Monthly Archives: May 2013

Bloomberg Radio May 30 with Kathleen Hays

Kevin Ferry Says Rising Yields, Volatility Inevitable (Audio)

May 31, 2013

Kevin Ferry, chief market strategist at Cronus Futures Management, says rising bond yields and increased bond market volatility are inevitable as the Federal Reserve, acknowledging the financial crisis is over, moves away from its "emergency" monetary policy of bond purchases. Ferry speaks with Bloomberg's Kathleen Hays and Vonnie Quinn on May 30 Bloomberg Radio's "The Hays Advantage."

On Monetary Policy Metrics

Back in the late 1990's a debate broke out about targeting the Fed Funds rate as a policy metric. (Oddly, some of the biggest critics..cough Jim Grant..cough are bigger critics now) The oft stated rub was "If you were a monopolist would you peg the price or the quantity of your good? The Taylor Rule is the bastard child of this debate. My problem with Taylor was his inputs, GDP based, were heavily lagged and widely revised. As a Eurodollar guy, I took a market determined money rate as a compass. After several months of tinkering I came up with a rule of thumb: In equilibrium- that is Neutral Fed - the Fed Funds rate "should" be about 60bp under the 12 month LIBOR rate. (This rule solidified itself in our work when it predicted a 1% FF rate well before Sep 11 2001 and indicated the Fed was "too tight" at 1.75)
Taking a small sample of recent January fixes shows the policy tilt into the financial crisis:

Year      12 mo    FF Rate     "Neutral"    Tilt
2002      2.4       1.64            1.8            easy
2003     1.45      1.25            .8              tight
2004     1.47      1. 0             .8             less tight
2005     3.11      2.25            2.5            EASY
2006     4.85      4.2             4.2            neutral
2007     5.34      5.25          4.6            TIGHT-BOOM

The Fed had raised the rate from 1% to 2.25% and was "More accommodating" in 2005 than 2004. Conversely, the 2007 rate hike was overkill, and a key force in the collapse. Once we entered the tail and Quantitative Policy was - once again (Odd sidebar #2, Volcker is praised for QT but Bernanke is vilified for QE) employed, (and LIBOR became a fantasy rate) we wondered how the Rule - more like a guideline - would hold up. Surprisingly, still quite well. If we ask, Where would the funds rate be if the market could set it? The answer today is roughly 10bp with a 12 month set at .697 . Thus the LSAP push is the zero bound policy tool. The question is, given recent movements and explanations: What "Tilt" would policy have if LSAP activity was tapered/halted?
Our model would say today that the Fed would be Neutral. Here's what to watch for- If 12 month rate sets rise in the days to come, then the Fed finds itself EASIER than present even as/if/when LSAP becomes SSAP or nil. Also, the Balance sheet would need to be declining at a moderate pace to offset a portion of that now "too easy" stance.

Classical Thursday

All graphs are based on June contract

zb zb1 zb2 zb3 zb4 zb5

 

On the economic calendar:-
08:30 GDP (Consensus 2.5% v Prior 2.5%)
          Jobless Claims (Consensus 340 K v Prior 340 K)
          Corporate Profits
09:45 Bloomberg Consumer Comfort Index
10:00 Pending Home Sales (Consensus 1.5% v Prior 1.4%)
10:30 EIA Natural Gas Report
11:00 EIA Petroleum Status Report
         3 Month Bill Announcement
         6 Month Bill Announcement
13:00 7 Year Note Auction
16:30 Fed Balance Sheet
          Money Supply
POMO:-
 
10:15 - 11:00 Outright Treasury Coupon Purchases up to $1.75 billion

Imaginary Axis

A vortex in fluid dynamics is the region where the flow is mostly a spinning motion about an imaginary axis. The collapse of Western Civilization is allegedly at hand because a "Bond Vortex" is forming at the 2.2% level in the 10 year Note. The catastrophe revolves (get it?) around some pedestrian notions of MBS convexity hedging attached to long held fear and aversion to LSAP monetary policy.
Disaster film pitch GO: The Fed tapers off POMO schedule and Note rates cross the 2.2% "line in the sand." This causes an unheard of amount of MBS convexity, duration and "Shit's broke" hedging that spikes rates, breaks the economic expansion and sucks the SP Index downward. We've talked to Bruce Willis and we'd love to get Affleck on board.
Well, never mind that the "vortex" in the other direction-lower rates and reduction in 10 year theoretical equivalent supply was a primary positive of LSAP; the present MBS distribution is pretty smooth (i.e. no heavy skew). Also the vast majority of the product resides on the balance sheet of an institution that isn't marked to market and doesn't hedge. Now don't get us wrong, we love a good convexity blamed air pocket in Notes and Eurodollar strips, but the "Mortgage Boys" are always a flamboyant moment from the end of a move. The Vortex Story implies that no one will be be around to carry better (higher seems a misnomer) yielding securities at 0-negative finance rates.
Our opinion is CBs around the world have embarked on a flawed policy goal- Stability. A New Wave Central Banker's preferred metric of stability is tight spreads and low volatility. To the extent they can produce the former the latter entrenches itself in market participant behavior. However, when markets adjust back toward the natural state of "movement" the increase in the artificially suppressed metrics scares the bejeezus out of everyone. Here's a tip, every time the capital markets adjust its not a crisis and the Bond Vortex spins around an imaginary axis.