Backstage at the Fed

We’ve chatted with a few folk past days from Fed districts here and there, to get some idea of staff reaction to Bernanke’s recent Congressional testimony. There is nothing official about our survey, nothing statistically significant; just a few friends with nothing better to do at lunch time.

First, no one thinks that another “twist” would make any difference. The interest rate level at the long end is not the problem. All twist represents is a change in the makeup of the Fed’s portfolio; this is the same as doing nothing they say.

However, most of the folk we spoke to do not think the Fed is impotent. One reminded us of Friedman’s 2000 comments re Japan: “Now, the Bank of Japan’s argument is, ‘Oh well, we’ve got the interest rate down to zero; what more can we do?’ It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy. The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy.”

And it is true; the Fed can buy anything it wants to, including a herd of cows in Montana. So outright purchases of all maturities remain an option – continue to expand “high powered money”, that is - currency and bank reserves, until she fires up. Still, a hawk or two may stand in the way, for now.

Next, most have conceded that the Bernanke Fed has resorted to cheer leading and will continue to do so.  Fine.

Finally, most are exasperated with the “mental midgets” in Washington; referring here to those who stand in the way of a rule-based fiscal agenda vs the flagrant, shotgun approach of an interventionist administration; referring in this case to the left.  This is the only place that staffers fault Bernanke’s testimony – “the case is obvious.” Why was he circuitous in his testimony? Why not more direct?  “This is not a secret,” one source noted.

Who knows?  He does the best he can, trusting in his instinct. We have to do the best we can, trusting in our instinct to translate Fed policy to the bottom line.


Robert Craven

 

UK Term Structure

Let’s revisit the UK term structure for just a moment.

Early June we advised that clients were to look own this spread, that course-of-least resistance was to be wider over the intermediate term. The spread 2-30 for example was 277 at that writing (6/12). We noted that there was no hurry, but that the aim should be to acquire a position ongoing, and that 270 was a reasonable entry point. The E-Z panic of 6/26, 27 afforded that print and clients were in some fashion to be long from that juncture. 

The spread expanded satisfactorily, printing 285 +/-, July 5, assisted by the announcement of further Bk of England foraging. This is why we noted that owning this spread was not simply a directional exercise. Indeed, the short end improved substantially.

Following, the spread has come back in, last 269. The overall plan remains the same. Gather a long position, or, set other trades but with this background in mind. The total collapse of the Euro might prove corrosive to the strategy but that’s a ways off yet. The rest in priced in.


Robert Craven

Next Meal Through a Slot

As we wait it out, the LIBOR “scandal” provides instruction, maybe even salvation.

When we worked on the street there were gentlemen to be found, a sense of order, a shared moral compass.  Now it appears that all that remains are moral lepers. Of course that must not be true; we are eternal optimists, always in search of the good in mankind.  Are there any of the good left on Wall Street?

Sure.  But on the whole you are paid for how much dough you bring in, not for how much worldly good you may accomplish. There is nothing illegal about this, about greed. If you go to work for a St firm don’t expect respect from your fellow human beings in the sense of respect directed towards a nurse, paleontologist or astronaut. You’ll have plenty of money, a good thing and you’ve earned it all legally, maybe. You just haven’t contributed much, like say a skilled irrigator for an artichoke farmer in Monterey, or a filmmaker or an Apache pilot, but again, there is no law yet against churning for a living.

But for some of the anointed, the big guys – major firms – the temptation can be too great. They’re not sure about the masters of the universe bit but they saw the movie and figure they’ll try it out now and then, see if it really works.  One way to do that is to pay a depositor 0.05% on his CD, then risk the $ on a structured product that implodes, then come back to the same depositor and ask very kindly for a bailout, and lo and behold – get it! That’s pretty slick. 

Yet human nature requires a stretch now and then, just to the edge, for the thrill of it if nothing else, even though the risk is to be taking your next meal through a slot. Cut corners and see what happens.

Here is where submitted rate manipulation comes in. Any fool knows it’s not just Barclays; no doubt BofA, Citi and good –ol JP are in up to their necks too. And with this will come the chant from Washington for more regulation. But in my time we behaved as gentlemen, at least those of us who submitted official rates did. We all behaved honestly. We had respect for ourselves and our firm; we did not change jobs every 9 months for a measly buck either. We most certainly did not need to be regulated because there was nothing to regulate.

So the problem is not one of lack of regulation, nor intrigue but society and the lack of civility.  Licentiousness in our financial dealings has grown exponentially past two decades. Things are too easy.  There is no respect for elders or for once-great institutions. There are no longer standards of behavior, only modes of behavior.

Finally, and key – there is no sense of responsibility on the Street any longer for the simple reason that you can get away with it; that is, you can be irresponsible and do quite well.  In what other occupation is that possible? A plumber? Don’t think so.

So we have the answer. No longer is any bank, or anyone else, too big to fail. No longer is a phony currency cooked up by elitist types in Brussels too key to fail. No longer is there a parachute for fools and lechers.  You screw up and that’s your own look out.


Take the pain. Stop the nonsense. Listen up, Washington.


Robert Craven

Politics and the US Jobs Machine

Coming into Q2 we attributed more horsepower to the US jobs machine than she could muster. We want to understand why; thus equipped, we will have an accurate view of reality ahead for this sector, of those factors needed for a burst in this activity.

In earlier posts we highlighted employers’ lack of enthusiasm for the current administration’s interventionist policies, Obamacare chief among these. Our problem at making strategy for the jobs sector, Q2, is that we underestimated this concern.

From reported interviews and those of our own we know the dynamic remains firmly in place – businesses which have an increase in demand are meeting that demand by working existing employees longer hours, only adding to staff when the shortage is extreme. Or of course they hire temps who are not freighted with benefits (nor much salary either). This should be news to no one.

Employers do not have any idea yet how much Obamacare will add to the cost of new employees. They won’t have an idea of tax rates or health care costs until after the Nov election. The threat of an expanded regulatory burden coupled with the mess in the E-Z simply keeps them on hold, swimming in cash.

CEO’s are paid to take risks but not in a game where the playing field is uneven and rules change every Qt.

Next, there is little the Fed can do and most policy makers know it. 

We praised Bernanke for the impulse towards openness but warned him last year it could well get him in trouble if taken too far. That has been the result – there is no longer the power of impact, of announcement, the wallop so needed is gone.  There is only crazy making.

The Fed’s “dual mandate” (a huge mistake) gives everyone, policy maker and politician alike a license to meddle. The Fed regularly refers to its dual mandate in justifying its unusual and mostly harmful interventions. We are not referring to 2009. Something bold was needed, but now, Bernanke’s tinkering, his non-rule based activity is nearly as corrosive to business and investor confidence as Obama’s. 

Potential employers hope that given a Republican victory in November, Washington’s interventionist policy will be jettisoned. The hope is that microeconomic planning, the hallmark of a statist president gives way to a coherent, long-term fiscal policy instead.  We can also hope for a return to sound and sane rule-based policy making at the Fed; if we are lucky, a return to a single mandate of price stability. These two measures will lend considerable confidence to business planners, and away we will go.

In the meantime, the best thing Obama and Bernanke can do for America and the rest of the free world is to sit on their hands.


Robert Craven

UK Term Structure

We noted on June/12 that the course-of-least-resistance for the UK curve over the intermediate term would be one of expansion, and that under no circumstances were clients to look to sell this spread (S – L) as a strategy.

We had expected that UK real-sector weakness had been priced in, including a stagnant service sector, and that the better part of contagion to the E-Z was priced in also, short of another panic.

Thus, we recommended clients look to own the curve given when for example (2-30) approached 270, then 277. The panic of June/26, 27 did the trick (270). Last, 276.

Many may of course consider 2–30 simply a directional play. It is not but that is fine. Then work something else along the curve, or of course any of the other strategies based on expansion of the term structure, that is, with this dynamic as their foundation.

The approach is to gradually gather a position; the first accumulation should have been June/26, 27.

We personally hope for a complete and sudden failure of the Euro. But of course that is not likely over the intermediate term. Only if we knew that it were, would we want clients to stay away.

Bank of England firing ahead will not hurt, nor will the emergency lending scheme, nor will the Bank’s recently announce plans for liquidity relief. 


Robert Craven