Author Archives: Kevin

Hello Harry

Last night, Madoff aired on network TV. The amazing aspect of the saga remains his aversion to trading his way out of the mess. I remember getting a tour around the massive Peak 6 facility while the story was unfolding. The Managing Director said that they were roughly 50% of the CBOE volume and Peak 6 had never traded with Madoff.

In an interview yesterday morning, Harry Markopolos, the man identified as exposing Madoff, said this:

"I'm looking at about 5 funds right now that are also Ponzi Schemes. 1 is bigger than Madoff."

The truth is Mr. Market exposed Bernie Madoff, not the geekily- portrayed Markopolos. Mr. Market has kicked off the year with a nice drop and some currency volatility, his version of a Ponzi investigation. We should be hearing the names of the fine institutions Mr. Markopolos is looking at this Spring.

Nice work boys.


Econ 200

Econ 200 Money and Banking

Revised Edition. Chapter 5 Quiz

What is the purpose of a Central Bank?

A: To create excess reserves for its constituents.

What is the basis of modern monetary policy?

A: To penalize said constituents for holding created excess reserves.

Why do Central Banks raise the IOER?

A: To create a pool of funds to pay the future penalty with.


The Ghost Rate

Over the past 48 hours, two significant posts crossed my desk. The first was the news that 4 of the 6 cabal members charged in the LIBOR manipulation scandal were found not guilty. These were brokers who were on trial for a specific charge of working in agreement with Tom Hayes. The case was poorly constructed and the verdicts fell. The public story that Mr. Hayes was responsible for, or the lead agent in, the largest financial scandal in history is a dummed-down version of reality. The truth is, for those of us that were there, the entire market was a ramp up of a change in the reporting set that regulators were too inane to understand, The "OR" in LIBOR stands for "offered rate." The original set was based on the reporting and averaging of submissions of the rate at which one was offered money. As bid/ask spreads collapsed and the rate structure became the benchmark (remember that term) for the global financial system, the cabal asked for-and was granted - the right to submit the rate at which they would borrow money. The difference between "would" and "could" went from minimal to unavailable as the crisis unfolded.

Yesterday, the brilliant mortgage specialist Harley Bassman, now at a small west coast FI firm called PIMCO, penned an excellent piece on the global financial system "benchmark rate." And the winner was?? You guessed it, the sullied reputation. now rarely mentioned rate at which banks don't borrow from one another, LIBOR. Its a great piece and takes pains to differentiate between "risk free" and "benchmark" and open your mind to a possibility. Go read it,

The irony of these 2 stories crossing my stream on consecutive days is not lost on a semi-reclusive former player in the above mentioned mud. Beside the court's inability to prosecute a known crime successfully is the post-crisis understanding that pulling the curtain back on systemic fraud brings scary and systemic litigations. However, I am pleased to see a respected player posit the notion that the rate remains - with all its tarnish - the proper global benchmark to calibrate by. In fact, I have calibrated my concept of the neutral FF rate by it for decades. Sovereign, GSE and corporate risk can be better understood through this "cartel formed" rate, Negative swap spreads are not as difficult a phenomenon to grasp.

Here's my take: The global financial system is benchmarked to a myth. A ghost rate. A rate that exists only in the minds of the participants that in their most private moments know they could not fund at. A rate that were it to quake governments from developed and mercantilist nations would jump to stabilize. The global term structure of rates is based on a sanctioned fraud. But somehow it works.

Back to Work

The Ten Year future moved back onto the "trap gap" for MLK Day after the entire complex rumbled another upside pattern Friday. The new year has been one equity carnage day after another and a string of debris ridden explanations why. The continued meltdown toward equilibrium in crude is often mentioned as culprit #1. The contract is 6 dollars contango into next Oct. quietly disputing the claim. Another blooming meme appears to be that Chinese equities are only remotely connected to their economy. That both are sputtering and the same can be said for Uncle Sam provides me little succor.

Meanwhile, on Main St., postal service prices rose 14% last week. Fed Ex and UPS followed with 5% upticks. Back in my time, when trading was conducted with charcoal on cave walls, it was common for businesses to ring in the new annum with attempts to "take price." I expect more companies to take a shot leaving Q3 and Q4 to adjust to the consequences. After a decade of "too much everything," structured restriction is coming back into vogue. The oil patch is well played out but even Walmart is closing stores. Will Chinese manufacturers be able to gear down peacefully? How you gonna keep 'em down on the farm now that they've seen Shanghai ? I feel we are finally going to find out.

John Q. seems to have a default position in the market now. I've found little daily market juggling with most workers. The hype, convoluted causation, simultaneous apocalypse/buying opportunity is confined to the "professional" community now. Then, there's the Fed. All those pretty charts of how well equities do after the Fed starts raising rates are wrapping month old fish. I continue to be skeptical of a CB attempting to steer a quantitative ship with a rates rudder. Markets have tightened conditions farther and quicker than sweet Aunt Janet and her Merry Pranksters intended. The monetary primordial soup remains vast, however. Hooper is scratching behind his ear and we are set to start selling Notes again.



Last year, @thestalwart and @boes_ , working for a different outlet, asked some of us what our favorite trade for the next decade was - I submitted a short note on WATER.

Here's another guy fleshing out how to play it. Embedded in his answer you may see mine.

The last line of the movie, printed on a placard, is “Michael Burry is focusing all of his trading on one commodity: Water.” It sounds very ominous. Can you describe this position to me?
Fundamentally, I started looking at investments in water about 15 years ago. Fresh, clean water cannot be taken for granted. And it is not — water is political, and litigious. Transporting water is impractical for both political and physical reasons, so buying up water rights did not make a lot of sense to me, unless I was pursuing a greater fool theory of investment — which was not my intention. What became clear to me is that food is the way to invest in water. That is, grow food in water-rich areas and transport it for sale in water-poor areas. This is the method for redistributing water that is least contentious, and ultimately it can be profitable, which will ensure that this redistribution is sustainable. A bottle of wine takes over 400 bottles of water to produce — the water embedded in food is what I found interesting.

The El Nino is still of significant magnitude. The Mid-America flooding is something we did not expect to start until Spring. Next up, the PGA hits Southern California - watch the weather at Riviera CC.

Stocking Stuffer

Hooper put a little something under the tree today in Bond Futures. We shorted 155.23 on the weekly pattern. The stop is 2 points and the objective is 149-10. Standard Op. is to cover 2/3 at that point and adjust to new pattern on the remainder. Its a great gift, because we love to sell. The daily pattern turns negative at 152-19 so more selling there for the fun of it. The daily - which, to be clear, is not in a negative configuration so not confirming the weekly (an odd scenario) - has an objective of 148-30. If the downside unfolds, the daily and weekly would be back in alignment.

Did I mention I like to sell?

SP futures have a daily pattern buy level of 2007.57 (Hmm look at today's low) looking for 2043. The contract has been slicing and dicing through the "trap gap" from 1997 and 2007.

ZIRP Normal

Today, I participated in some of the back-n-forth on the Fed meeting with "finance twitter." My views on Fed policy, accurate and delusional, are well documented on this site. I voted "No hike" on the last couple of Fed Polls by Finance Twitter Chairman @IvantheK. Whip smart and a Hooper decoder ring (Be sure to drink your Ovaltine) holder, Ivan noted that my no vote reasoning - tweeted to our friend Joe Weisenthal ( @TheStalwart, like I need to clarify)- "Sounded more should than would." BINGO

My affinity for shorting things FI, Treasury issued and Gyrodollar proxy for is well known. Take a minute and view your pricing screens in terms of the adjustments in credit and debts since the Fed allegedly "pulled the football away" 2 meetings ago. What matters tomorrow is not that the Fed follows through with its vocalizing, its what position can profit from it. More importantly, how well can you evaluate the risks associated with such a position. That is all I can pass on to the future generation of relevant market participants. THAT"S IT.

For a long time in my career, I thought there was more to our buying and selling and thinking and writing and explaining what "we" did in the world. The truth is the beauty that that IS all we (should) do. Evaluate the risk associated with a position. So, the question - not asked in any poll- should not be "Do you think ?" but instead "How are you positioned? and why?" Everything else is fluff.

Quantitative Hoping

I spent the morning reading 6 reports on pending Fed activities coming down the chimney for Christmas. Two took a few sentences to address the follow-on adjustments to IOER and RRP. Almost all included soothing comments about "dovish hike" or reduced path. Many took on a nostalgic tone of returning to "normal."

The truth is the ab-normalcy is just about to start. The never before successfully attempted trick is to raise the operating floor of the system without actually altering the flow of activity through the plumbing. The important part of the stunt, lifting the Death Star capacity to at least $1T, most likely won't make the evening news. The use of the weapon will be the highlight (or possibly lowlight) of the 1st quarter of 2016. The Open Market Desk has expectation jitters only JJ Abrams can appreciate right now.

This is the time of year when everyone makes next year predictions that fortunately are rarely graded. I'll toss my kindling on the fire here: A central bank can guide itself by rates targeting or quantity targeting but not both. If credits continue to snug after the move, the Fed will struggle to pinpoint the cause - the level of rates or the level of "stuff"in the system. If things get frothy, the promises of an attenuated cycle will have to be thrown overboard. The Fed gets blamed in either scenario.

I keep thinking about an old X Files episode where all the phone-in TV psychics are getting murdered. The killer turns out to be a guy who actually can see the future that tells his victims, "You shoulda seen this coming." I've got the uneasy feeling all of those market guys I've read today, and myself, are going to here that statement in our heads next year.

Dog Barks

670 square feet. 1 bedroom 1 bathroom. Palo Alto bordering neighborhood. 1.4 million dollars. Termed "not unreasonable" by local broker because you know, "the average home price here is now 3.3 million".

i'm old enough to remember when Boston cratered and the west coast followed in the credit crunch of the early 90s. Homes in the Pacific Palisades  area of LA traded at 50% of replacement cost before prices rebounded. Unlike the disaster that would follow in the first decade of the 21st century, the middle of the country held up ok while the NE and the West got a lesson in gravity.

My dog is barking. Save that listing above.

3 mo LIBOR

Sometimes stuff happens right up front in the yield curve while all the focus is on the random meanderings off in the distance. Last year at this time 3 month LIBOR - the unsecuritized uncollateralized rate at which banks don't borrow from each other - was 23bp. This rate was about 10 to 12 bp over the ZIRP induced FF rate.  A month ago this posted set was 33bp and now (turn included in 1s and 3s) is 42bp. (1month was 16 and now 24). GC has been trading slightly over the open rate for more silliness tossed off as "technical".

The EDZ15 contract that expires in about a week is trading 9948+/9949. The contract has over a million in open interest about 100k skewed to the put side. The contract expires 2 days prior to the FOMC meeting. Jan is showing at 9942 and has lost an amazing 19 ticks since Oct. None other than GS'  Hatzius is warning of 2 yr rates not adjusting enough to the pending Fed "normalization."

On this meta-narrative we remain amused if not quite disgusted. Throughout the past year, as long- enders have seen their Fed bets turn bad meeting after meeting, the front has done a Bataan Death March higher. Now sufficiently in front of the Fed, the Committee will adjust up behind Mr. Market. Normalization? This is a concept regurgitated on the public that plays to the embedded notion that policy rates were aggressively held down below their "natural" levels. We have shown, and continue to highlight here, that is/was never the case. The Fed is now pushing a follow-up narrative that hikes will be attenuated and inconsistent, a process that by definition refutes the normalization meme. ("Slightly less abnormal ?")

The "Slow Fed" movement  is actually an admission that prior habits were dangerous and wrong. The Greenspan 1/4 point a meeting folly saw the funding rate (of a system actually based on wholesale funding) go from 3 to 5.25 with virtually no reduction in credit creation. That financial system no longer exists.  We see policy calibrated still accommodative after the hike. Balance sheet management and Death Star firings, if and when they occur, will be far more important to our view in 2016 than the FF rate.