Monthly Archives: March 2017

Purple Hayes

The Spider Network by David Enrich is a book on the LIBOR scandal set for release on Tuesday. The WSJ posted a tease this weekend. The long title is "The Wild Story of a Math Genius, a Gang of Backstabbing Bankers, and One of the Greatest Scams in Financial History." WOW that's a mouthful ! The story focuses on Tom Hayes as the protagonist villain, a scapegoat for a twisted system-wide farce facilitated by ignorant regulators, powerful banking interests and short attention spans. I know, because I operated as an institutional futures broker on the front lines of the "scam."

Long before the financial crisis, I had prodded the idea of a systemic deceit in the money market in periodic appearances on CNBC's Squawk Box. I would dare say I coined the term "LIE-BOR. The eye glazing and subject changing was as rapid as the producer's jump to the next commercial. But let's not get too far ahead, first some background.

The system was a "faith based" system. This structure filtered far deeper and wider than the yellow metal adoring critics cared to explore. "Money", whether geared up as Dollars, Euros or Yen was not constrained to a printing press and colored ink but free to expand into  financially engineered shadows and shared hallucinations. A kind of reverse Cardinal John Henry Newman - "Out of the world of truth and into shadows and images." (#GIK Ex Umbris et veritatem in imaginibus" !) And it all started with a simple request from the bankers.

LIBOR sets were posted by the BBA after a morning polling that originally asked, "Where would you OFFER money to a like participant for a given tenor." Bid ask spreads being sometimes wide (but rapidly closing) and transactions hypothetical to the poll not the actuality, banks and their lobbyists requested that the language be adjusted to "Where do you believe you could BORROW money from a like participant for a given tenor." When the regulators agreed I am sure those players in the room had to strain not to chuckle out loud. The rest as they say is history, or as the only accurate part of the book's title puts it: One of the greatest scams in financial history.

The public would love to believe that a "socially awkward" Asperger -touched "math genius" led a global team of crooks on an international caper of  'bending a few rules and taking a few liberties with their swapping party guests' but it just ain't so. They, We, I were all involved. The structure and older managers unwilling or unable to question the ever expanding -literal - money making machine gave us free reign to lie away. Like all faith based systems, once the lie was exposed  - that one could not actually borrow at the rate submitted - the system collapsed under the weight of the ugly truth. Tom Hayes is a legal convenience.

So, after all the QE, all the Dodd-Franking, all the LSAP-ing and Twisting, what system am I allegedly believing in now?

2 Charts

Chart last year

Chart full term

Here's 2 charts - Peeps love charts - I check at least once a week. Note the chart on left since July of last year. Despite several bouts of TLT loving hype, the unmistakable direction of this benchmark rate has been ? UP.

My friend @Conorsen has attempted to keep Fin Twitter abreast of these developments.

The chart on the left appears to be approaching the downward slide trend of the last 25 YEARS !

Now, I don't know much about charts as I never learned the language; however, I suspect some dark arts voodoo-ist might be conjuring an If/Then statement something like this: "If level X is taken out, then rates are going up to level Y."

From where I sit, its been happening for almost a year.

Big Hitter the Lama…LONG

An omen that the long dirge of low volatility may be ending is the recent interest of the general public in the mundane operations of Treasury Dept. issuance decisions.  Larry Kudlow began floating the balloon in December and Sec Mnuchin gave the meme a boost by saying, "Treasury was looking into the concept." (Spoiler Alert- TBAC has been "looking into" it for years) The pedestrian argument for issuing 50 and/or 100 year bonds will be played by Dorothy's favorite walking companion thusly:

Rates are low, the duration of government issuance is barely over 5 years, "lock in" low rates now. Oh, and asset/liability maturity matching, but we are losing you, so, the first things.

Here's my longstanding argument for devoting time to more important issues:

The shorter duration of the T pool helps grease the gearing of the financial system through its REFUNDING. The key characteristics to refunding are that the secondary market for the issues is DEEP, WIDE and RESILIENT (the decline in this 3rd characteristic to be picked up later).

To promulgate the vitality of the process, Treasury MANDATES that the issuance schedule will be "regular and predictable". When the duration of the pool began to slide toward 4 years, the IR risk was deemed substantial enough that extending duration became a stated, incremental goal of the department. Then, this little hiccup called the complete meltdown of the financial system scared the bejeezus out of everyone and T-Bills were deemed in short supply. The Fed (the guys that get all the attention) then embarked on a once taboo activity for CBs of buying Yucca Mountain amounts of Ts and such also in "regular and predictable" arrangements and doing a little number called Twist. To avoid getting looked at like a sick patient with his hospital gown open, Treasury back burner-ed the duration extension concept. Translation: The Treasury wisely opted to not appear a TACTICAL issuer, a stigma with possible negative signaling to markets.

Kudlow likes to drop this nugget in his pitch for 50s or Centuries, "Ts held by the public have grown from 32% in 2008 to 74% in 2016." I'm yet to figure out what that means except that it would behoove the Gov. to inflate away those debts more rapidly -if it could, it's harder than textbooks would have you believe -since the holders are increasingly it own citizens, but wait, I heard China might own a fair amount of these babies too ! Let's scrap that idea ! FI practitioners (of which I once was and am considering again) compute a thing we call DV01 - dollar value of a 1 bp change in yield. The beauty in the Eurodollar contract was/is the $1million dollar size (if invented today I bet it would be 5 or 10m) and the constant "always and everywhere" $25.00 DV01. (Think of back month Eurodollars -colored Gyros in Dog-speak- as strings of zero coupons) The DV01 of $1million in 50 year bonds, let alone Century, is roughly a messy couple thousand ! The CME Group would come up with a "Super -Ultra " contract to help the hedging but the development would be hindered by the original mandate issues. And here's the problem that relates back to the RESILIENT characteristic - very few people/institutions remain in the business of making markets and gearing these securities. In fact, if the public knew the small cartel of extremely large players inter-acting with themselves, they would become uncomfortable. The Taper Tantrum and 2014 "Melt-Up" were glaring examples of fissures in the most important debt market in the world.

Here's my advice to Mnuchin and the Trump administration: Concentrate on something more important, like a regulatory environment that promotes more participation in the process.

 

Unenjoyment Day

4.7% and 235,000 never looked so average. I got up early to watch the talking heads spin their political views all over the number. To think hiring managers have ramped up their actions in a policy environment that has been thrown into flux is new wave economic thinking devoid of foundation.

The focus should have moved away from the Employment data several years ago. Retail Sales should be the market blistering data drop of the month. And yet. Our warning over the last month has been the abrupt drop in retail activity. The sector posted a glaring negative in the otherwise standard advance. The "late tax return" meme holds a tad of water but should be gone by the March print and then, well some peeps may actually owe.

The cognoscenti wasted no time in tossing off rate levels 100s of bips higher than the prevailing. FI practitioners were once again portrayed as hapless rubes mesmerized by the Fed's sleight of hand. Equity boys, on the other hand, are brilz. The incredible heavy force of Europe that has been weighing on the term structure, and is now shifting, was never mentioned. The Fed, of course, was "behind" the "curve."

We still contend it is the SHAPE of that curve that needs adjusting more than the LEVEL of rates. The ghost of the 70s/80s  rates anomaly still haunts people's views 2 generations later. Low does not mean "easy" and Higher does not automatically equate to tighter.