June is now the front month
June is now the front month
The Madame Chair was finally asked a FAFRRRF -aka DEATH STAR - (we are very happy to have coined this now universally accepted term) question today by Sen. Kay Hagan of NC. In Heidi Bowl fashion CNBC broke away from the answer for something about Dan Loeb. I did a little call around yesterday on the subject and we all came away scratching our heads.
Sen. Hagan wondered how much action the death star was seeing. Madame Chair confirmed activity at about 5B up from 3B and that the rate had moved to 5bp. (Sidebar- I'm not convinced they were confusing size with rate in this exchange) Yellen accurately pointed out that there were large spikes around certain bad dates and what not. Taken on AVERAGE the facility is tracking roughly 75B/month. Sound familiar? Since "Taper Part 2" to 65B/month in LSAP, the Fed is - may be - possibly isn't - can't be sterilizing a slightly larger amount of bond buying than they are conducting. (We're not sure, that's the point of this discussion and we welcome clearer thoughts)
The reason we are thinking about these activities is 2 fold:
1) We believe the Death Star Rate should be walked out to 8-12bp in conjunction with taper to zero for obvious reasons.
2) The ECB will have to have a serious discussion right before the US Employment report about a negative deposit rate or suspending the sterilization of the SMP.
Ending sterilization there, only doable with a big hand from the Bundesbank, would add roughly $240B to the EU system. Quietly, it appears the Fed has moved to the other side. Perhaps, coordinated CB policy has not ended as quickly as we had thought. From a market perspective, the possibility of a negative rate, the steep roll in Treasury Futures and the large spec short base are combining to drive a squeeze of sorts. Tactically, we'd like to see the rally spike around the ECB next Thursday. Generally, we are wondering if the Fed hasn't already used the Jedi mind trick of Forward Guidance to secretly fire up the Death Star.
The Emperor's Phone Call
For the time being, there is more concern about what a "highly accommodative" monetary policy, with the federal funds rate near zero for more than five years and asset purchases still swelling bank reserves, might mean for risk-taking and financial stability than about what it might mean for wages and prices. Charles Plosser
This is the heart and soul of the monetary policy debate in one clear statement. How "accommodative" is policy when LSAP activity is gone? How will "risk taking and financial stability" be affected by the adjustment? If, as many pedestrian commentators have opined, the market is only up because of QE, then it "might mean" something awful.
On the other hand, if (and members know we lean this way) LOW does not equate to "EASY" then the consequences of adjustment filter to an already anemic recovery quickly. The data cluster from the recent market activity is too clouded by year end, EM hot money and weather to say for sure. Q2 shapes up to be a big gateway to the path ahead. We are already seeing evidence that money is chasing some "stuff" other than financial assets. This may/may not/ prolly isn't "inflation" but certainly changes the narrative.
Unlike prior easy money experiments - oh say Greenspan - that tolerated financial institution growth and financial asset kiting with underlying GDP growth and low unemployment, the QE era has seen tons of the former and little of the latter. Sometime, in dark quiet moments alone, a Bond King may realize he was just lucky to coincide a career with a secular disinflation. The fighting in the Kingdom is a sign the times are changing.
Thus, Mr. Plosser sizes up the money question perfectly : Without LSAP, how accommodative is monetary policy? More importantly, how will we know before its too late?
We have long held that no self respecting fixed income practitioner would ever use the term TLT in a discussion about "bonds." The popularity of a wide variety of bond ETFs continues to rise and the latest numbers fly in the face of the Great Rotation story. According to the Wall Street Journal, bond ETFs took in a record amount of money this month. Flows were wide and varied across product lines with Em concepts grabbing a big chunk. The 2 to 6 year products increased modestly despite Taper. The leveraged 2x Pro Shares Ultra 7-10 year jumped by a factor of 200 from 13.2 million to 2.9 Billion, according to the WSJ and Trimtabs.
This flow is a head turner on its own but in a context of 2014 bond avoidance playbooks and record CFTC speculative short interest in the complex (Treasuries and Eurodollars), the surge is stunning. The buying is difficult to square with equity highs and Fed forward guided prognostications. This smells like the most fickle of FI money. These "bonds" are Capital Appreciation Notes that can be flipped and exited quickly, as we see it.
Last Spring, reduced capacity, duration extension and negative convexity combined to morph a long awaited bond fall into a mess (a "vortex" long before the Polar kind). We continue to think the ETF universe will complicate and rattle the underlying fixed income world soon.