UK

October 6, the day King announced an expansion by $120 bln to existing stimulus, we immediately recommended selling UK debt or owning (L - S) the term structure. Such a jolt in this particular environment could not help but weaken prices and expand the curve. The strategy worked very well.  Half was taken in earlier and we recommended an exit 10/28.

Today of course prices are richer and the curve has come in a tad.

Europe is a wild card for us but past the noise and bullets there we are looking for the opportunity to repeat this exercise, to again own this spread, certainly not the reverse.

But then timing is always key is it not? Consider the gentleman black window spider. He’s a midget compared to the lady spider.  During times of romance he’d better not forget his tennis shoes because just following the conjugal visit, he becomes dinner.  Timing is everything for this guy.

The crisis may pull the spread even further away from fundamentals, stretched like a rubber band. We want to take advantage any distortion. The Bank of England’s approach, combined with an enlightened administration means more vigor than observers expect into Q1.


Robert Craven

Update

We advised clients not to take trades based on disappointment into the EU decision because we expected the market crowd to be cheered. That was the result.  We did not predict a real solution, only the market reaction, our job. Key is that one can be right at the wrong time and converted to crow bait in the process.

Sure enough, there’s been a bit of sobering up over there. We’re not sure how things will turn out in Europe but remain keen to sell the US or Canada to the Bund. Germany is a stand out in Europe of course, relatively healthy, but that credit won’t be up to US or Canadian speed, Q1. It doesn’t feel quite right just yet, but the opportunity will come, and, can be worked any number of ways.

Next, we have been constructive on the US relative to expectations. In that spirit, we predicted that today’s Chicago Purchasing Managers Index would broach consensus.  It did not, coming just inside.  Oh well, we were getting to be spoiled.

The general landscape ahead can be picked up in the term structure.  We advised Oct/11 that clients own that curve or sell US debt (we almost always prefer spreads). The 10 yr then 2.14%, 5 - 10, +101, 2 - 30, +276.  Modest progress, last 2.23%, +118, +300.  We don’t have a complete explanation for the recent firming of prices following the EU decision; it is not all due to disappointment with our friends there.

Robert Craven

The Week Ahead

Recent US consumer activity caught the Street flat footed. This bunch note that this spending was on the back of savings (as income growth was modest) which is why they missed it.  After being thoroughly beaten about the head and shoulders, these observers now claim that since savings won’t hold, neither will spending and no way we will continue to see improved consumption into year end - hoping they eventually will be right!

Consumer activity will continue to improve into year end, again blowing through estimates.

Next, although burning on at best 6 of 8, job activity will continue to improve, modestly perhaps, but improve. A good part of the reason for this is that employers are beginning to be cheered by developments in Washington.

Therefore, our anchor set weeks ago will continue to hold. (Our positive view however is not linked to Friday’s buoyant Michigan sentiment read. We know from years of personal observation that the correlation between survey results and spending just ahead is zilch.)

This week we have the ISM survey for manufacturing and services. The risk is that both will flatten estimates. And we have Oct Payroll on Friday.  We cannot assign a risk to the headline but private sector jobs will exceed estimates.

Key to our purpose then is the provision that banks are to establish a core-capital ratio of 9%. But why will so many want to raise new equity and dilute their shareholders’ stakes, when their share prices are only about ½ book anyway?  They won’t.. Suspecting the same, officials warn banks not to cut loans to get to 9% the back-handed way (which is exactly what they will do) but instead “seek national government support” if needed.  Right.  Traders can then expect relative vigor, US or Canada to Germany or France and are to set trades accordingly.

Finally, the Mid East remains a potent wild card; if not a Saudi / Iranian conflict, certainly the potential for an Israeli strike on Iran, the rattlesnake nearby.  As reported in the Washington Times, military analyst Amir Oren of the Ha-aretz newspaper noted that, “...until recently, Mr. Netanyahu had faced opposition to attacking Iran from Army Chief of Staff Gen. Gabi Ashkenazi and Mossad intelligence chief Meir Dagan.  Both retired earlier this year and have been replaced by men believed to hold a different view on Iran.”  

Such a strike would translate in the US to negative growth for at least a quarter as it would place WTI through 130 and keep it there for some time.


Robert Craven

Week in Review

Evidence this week (including today’s Real Consumer Spending print, the Q3 average now 2.4% above its Q2 average, the fastest growth in a year) adhered to that anchor provided earlier as a backstop, as security to clients - forecasters underestimated US vigor. These folks are in the process of correcting their models now. If we expect to do well as strategists, we must anticipate such a change, not react.  The pattern must be closed early, while others are looking elsewhere.

Next, clients were reminded Oct/9 and again Oct/15 to look for what would be perceived by the market crowd to be a solution, matters of the EU and most certainly not to set up trades which would do well on disappointment. That worked satisfactorily.

That celebration expanded the UK term structure a bit, providing a window for an exit.

That celebration also expanded the US term structure (2 - 30) 15 basis points or so and now 40, same spread, since recommended Oct/11.  We recommend that position, or something similar be held into next week’s FOMC. Anything from the Fed, as “anything” will be reckless, will further expand the curve.

Robert Craven

Goodbye UK Curve

Goodbye UK Curve

We have been long the UK curve since King’s surprise, Oct/6 (10 yr - 2.31% / 2 - 10, 171 / 2 - 30, +266, 5 - 10, +102.). We told clients just after that announcement to either sell UK debt outright, or own the curve (L - S). The trade performed satisfactorily, and half the gains were taken in 10/14 (2 - 10, +200 / 10yr - 2.61%).

We told clients to take the remainder of the position into the EU decision.  Last, 10yr, 2.62 / 2 - 10, + 202 / 2 - 30, +291 / 5 - 10, +119.

We recommend exiting this trade.  We’re not especially happy with the CBI read of Oct/26, something we did not anticipate. Plus we simply don’t like the feel, past few days.

It’s been a fun experience.  Let’s put it to rest and go on.


Robert Craven

Sit On Your Hands Please

We have been critical of planning in any theater, especially the Fed. Non rule-based activity will never work. Thus, ahead of QEII, we predicted the impact would be corrosive.  This was the result, triggering a surge in commodity inflation and the collapse of consumption, Q2.

We set an anchor for clients a few weeks ago. Any surprises were to be to the side of growth, not weakness and trades were to be set with this in mind. We have used the term structure to illustrate this reality.

If we look at today’s advance Q3 GDP print, we receive further support for our anchor. Some may have noted that service spending was up 3%, the most since Q2 ‘06, suggesting broad improvement.  Next, auto sales will slow Q4 but that’s alright; we see that ex-vehicle activity was up 2.5% vs 1.5%, Q2. Guess why? Because the impact of destructive Fed policy has faded; that is, income growth is keeping up with price increases.

Bernanke - now sit. Good boy.

Robert Craven

Opportunity

As expected, European banks are told to raise capital. But raise capital in this market where even the stronger contenders see share prices at about ½ book value?  Maybe not. Some will simply withdraw, tortoise fashion. If these guys have to backstop capital to 9%, they will do it by shrinking the balance sheet. Goodbye credit.

This reality underpins the act of once again spreading the US (S) and Canada to Germany and others.  We will do just that, next window.


Robert Craven

Back to the USA

With our EU friends center stage, the rest is on the back burner but assuming (as we do) there will be no Armageddon, let’s get back to business and take a look at the US.

We had set an anchor weeks back and it remains in place - there is a flaw to consensus regarding US vigor ahead.  Knowing that to be the case gives our clients a leg up.

Today’s Sep Durables print was consistent with our view, suggesting as it did that capital spending expanded strongly in Q3.  We expect the GDP advance tomorrow, and the Claims print to further cooperate.

This reality can be worked in any number of ways, none of which call for complexity.

The option is one of the most versatile of tools in this regard. For example, the bear call spread on the 10 yr would be a nice fit. This is a vertical credit spread, with limited profit and loss potential. This is conservative, but of course options offer the alternative (uncovered call write, with unlimited loss potential) so it’s all there for the desk.

In this situation, we would be in no hurry to place a trade.  Look for a window. For example, if the Michigan read on Friday is extremely weak the FI market will firm. Then consider that event to be a gift and set the trade.  (A real window of course would be total EU failure. In that case, all bets are off.)


Robert Craven

Cowboy Wisdom and the Euro

We’re optimistic we will get past chapter I.  Of course King rightly notes that this is no cure. That’s right. It’s not meant to be.

To most folks observing from afar the single currency never made much sense. We recall back in 1999 when the idea came up that Charlie, the cowboy to whom we lease 118 acres of California foothill land, noted that, “Hell, that don’t make sense. They’re none of ‘em the same. It’ll blow up.”

Indeed it will. All but the willfully blind understand that the only way to have a bunch of currencies lumped together is if these sovereigns are culturally close. Charlie might have miscued on Germany and Austria but he has Germany and Portugal, and the rest of the south, spot on.

What else is there to understand?

The folks who put this thing together may have had an education but they couldn't find their way out of a wet paper bag. Charlie’s never seen a college classroom, but in a pinch, you’d want him on your side.


Robert Craven

UK Interest Rate Landscape

While we’re on hold for our EU friends, best to revisit the UK term structure.

On the announcement of King's surprise, Oct/6, we alerted clients that the curve would expand, debt prices weaken and to take advantage of that reality.

That is, the lay of the landscape just ahead suddenly took on a different shape. Investors, traders, planners were to navigate that landscape with tools that fit their needs the best.

Pre-announcement, the 10 yr  2.31%, 2 - 10, +171, 2 - 30, +266.

We recommended Oct/14 that clients realize half the gains on this trade and remain with the balance.

Last, 10 yr, 2.60%, 2 - 10, +202, 2 - 30, +292.

We expect progress in Europe and see no reason abandon this position.



Robert Craven

The EU and Attitude

We told clients on Oct/9 and again Oct/15 to expect progress towards a solution, that EU leaders were on to something and that - key - the market crowd would come to agree. Clients were then not to set trades which would benefit by the way of disappointment. There were no odds in such of move.

Timidity, half measures are corrosive but this has not been lost on EU policy makers; they have known that for goodness sake; this is not just the stuff of critics. But suddenly, late Sep they realized they’d approached the point of no return. There was a sea-change in attitude then when policy makers came to understand the wisdom of Ben Franklin, that they had better pretty quick find a way to hang together, or they would all go down together.

And of course we know that the tools have been there all along. We’re not smart enough to know which will be chosen but that doesn’t matter for our purpose. It was only sensing the change in attitude and intent ahead of most others which mattered for our clients.

Irish Prime Minister Edna Kenny, in today’s WSJ, "For the first time, I found leaders of the Eurozone focusing on the fundamentals here in respect from the situation arising from Greece and the fear of contagion. There was clearly an understanding the world was watching and there wasn’t any point in doing this in a half hearted fashion."
　
Indeed.
　
Robert Craven

The Week Ahead

When most had the US economy sideways at best, we predicted more. Now, others are coming to agree. But the horse is long gone. We want to anticipate change, not react.

There are plenty of releases with the horsepower to move the market this week, among these Durables, Claims, the advance Q3 GDP, and Michigan sentiment. We cannot assign a risk to the Durables print. The risk is for Claims to come inside of expectations, for GDP to just exceed expectations (+2.3%).

We advise that clients read nothing into the Michigan result. This and other confidence measures carry little by the way of leading characteristics. For example, September confidence reads were weak, but Retail Sales improved nicely that month.

Our friends at the Fed meet Nov 1 and 2. There will be more chatter from officials ahead of that meeting, most of it designed as cheer leading.

“We are prepared to employ our tools as appropriate to foster a stronger economic recovery in a context of price stability,” Vice Chair Janet Yellen said last week. Come on Janet dear, leave well enough alone.

Finally, to Europe. It's been too easy to find fault with EU types. Observers got into that habit, past two years. Gloating, they now missed the turn. We highlighted Oct/9 that there was a change in dynamic. This positive dimension will continue to unfold this week.

Robert Craven

Week in Review

We’ve been at this business for a number of years and the present situation is one of, if not the toughest we’re ever had to navigate. We’re thankful for no major casualties along the way.

Coming into this week, clients we advised to look for more US vigor than that which was priced in; that is, than consensus. There was/is a flaw to St estimates, a result of the clubby nature of that environment and thus lack of independent research. One of these types changed his view after seeing the data, noting today that, "A recession now seems a lot less likely." Of course the horse is long gone.

If there were to be surprises this week they were to be to the side of more vigor, not less and clients were to prepare for that event. That was indeed the result as PPI and the Philly Fed flattened estimates. Industrial Production (+0.2%), CPI (+0.3%) and Claims were about as expected.

Recent crude price activity might represent a threat to our constructive view on the consumer. Recall that it was crude as tagged to the Arab Spring which crippled US consumer activity late Q1, Q2 by the way of gasoline prices. Now we must look no further than the recent work of our colleague Nick Kennedy to see that crude prices represent perhaps less of a threat, and are likely to move lower over the intermediate term.

Finally, clients were advised Oct/9 to expect positive results from the EU, not to position for disappointment. Events last week made us out to be seers; this week it seems we’ve lost some traction. We still expect events there to congeal, and in a positive fashion. It is in fact those in the cheap seats who will be disappointed.
　
　
Robert Craven

Handy Tool

As part of this service we regularly review key releases for each week, and assign a risk to each. This exercise enables the client to have a good idea of mkt response, ahead of the fact. We aren’t always right, but past years, something on the order of 65 - 70% (past records on file).

To see how this works, let’s review. Last week we predicted that Claims and Retail Sales would both cheer the market. Claims was just inside of estimates but Sales blew through consensus, cooperating very nicely. This week, we predicted that CPI, Ind Production and today’s key Philly Fed would exceed estimates. CPI was at consensus, Production only a tad through, but the Philly Fed blew through estimates, also cooperating very nicely.

Thus, although we missed on a few, it was not because the result was in the extreme reverse, but at consensus. This is a key point. Rarely in the many years we have produced this product has the result gone radically in the reverse of our prediction.

Thus, clients acquire a good deal of security from this exercise.
　

Robert Craven

US Term Structure

Coming into "twist," Sep/21, we advised owning the curve, looking for an expansion (contrary to Fed intent). Instead, 2 - 10 for example, at +178 pre-announcement, contracted to 169 by the end of the day. On Sep/22, it printed +160. Not a satisfactory experience as we were rolled by the mkt crowd so that traders, depending on risk control, would most likely have to realize a loss.

Investors were advised to sit still as nothing had changed. Dynamics for expansion remained in place.

Next, in an Oct/11 update we told clients to continue to look for cheaper prices, US debt, and a more expanded curve, especially 2 - 30. The 10 yr then 2.14%, 2 - 10, +184, 2 - 30, +276. Last, 2.20%, +192, +294.

Most feel still that the consistent right trade on Europe is to position for disappointment. We have disagreed (see our 10/9 piece - Kicking The Can). There will be more US price pressures than expected over the intermediate term; there will be more consumer activity and employment activity than expected over the intermediate term. Thus, the course-of-least-resistance for the US curve to remain steeper, even now. This defines the landscape ahead.

Clients are left to their own devices to best lever this reality.
　

Robert Craven
　

Backstage with the Fed

Europe is front and center but investors and corporate planners are to remain anchored, not to ignore other key dynamics which have not gone away and will help define the US economic landscape ahead. One of these is Fed policy. Naturally clients need to know how to figure policy into the equation.

We are more constructive than most others on the US economy but in spite of, not due to recent Fed activity. We predicted QEII would simply fire inflation and less-deserving equities. Most now understand that was the result. We noted that "twist"would accomplish little past some trading opportunities. The jury is still out but will no doubt return with our verdict.

One of the most qualified of Fed officials is Jeff Lacker, president of the Richmond Fed. Speaking recently of QEII and Twist, Lacker noted: "The effects of these operations is uncertain, but is likely to be relatively small. My sense is that the main effect will be to raise inflation somewhat rather than increase growth," he argued in his prepared remarks and noted a risk of inflation to the upside.

Agree.
　
Lacker said MBS purchases, which got a fresh boost in September as the Fed decided to reinvest maturing mortgage bonds back into that market, were not well-advised. "It's simply inappropriate, in my view, for a central bank to attempt to channel credit toward some economic sectors and away from others," he said.

Correct again. These types are not planners; nobody is; it doesn’t work.


Thus investors and corporate strategists when setting strategy for H1, 2012 are not to include recent Fed policy change as a spark but as a wash at best, if not a retardant.
　
　
Robert Craven

Week Ahead

We suspect that European policy makers will continue to make progress.

The corrosive result from timidity in policy making is now crystal clear to most of them. Their new determination however is naturally complicated by the fact there are 17.

In the US we had 13. Ben Franklin, when pondering the threats of King George III noted that the 13 had better, "..all hang together, or most assuredly we will all hang separately."

King George has been replaced by 21^st century market tyrants but most of the EU get the point. This is why we could say in our Oct/9 sketch that we thought this time (Merkel / Sarkozy meeting) was different, that leaders were on to something and that we expected the market crowd to come to agree.



Stateside, let us look for releases next week to support our view that St forecasters have been caught with their pants down. Thus, the risk is that CPI will alarm. We expect Industrial Production to exceed estimates, along with the Philly Fed survey later in the week.
　
　
Robert Craven

Review

We earlier advised clients to look for more from the US real sector than expected, especially the jobs and consumer sectors. Yesterday’s Claims release was only a tad inside of expectations yet today’s Sales result was far through expectations, thus cooperating very nicely.

Ongoing, we can expect this anchor to remain set; there remains a flaw to St estimates.

Next, we have advised that both the UK and US term structures will expand and that clients are to either sell that debt outright, or, own both curves. This has performed satisfactorily. We advised buying the UK curve Oct/6, the day of the Bk of England’s surprise, and exactly because of it. The 2 - 10 was then 171, the 10 yr, 2.31%. Last, 2 - 10, 200, the 10yr, 2.61%.

Of course exercising this view or navigating the landscape we set for the client can be done in any number of ways, the weighted futures spread perhaps the simplest. However it was done, we recommend clients take in half the trade, stay with the balance.
　

Robert Craven

Long End

Today’s auction of the 30yr went well at 3.12%. "It’s the only place to be," say strategists, and, "we know the Fed is a buyer."

No matter. Remain long (L - S) the curve. We noted Oct/11 to look for more from the 2 - 30, then, +276, last, +288.
　

Robert Craven

Five-Legged Calf

One of the reasons we want our clients to own (L - S) the US term structure is that we expect price pressures over the intermediate term to increase. The Fed’s link to core CPI as a policy guide simply puts off the inevitable.

St. Louis Fed president James Bullard writes in the Bank’s July/Aug 2011 Review: "One immediate benefit of dropping the emphasis on core inflation would be to reconnect the Federal Reserve with households and businesses who know price change when they see it."

Nixon got Burns to convince Congress it was best to drop the headline because he, Nixon, wanted Burns to fire on all burners.

Bullard continues, "There are several..arguments...used to favor a focus on core inflation.....all of them are essentially misguided." As we have argued for years.

Thus, the mkt crowd obediently accepts the core and will eventually get bush wacked as a result.

The FOMC might recall the Lincoln story, and the case of the boy who, when asked how many legs his calf would have if he called its tail a leg, replied, "Five," to which the response was made that calling the tail a leg would not make it a leg.
　

Robert Craven

Crude

We have maintained a wild card all year; that is, the overlay of risk from the Saudi - Iranian dynamic.

We did not know how this might manifest itself, but had the risk that it would. That of course translates to crude and we can do without that burden right now.

The plan to take out the Saudi ambassador (and perhaps others) may be the manifestation we had feared.

Let’s put the odds of violence at 30% at the moment.

Figure this into the desk’s operations.
　

Robert Craven

US Releases

We expect consumer and jobs-related releases to broach expectations over the near term.

There is nothing really strong about the US economy of course, but since we are interested in price change, we are not interested in absolutes, only reality just ahead vs St consensus.

Thus, look for tomorrow’s Claims result and Friday’s Retail Sales to cheer the market (worry debt prices). This is the risk, our view.




Robert Craven

Planners

Seems there is only one thing all the Republican presidential contenders can agree upon - fire Bernanke.

This is by instinct. Conservatives do not like planners. They know enough to know it doesn’t work. The gov’t (and the Fed answers to the gov’t) cannot pick winners.

As we noted in our earlier piece, Renaissance, the masses are catching on. Before their very eyes they saw
Obama try to pick a winner in the green industry and they saw it fail. They saw Bernanke try to pick a winner with QEII and they saw that fail.

The Fed and administration must refrain from this foolish behavior.


Robert Craven

"Twist" revisited

Ahead of "Twist" day, Sep/21 we predicted just the opposite price reaction to that expected - cheaper debt prices and a steeper curve. We were wrong. The curve flattened and prices rose - the Fed’s intent. From a trading standpoint, one could not stay with that position. One can be right at the wrong time. Given reasonable risk control, it had to be taken in.

Now of course, prices are considerably cheaper out to the 10 yr. than pre-"twist" levels (2.14% vs 1.90%) and the curve, steeper than pre-"twist" levels if 2 - 10, yet still flatter if 2 - 30.

"Twist" never had any implications for the economy, only for trading operations. The level of interest rates is not the retardant. Nor is lack of liquidity. There is plenty of that. "Twist" was pure and simple cheerleading.

Over the intermediate term, short of a Merkel / Sarkozy boondoggle, look for higher yields and a steeper curve, especially 2 - 30.
　

Robert Craven

Bk of Eng’s QE2

The Bank’s David Miles today dismissed those of us who contend QE2 will not accomplish its desired end.

It will accomplish something alright - lower UK debt prices.

The instant we read of this policy change we wanted to tell David - thank you for the gift.

Most central bankers have difficulty understanding policy impact on anything out past a year. Too bad Buiter is not still at the levers. You do not adopt such aggressive policy in the face of building price pressures, and, the hint of recovery, EU.

Course of least resistance for UK debt prices remains lower; course of lease resistance for the curve - steeper.
　

Robert Craven

UK

Following the Bk of Eng surprise of 10/6 we recommended that clients look to sell UK debt, and, or, own (L - S) the curve. The 10yr Gilt then 2.31%, 2 - 10, +171, 2 - 30, +266. Last, 2.51%, +188, +279. Remain with these positions (or something similar). The Bk of Eng move will be seen to be in excess, especially considering UK price measures. Near term developments in the EU to contribute also, our view.

We prefer spreads, but then that’s up to the desk.
　

Robert Craven

Kicking the Can

A friend of ours noted this pm, after the Merkel / Sarkozy announcement that it was, "The usual European story, everyone is in total agreement that things need doing, just not on how and who should pay! Can kicked down the road for another month. If markets improve between now and then can will be kicked again. Only the market can force the issue."

That perfectly sums up the past 12 months. And as to the period up to Nov/3, Nick feels that if the market stands back and drops the 2x4, then EU types will simply go slack.

This time, we think these leaders have learned something. They’ve gone through the process of squirming, then screaming and kicking, all the way to the operating room. We think the frontal lobotomy actually worked (sorry Randle Patrick McMurphy).

We think this time our friends Merkel and Sarkozy are on to something, or at least a large part of something - compromise, then move on, or their legacies head for the dumpster. We expect the mkt crowd to come to agree. (They don’t at the moment, as the Euro is lower, Singapore open).



Robert Craven

Incest

Incest can produce brilliant offspring; more often, the result resembles that perched on the porch in the movie Deliverance.

The same holds true for Street research. These folks - holding hands, shouting out together in the dark. An error or what we call a "flaw" is expanded as analysts borrow from each other until the final product is horribly distorted, its parents too intimately connected.

Best to do our own sensing. In our earlier career we counted rail cars and haunted shopping mall parking lots. We don’t do much of that any more but we do listen to those in the arena, not Wall St seers. And we own as a result a good track record at closing the pattern on consumer behavior before most others.

"It doesn’t feel like 2008 out there," Jason Seidl, a New York-based analyst with Dahlman Rose & Co., said in an interview carried on Bloomberg. At his firm’s recent transportation conference with trucking, rail and air carrier executives, "no one thought we were heading into a recession."

Agreed.
　

Robert Craven

US

The risk this am was for a NFP result through expectations. That was the result.

Ongoing, both consumer activity (Sep Retail Sales, 10/14) and employment activity will "surprise" to the upside.

Most observers continue to under-estimate US vigor - that is the flaw to consensus.

Further encouragement will be provided by change in Washington, now that the electorate has come to understand that an interventionist administration impedes growth.
　

Robert Craven

Opportunity

King is the most qualified central banker in the world. Yet even he cannot shake the habit of driving with his eyes in the mirror.

The mkt crowd demands a god and King is one of them. Thus, when King says that, "This is the most serious financial crisis we’ve seen, at least since the 1930's, if not ever," the crowd will react in the extreme. This provides opportunity.

In the most general sense, clients are to look for the opportunity to sell, not own, UK debt, or, to own (L - S) the curve.
　

Robert Craven