Freddie to peripheral Europe, the problem is the ability of lesser credits to borrow at narrow spreads to benchmarks. A huge amount of government intervention and policy is oriented toward the false stability of spread compression. The history of the Greenspan Fed is a road map of the dangers of the artificial  socialization of credit. The problem with Greece (and now Italy and Spain) is not that their borrowing cost is wide to Germany, its that they were permitted to borrow so much as if they were the same.

The economy stumbled in early Spring and Treasury yields moved down. The VIX did not break out to the upside until August contingent with equity index declines. Swaps, TEDs and other spread metrics had moved out well in advance. A bumpy ride to nowhere since has seen the VIX remain elevated, yet economic activity appears to have held on at a moderate pace. Put simply, the benchmark for financial market volatility is a lagging indicator at best. "Volatile" is the natural order of markets,  "stability" is a false god and terrible metric of reality.

Eurodollars (full disclosure, I grew up with the product) and packages of futures contracts offer a unique look at the mayhem. Settled to the rate formerly known as LIBOR, most would contend they are "cheap" at the present 99.40 ish prices and the set at 40bp. I believe LIBOR and Eurodollars are attempting to reflect a new (actually original) structure that more distinctly shows their difference to Treasuries. An entire generation of traders and quants have come of age under the false constant of FF + 14bp = LIBOR.  I don't worry about a credit world that distinguishes between borrowers and counter-parties. I worry about what happens when policy and players treat all credits the same.

Mo’ Money

Way back in the mid 90's I began to argue that the Greenspan Fed had lost its bearings. Using a host of seat of the pants indicators, often studied in the tub at Andrea Mitchell's, Greenspan basically pulled the Fed Funds rate out of a hat. In hindsight, people began to plug in numbers to the Taylor rule. The data was far too inaccurate to get it right in with any lead time. Thus, I put the time into an equilibrium model for Fed Funds that could tell me if the Fed was on the wrong track.

The model proved a valuable guide. The Fed was too tight prior to Sept. 11 2001 and too easy and predictable on the way out. By the time Ben took over and hiked 1 more time, the model was neutral. The model says the equilibrium rate for FF today is 30bp. The Fed is rightly pushing rates below that level. As the zero line brings out the "Out of bullets" crowd, Ben and Co. use alternative (quantitative) operations.

The efficacy issue is the big problem. The St Louis Fed showed in a paper before Greenie's failed exit that surprising and over doing were the Fed's best friends. The transparent and trial balloon telegraphing of policy has neutralized its effectiveness.  The Fed is not overly accommodating. The push for budget cuts complicates the Fed's job. Operation Twist will  create some additional excess reserves (est 60-80 B). If the EZ continues to blunder, the Fed is going to have to print mo' money.