the Big Short

I've been re-watching Michael Lewis' 60 Minutes interview on the crash. And with that, I've studied various scenes from the very entertaining movie version. I enjoy it but the process also eats away at me, even secluded away on Howell Mountain.

You see, i was one of the 20 or so people Lewis talks about who didn't just talk about the coming crash but bet on it happening. I founded Cronus with the collapse in mind. Our purpose was to short SP futures and buy Ts. My best position was long 9925 Eurodollar calls when rates were posting at 5 and 4.75. My calculations at the time led me to believe a penalty rate would price Libor somewhere between .75 and .5 not a full fledged zirp. We paid a half a basis point for the calls and they ended up 50 ITM -250k/200m.

The most interesting scenes in the movie come when the shorts are finally right but the Street still won't value the securities up. We played on a regulated exchange so didn't have the same problem. We did have serious issues, however. We cleared at EDF Man and with the system failing and guys next door getting wiped out for clearing at Lehman, we were solicited by representatives for GSEC to take on our services. The IB, wanted us to trade 1m for him given our strategy also. We figured being under the GS umbrella would make us safer than EDF.

Little did we know, the IB was deep under water also and had diverted the monies through GSEC into a margin account at CBOE. Both the GSEC back office and our own London accountants were phonying up the daily balances. (when the Feds realized i had pass codes into GSEC clearing the jig was up and they plead guilty and paid $7m in fines) I returned the customer funds and shut the fund. Amazingly, if we had remained open, we would have been embroiled in the Corzine debacle shortly after. Think about that, a couple of nobodies from the floor of the CME bet on the end of the financial system, were right, and the 2 banking institutions they (we) used to do it both stole the money to cover their own losses !

When I returned the investor money, after working with the NFA to ensure it was done properly, all the NFA investigator could say was, "We are really glad for you, no one ever gets the money back." I'm worried why I keep re-watching, something is bugging me again. It's real hard to be early. I'm happy up here, away from it this time.


On China Holdings

The pre-packaged meme on the Trump trade policies with China is now on the shelf from several sources. it goes like this: "China could sell a chunk of its large holdings causing yields to rise, the ccy to fall, and all sorts of trouble."

The story sounds right but loses some hype when looked at correctly. One must think about why and how China comes to want/need to purchase such large quantities of US obligations in the first place. The Administration actions would act to reduce the source demand. China could sell off chunks but the question then becomes "to who?" LSAP provided a well structured environment to adjust holdings.

There is no doubt that the threat overhang of a $T in government holdings can have on the issuing country is significant. The idea that China weaponizes those holdings is a totally different animal. Remember, the Chinese were massive owners of defunct notes from the permanently insolvent Fannie/Freddie and made out just fine by hanging on.


I watched a mind numbing TEDx talk from 2014 by Brian Westbury called The Truth Behind the Financial Crisis. It's on Youtube if you want to get your year's intake of fake news.

See, Brian just happens to be the same guy who - outside of Cramer and Kudlow - did not see the hurt coming and then became the highest decibel cheerleader for the economy in the throws of and well into the burning of the biggest financial calamity of modern time. His denial interviews are classic historical blunders. Yet, here he is, mansplaining to an audience of god-knows-who; the "real reasons" behind the collapse. Um, that would be the Crisis you never saw coming, denied was happening and then had the ignorance to say did not even create a recession !, That one Brian?



In June, the ARRC announced its recommended alternative rate, the Broad Treasuries Financing Rate (“BTFR”). However, as the pronunciation of “BTFR” apparently is unsavory, the acronym is being replaced with “SOFR” (Secured Overnight Funding Rate). But it’s the same thing – a secured overnight Treasuries repo rate. 

"Apparently unsavory" is the new standard for short rates.

Couple a Things

Item: SOFR update - So the roll out of the new benchmark rate for money funding has arrived with little fanfare and even less understanding. I was chatting with a government bank examiner working at an extremely large bond house about the Secured Overnight Funding Rate and she mentioned something curious : "Neither she, nor the team at said extremely large bond house knew how the rate would be set." She asked my opinion. I said  that trillions of contracts were still set to the tar pit animal previously known as LIBOR so I hoped the new rate sets worked out, oh and the 2015 vintage is spectacular but in tight supply.

Sidebar - secured vs unsecured is key difference.

Item: Rates have calmed and corrected in March as the Lion/lamb transition has played out. April - and Q2 - seem less clear to us than the preceding 6 months. Our base case remains unchanged, however. Equity markets chasing around a wide and volatile range that by Fall will appear sideways and rates clawing higher. The Employment Report looked to put the data together, so this month's could be less accurate. We think the data after will be a better guide.

March 28

Well well, after months of uninterrupted rise; 12 month money retreated a smidge on Wed.

We still see the equilibrium rate of funding at 2% and given other stimulus, the economy and pricing remain strong. We do not buy recent retail softness given the extreme weather patterns of late Winter. Trump's Fox News cabinet and 1920's trade ideas will not be the undoing of the post- FC expansion.

Hyper-moves and demon drop equity flushes may brown stain a junior casino capitalism millennial but those moves are more a function of waves in the zero rate surface breach than economic trouble. Year 2 for any POTUS, let alone one as totally incompetent as this one, is usually a choppier one. The measure of the quickly buzzed about Powell Fed will be the new Chair's understanding of the 3 year old in charge, his creepy Treas Sec and on the wagon Economics adviser. "Measured" isn't a strong enough term for being the independent counter-weight to Larry, Curly and Moe.


Above are a couple of good primers on the impending roll out of SOFR. Stringing out 3 month SOFR futures in deep and resilient packages will be an important step in the rate's rapid jump from infancy to benchmark.

As this roll out has approached, a steady march upward has occurred in the soon to be tar-pitted rate sets that bench-marked money rates for the last 35 years. Much ink has been spilled of late to explain the relentless rise ex-post. Even Seeking Alpha, on Mar 13, posted on the now nearly 6 month rise with a chart. The "deep dive" amounted to "I'm no technician, but this looks like a breakout !" Sad trombone. We have been yakking about this rate adjustment (and cheering on its arrival) since Q4 2017. Now, looking forward to the April SOFR roll out and the May futures contract, these wider and higher sets offer a cushion to the largest switch from an existing rate base to a new anchor in monetary history.

Even with the long lead time for participant adjustment, billions of dollar (and yen and euro) products could find themselves adrift after the disappearance of their underlying. Nearly 2 million Eurodollar contracts traded from Dec 2018 to Dec 2020 last Friday alone. Over $10 T notional amounts remain in open interest covering the same term. This is a BIG universe and its getting a new Sun.

Of course, nothing will go bump or bang, let alone crash. Of course not. Just like raising the funding rate and shrinking multi-trillion dollar balance sheets, everything will go smoothly and just as planned (hoped). Considering the underestimation of most as to the already significant rise in term structure sets, we feel the potential depth and liquidity needs of the soon to be hatched market will be too shallow for efficient operations. An unexpected need for actual dollar funding in the first 6 months (minimum) of SOFR bench marking could become dicey. The predicted non-event re-Sunning of the financial universe will need a narrowing of current relationships to confirm.


Today's Un-enjoyment figures posted under an old rule of thumb I used to promulgate back in the dark ages on CNBC. Simply stated, The most accurate employment data set occurs when an outside "miss" (up or down) carries 2 month's revisions in the SAME direction of the print. Such as the case today.

The labor pool is showing some elasticity but I can certainly attest to the dearth of skilled labor here in CA. The wage component is annualizing around the 5 year T rate.(see below - but GDP prints of 5 are possible in our calculations) Businesses have moved quickly to support the fiscal stimulus the Administration has tossed on the already vibrant up cycle.

My post-mortem  of the release is a reminder that our market based neutral model had been leaning in this direction since early Q4 2017. Presently, with a 12 month money set of 2.53, (le cinco es 2.66 !) and the other strong stim, our calibrated neutral rate for FF in the policy corridor is around 2% and .75bps from the lower floor. Policy today is dialed up near 11 a full eight years into the economic advance as  Old World and New Frontier economies brighten.

We will be shifting our focus to the potential "whip-snap" effect in the term structure as J.C. Lately and the Powell Fed Flap-jawers have finally bought into what Mr. Money Market has been screaming for months. The unintended consequences and unknown unknowns of Op Twist and moving rates before balance sheets could take shape as Q2 bleeds into 3. (this has always been our gripe with bandwidth filled with equity pundits hyperventilating over today's price action - money is a good 6 months ahead of them) Eurodollars for the end of 2019, and those of the Green persuasion will have our attention into and well out of St Patrick's Day.



Policy makers are turning to Nobel winning theories in behavioral macro in the wake of the Florida school shootings. Perhaps the Powell Fed will embrace similar thinking as decision making becomes more difficult in 2018.

The Fly in the Toilet

One way the FOMC could "increase its aim" is to allow policy to be nudged in the market determined direction. This simple compass calibration would actually be a radical departure from the last 30 years of leash pulling. Using our cocktail party rule for neutral, the current FF rate would be around 1.75 if Mr. market could set it. Toss a late cycle, full employment tax cut and a potentially pro-cyclical budget agreement and "neutral" tilts a tad north of that rate.

The Unseeded Hurricane

Two high decibel attacks on innovative monetary policy during the crisis ("defining down monetary pornography" I believe was the way one delusional CNBC contributor - I heard he was awesome - termed it) were : 1) It would be "better" to let everything fail

2) Deficits are bad

The former was a counter factual value judgement and the latter was a straw man handcuff that forced monetary policy to perform even heavier lifting. In behavioral terms, if you seed a hurricane you accept the liability of the landfall. Extraordinary monetary policy, euphamized as QE, now must accept the consequence of a successful landfall. Too many have locked into the balance sheet rolloff camp under slow rate rise Zoloft, in our opinion. Dumping securities and holding the anchor rate slightly lower than neutral (maybe just a nudge higher) should be an option, at least. Continuing to fiddle with the funding rate will increase impacts in the already messy fulcrum of the curve. (Year money at 2.39 today and 5 yr at  2.66+ and the 2 at 2.23 (auction day))

Was he a good dog? Who's to say, but he didn't deserve to die

Should the normal arc of Federal Reserve tightening, snugging, nudging cycles prevail; The Fed will own the expansion's demise. For many perma-bears and apopleptic TV bond reporters, this would verify their long held inaccuracies about the cycle and the bold innovations that nurtured it.



Resignation Boogeyman

Now that equity markets have broke loose from the velvet ropes of global CB policies reverse engineered for low vol and promoted as "Zee Stabeeelitee" - the "Bond Market" has once again found itself the near universal boogeyman excuse for the violent sloshing around. Got that? Move along, nothing to see here...millennial buying opportunity..yada yada ....

Now, if my martini soaked brain serves me correctly, same said pundits were trotting out all kids of graphic representations 6 months ago showing how the Fed's actions and the subsequent rising of the rates was all sorts of positive for their out over their skis equity holdings. The long flattening twist to the yield curve was also hunky-dory because the general direction was North.....they said. Presently, a jolt back steeper in a vol spike causing all matter of unwinds, is all Martha Stewart "good thing."

Speaking for the Bond Market, "I turn my back on this world. I'll turn my eyes from this world, Oh well...."

As we have mentioned before - and @Conorsen has also - from Oct thru Jan STIR futures broke away from the pre-ordained, vol suppressing, "we will tell you what we're doing" openness of the FOMC. Massive pro-cyclical fiscal initiatives at full employment 8 years into an expansion improving around the globe doesn't jive with "measured." The positive effects of "twisting" come with a caveat of "for a little while", then funding costs start to nip ya. Our core belief from 2016 remains in tact - Interest Rates Rise and that's different from 35 years of the opposite. (If you want to see a good graphic look at ZEM19 Monthly !)