Post Turtles Running the Show?

We must be dreaming.

Or, could it be that Fed management is actually handled by post turtles? You know, like Obama - he didn’t get on top of that fence post by himself, he doesn’t belong there, he doesn’t know what to do while he’s up there, he’s elevated beyond his ability to function, that kind of turtle. 

Obama’s try at economics was “The Stimulus,” except that there was none.  Very early on into that debacle we warned, and did so repeatedly, that this, the economic equivalency of taking water from one end of the pool and pouring it into the other was at best a wash, more likely a retardant. We were right.

And now Bernanke has come along with his brand of “stimulus” which is also, our view, at best a wash. The QE’s have benefited equities because now companies can borrow cheap and buy back stock. But that’s it. Not much of a real sector benefit, and maybe none; one at any rate overwhelmed by the negative aspects, the uncertainty for real risk takers given we have planners at the helm.  For more on the negative correlation between Fed meddling – QE -  and growth, see this recent sketch by Forbes contributor Louis Woodhill: http://www.forbes.com/sites/louiswoodhill/2013/10/23/as-the-job-market-falters-even-some-democrats-wake-up-about-growth/.

Today we found the FOMC bunch are just a tad more optimistic. What? They are either full-fledged post turtles, or 100% cheerleaders. Yet they will still keep the gates open they say. How long? Until we have the equivalent of a Mount St Helens blowout, our bet.


Robert Craven

Change at the Fed

Janet Yellen will likely expand on Bernanke’s policy mix. She will sponsor Fed activism; she will continue to enable the Washington left.  

In a recent sketch, Thomas Sowell, the Milton Friedman Senior Fellow on Public Policy at the Hoover Institution notes that Yellen has a history of asking the right questions and giving the wrong answers: “Will capitalist economies operate at full employment in the absence of routine intervention,” she asked. “Certainly not” was her answer.  “Do policy makers have the knowledge and ability to improve macroeconomic outcomes rather than making matters worse,” she asked. “Yes.”

This reality -Yellen as chair - will prove to be a retardant to US growth.

We are going nowhere, and quickly. Any recovery will be in spite of, not because of this individual’s policies. Normal free-market pricing mechanisms will remain unplugged. 

Calvin Coolidge, help us.


Robert Craven

Roughed Up By a Planner

After all these years it still never gets easy. But now a new variety of snake has been thrown into the arena, one even more unpredictable and deadly than the rest.

For example, past years if we had a fairly good notion of relative performance, sovereign credits, we’d do alright. So early May we were pretty buoyant, pretty darn confident when we isolated what we thought would be “surprising” vigor in the UK and what we thought would be a “disappointment” in the US.  The simplest way to translate this view was to sell the Gilt 10 yr and own the US note. 

So that is what we did, figuring we were pretty sharp hombres, putting the trade on about flat, or 0 spread.

As it turned out, real sector results did cooperate; they still are.  However, the trade blew up in our face thanks to Bernanke’s mid-May hint that he may ramp in QE. US debt prices collapsed. Son-of-a-gun.  We had looked for something on the order of -20 come July (US -20 bps under UK) not +20!

This added dimension is why many experienced strategists are to be found in their garden, at least for this season.

Robert Craven

Praise for Mark Carney

Mr. Carney has very much limited his dialogue with the market crowd. For this effort he should be commended.

Recall that after the last meeting he said nothing.  Then last Friday (Yorkshire Post) he said he would likely leave things as is and pretty much left it at that.

We had noted that Carney was a quick study but we didn’t realize just how quick.

Early on we sensed “surprising” UK economic vigor and in which sectors and, we predicted much higher interest rates. That worked. 

But then in the last post we predicted that Carney’s reaction to higher long rates could well be an extension of QE, and that this would – contrary to conventional wisdom – drive long rates even higher due to elevated inflation reads. Finally, we noted that this situation could then arrest UK growth.

Carney is concerned with longer rates as a drag but – key - he also understands that chatter will inflame, not settle the market crowd. The less said the better (a lesson lost on Bernanke).

Carney has demonstrated the ownership of an asset rarely found in central banking - an understanding of crowd behavior.


Robert Craven

Wrong Discussion

The discussion in the world’s financial press regarding Fed decision making is framed inappropriately. The discussion is about what is next and how markets will react.

The insanity is that this dialogue passes the sobriety test. Most sit in the theatre, lemming-like, riveted to the action; instead of waiting for the next act, they should demand a refund.


Background:  From a recent sketch by George Will: “The Fed has become the model of applied progressivism, under which power flows to clever regulators who operate independent of political control. The Fed is, however, a creation of Congress, which may not forever refrain from putting a bridle and snaffle on a Fed that increasingly allocates credit, wealth and opportunity.” 

The tragedy is that Bernanke and others think they can “out figure” the free market, that they, the anointed, have been selected by the market god to efficiently direct resources. 


Key to today’s sketch is that this tragedy is expanded by the effort, any effort to communicate with, to embrace the FI market crowd.

As a central banker you must never, ever put yourself in a situation where you feel obliged to engage. You are then held hostage to what is almost always a reaction in the extreme – this is as true of a lynch mob or the Bastille as it is of this bunch.

So when our activist Fed chair hints of an ease in QE, rates erupt; he then feels forced to say he will continue with QE, and so on; thus additions are made to this house of cards before our very eyes.

Observers feel betrayed, pouting because in their view the Fed double-crossed them on Sep/18. The Fed’s credibility “is now shredded,” whines one street economist. “They can’t be trusted.”

KC Fed pres George warns that the Fed’s message has been muddled and the Fed has surrendered at least some of its credibility. The Fed, “…will have to think about the challenges that come with issues of credibility….”  “The actions at this meeting, and the expectations that have been set relative to how markets were thinking about this, created confusion, created a disconnect.”

Of course; there could be no other result.

There is nothing sinister here. There is perhaps no intent to deceive; policy makers are simply not trained for the task at hand. But it is “the task at hand” that is the problem.

Robert Craven
 

House of Cards

Recent key US economic prints telegraphed a wilt for Q3; and equities erupt. What?  To regular folk this appears to be the theater of the absurd. They’re right.

Many of us understand it is something else - a house of cards.

Recall the normal cycle of expansion, contraction; then a re-birthing and then expansion anew – all very healthy.  Planners have aborted that process.

Some are beginning to catch on (after trashing a system that worked very well before they came along) that to interfere with the natural pricing mechanism will backfire. For example, some Fed staffers are worried about the chasm between equity prices and economic reality; some staffers in fact very close to Bernanke. This is why QE will be eased despite a “surprisingly” slower Q3 - because of the threat of an abscess.

Bernanke has unplugged the normal pricing mechanism. Thus the equity market takes off after weak data because one man at the Fed says it should. In the meantime, another sector, say normal, everyday retired folks who’ve got to keep the little they have safe and sound, get knifed because planners have decided that fate for them.

Background:  We know from the works of Friedman, Taylor, von Mises, Rueff, and others that rule-based policy making creates more prosperity than discretionary policy making. For example, US economic performance during periods of rule-based policy making has eclipsed periods of discretionary policy making; that is, the 60’s – 70’s was discretionary, then ‘85 – 2003, rule-based; and then  2003 to present - discretionary. Performance during the ‘85- 2003 period blew away the other two.

Planners at the Fed have rigged the system. They, the anointed, have selected certain sectors of the economy to fire, and others, to extinguish. This practice – the distribution of favors - is immoral.

For an anchor, recall the incestuous relationship between the Fed and the banks. This reality explains a lot (and why most of these guys who hatched the ’08 debacle are not under house arrest beats us). As fund manager Seth Klarman put it recently, when referring to Bernanke’s Fed, “What kind of ….entity cajoles savers to spend…tricks its citizens into paying higher and higher prices to buy stocks…and drives the return on retirees’ savings to zero… in order to rescue poorly managed banks?”

Guess.  And it can come to no good; meaning that what could have been a vigorous recovery will be instead, anemic; all due to the Fed’s meddling.


Robert Craven

Gilts Just Ahead

After our Spring alert that the UK real sector would blow through expectations (the result) and then more recent alerts that there were still more “surprises” yet to come (the result) one would think that observers have about caught on, changed their tired models. Not likely. Thus, the clear risk for key releases just ahead is for something more, not less than is now priced in.

Yet Mr. Carney fears a “false dawn.”  That may be but we are interested in FI price change over the near to intermediate term. We are not investors.  Thus, we have a central bank which will remain generous over the near term, we have a real sector with exhibits “surprising strength” day in and day out, and, we have elevated price reads which are not about to plummet.  This is the recipe for weaker debt prices just ahead.

Finally, Mr. Carney may well hint or actually deliver more QE in an attempt to dampen longer rates. He may do this because despite what one reads in the financial press he is in fact concerned that higher rates may well act as a retardant; and so, he may increase QE. But if he does, it will be by just a tad, not a wallop.  “Just a tad” will backfire and gilts will erode further, not strengthen.  That is the way things work in the real word. 


Robert Craven

Mark Carney - A Quick Study

Mark Carney kept it zipped today.  He is a quick study.  Almost always central bank chiefs get in trouble trying to communicate with a mob.

The financial press has it today that Carney has little fear of much higher rates, suggesting that is why they went even higher. For example, from our good friends at PIMCO, as carried in the Telegraph – “By issuing no statement the [Bank does] not see the back up in yields as being sufficient to risk the recovery, and as such the market has continued to sell-off to new yield highs.” 

Instead, Carney is not one bit comfortable with higher rates and very much does feel they could be a threat; but, he is apparently well acquainted with the first rule of holes – when in one, stop digging.


Robert Craven

US

We have provided clients (and later, blog readers) with value in understanding UK real sector dynamics ahead of most others.

Unfortunately we have not provided the same accuracy for the US.

We predicted more US economic weakness than has materialized. This was tied to our view that risk takers would quail, in the face of 1) a statist administration and 2) an interventionist Fed.  Planners at both organizations could come to no good, and they haven’t. But developments have not been as rough as we expected. We’re off to a slow start to Q3 but we thought earlier that we would be nearly flat.

Next, we don’t have an edge; we can’t sense where most analysts have gone wrong, if at all. We can’t sense value at the moment. And so with interest rates, we can’t offer strategy either within the US or against other sovereign credits.

And then there’s the good ‘ol Fed. Most of us long for the day when the tinkering will end.

Our advice to this organization is as follows: Step one is to set a target, say the PCE deflator at 2%. Forget the dual mandate – it is redundant and a lot of nonsense. Step two is to eliminate interest paid on excess reserves. Step three is to dust off the NY desk and use FF’s as the preferred tool, ongoing. Then sit on your hands.

At one point in our career we were able to strong arm the Fed to listen (with a little help from Congress) and to insist on results. This time around we can only hope.


Robert Craven

The UK - Surprises Yet To Come?

Insight can deliver results but it is courting real trouble to forget that these are ephemeral in nature. All of us have stuck with strategy just a day too long.

In the Spring we isolated a flaw common to most UK economic models; well, not the models actually but the observers, almost all of whom were driving at 90, gazing in the rear view mirror; a perfect case of group-think in economics. Once we had that in hand we in effect had the financial headlines in hand. And that is exactly how things worked out.

Key is to understand just when the analytical horde will catch on.  We updated through August that there were still pleasant surprises to come. And indeed there were, especially in services and in manufacturing, sectors isolated early on.

And now, after having been severely beaten about the head and shoulders for three months, have economists finally sobered up?  That’s generally within the time for a re-set; but our hunch is not this time.

Thus, we can look from more from the dear ‘ol UK economic engine than is priced in. And inflation reads are not coming down any time soon. And we have a stubborn central bank governor who thinks that arguing with the market will provide results.

Look for Gilt prices to ease further. 


Robert Craven
 

Carney's Dilemma

There are enough studies on the term structure to pave the way, as they often say, “from here to the moon.”   And that would be limited to central bank studies. Private studies would take us right out of the solar system (along with Voyager I).

We have specialized past years in term-structure strategy, the US and UK. Results have been satisfactory. We don’t examine the yield curve with scholastic rigor so much as common sense. But central banks, including Carney’s Bank of England rely on the “expectations model” of the term structure.  This forms, as John Taylor explains, the theoretical underpinning of so-called forward guidance. It’s a weak theory, explaining why for example Carney at this very moment is perplexed at the long end’s reaction to his preaching.

Perceived central bank generosity in the face of 1) surprising economic vigor and, 2) elevated price reads means corrosion in long-end debt prices. That’s the situation in the UK after Carney’s maiden speech today.


Robert Craven

Meddling - Never a Good Idea

We predicted in earlier posts that UK real-sector activity would flatten estimates, especially in services and manufacturing; that economists were driving full speed ahead with their eyes in the rear-view mirror. Most of these types are now extracting themselves from the wreckage.  And yet just a day or two after Manufacturing, Construction and Service reads all blew through consensus, Carney explained to the market crowd that he will keep the base rate very low (0.5%) until unemployment touches 7%!  Inflation last print at 2.8% was apparently not a problem. And then just following Carney’s announcement, both Jobs and Consumer data likewise flattened estimates.  Naturally, gilts have tanked. 

Key – central bankers rarely understand FI price determination, the workings of the auction market. This was especially true with Greenspan, is true with Bernanke and apparently true with Carney.  It is how and why they can get themselves in a lot of trouble.  

However – and this is a really big “however” - the skill or instinct to predict FI price change is not a requirement for the chair to be successful. Any chair can stay out of trouble given he has a lick of sense. To be successful the chair must function under some rule of order; that is, policy fixed for all to understand.  When the chair invents policy with all sorts of escape clauses and bells and whistles, as Carney has, and then compounds the problem by attempting to communicate through the noise and bullets, then that chair has stepped right into it.

Best would have been to stick with a 2% target but no, that was too easy.

Just ahead: Although she’s come along nicely, the UK economy has a few more pleasant surprises in store.  Gilt prices will ease further. Carney will then hint at more QE. Sterling will tank. And even if it doesn’t the Bank’s buying of a few long bonds will not stop the hemorrhaging. That is not the way things will work. Gilt prices will erode still further. This will retard economic momentum or even stop it dead in its tracks. 


Robert Craven
 

Gone Fishing

A rule of law allows individuals living in an open society to know the limits of behavior up front; these rules are fixed (unless changed by popular consent) and so provide an environment free of interference and prejudice from government. Players know the rules and conduct themselves accordingly.

A rule of monetary guidance is also required; required that is for an economy to thrive. Players will remain at the sidelines without it.  Hiring wilts when economic policy is discretionary, variable, and uncertain. Don’t believe us?  See the study Uncertainty and the Slow Labor Market Recovery by Leduc and Liu, SF Fed. On second thought - you don’t need to do that; it’s intuitive for goodness sake.

We do not have a simple rule of guidance in the US (nor does the UK now that Carney has changed the rules).  As a result, this “recovery” pales compared to a real one. Growth the past four quarters has been pathetic, not the 5.2% average four year growth of the 80’s recovery.  Why?  Risk takers have quailed.

There is hope however in the person of Don Kohn, a candidate for Fed chair.  Don, unlike Yellen or Summers, understands the benefits of non-interventionist central banking. Fingers crossed.

Finally, what about transmission to the bottom line, over the near term? Those interested in anticipating FI price change must buy a ticket to the carnival. It is no longer one’s view for near-term real sector change that matters, it is instead what one planner – Bernanke - expects regarding near-term change in the economy; but not even that – it is what the market crowd thinks that Bernanke the barker will think about near-term change in the economy and, what discretionary tool he may next pull out of his hat. That is why so many able folk have gone fishing.

Speaking of gone fishing, my granddaughter of 4 recently pulled a big brown trout out of a WA state lake with her 4’ pink fishing rod, a lake where supposedly no brown existed – only carp and bluegill. Her Dad helped a tad, but mostly got in the way.


Robert Craven

Always Look for the Flaw

We’ve omitted the UK for several weeks, for the simple reason we’ve had nothing new to contribute.

April/4 we noted that we had identified a flaw common to most economic models, so that there would be an under-shoot to key releases, and particularly an under-shoot to 1) private services and 2) manufacturing. With the July manuf PMI at a 28 month high, and with today’s PMI Services report at the fastest pace since records began (1998) and blowing through all estimates, that insight translated satisfactorily.

Key to those interested in capturing FI price change is to understand where the majority of observers have gone wrong; that is, the Achilles heel to most models.  That is our method.

Next, our sketch of Apr/23 – Stay With It George – resulted in outrage; half a dozen or so of our readers demanded they be immediately redacted from our distribution list and never, ever wanted to hear from us again. Darn. Yet we do have an enlightened administration, or as we wrote Apr/23, compared to that which went before. This administration has had the courage to cut spending; it is the revenue side –  tagged to a recovery, which is lagging; yet that won’t be for long given that we have been right about the UK.


Robert Craven

Kumbaya

Most of us understand that things as they exist today are the product of tinkering, the product of politics; that at the Fed (and the administration) the notion to simply refrain from further damage did not/does not register. Most of us understand further that a simple set of rules – Volker-style – would have had us on a smooth recovery long ago.

Kumbaya is not a market-crowd favorite. This crowd, like any other, understands only blunt trauma, applied force. Anything less telegraphs timidity; the market crowd reserves only scorn and rejection for Bernanke’s effort to apply a great big hug. This crowd is in need of the likes of a Ulysses S. Grant at Vicksburg or Ft Donelson and until it gets that is will continue to behave irrationally, violently.

When as a central banker you try to be a pal to the market, when you try to communicate as a friend, you get knifed.  For example, we know for a fact that Bernanke still cannot fathom the market’s reaction to his recent announcement. We can sympathize. It is tough to reason with a crowd (so don’t try it!). We recall at one point during Greenspan’s tenure when he was literally despondent, even near tears regarding the FI market’s reaction to a policy change  - a lift of 25bp’s, FF’s - that the market crowd judged an  act of timidity, not force, and then did exactly the opposite of what Greenspan intended it to do.

Some policy makers never seem to get it. To be effective, the Fed chair must remain aloof and detached. He must remember to set rules and to report to Congress twice a year on progress or lack of. But he must not tinker. He sets the rules of conduct (nominal GDP for example), then steps aside. Resources will find their proper home without his help.


Robert Craven
 

You're Not Alone Stan

We, along with the BIS and some others understand that market disciplines must be allowed to “discipline,” to operate in free form. Our caution to Bernanke (and Obama) in 2010 to please refrain from further intervention was ignored; that is a shame. We now have a rigged system; for example, Q1 GDP is revised considerably lower and equities erupt.  Too much.

The most generous thing that could be said about Bernanke is that he gave us borrowed time, but a time that has been mostly squandered.

The Fed acted appropriately, even splendidly early on. We were one of the first to say so. But this went to their head.  That is the problem.

No one individual, no planner can effectively direct resources in a modern economy. Picking winners is a loser’s game.  And so, we are now at a point where the end of this particular game may prove to be so corrosive, so disruptive, that we surrender all that we have tucked under our belt, so far this “recovery.”

At this center we generally convert economic insight to FI price change, and reveal a bit of that in this blog.  That has gone well past years but went very poorly the past month.

A friend forwarded this statement from Stan Druckenmiller (Stan – one of the best in the business): "It has become harder for me, because the importance of my skills is receding. Part of my advantage is that my strength is economic forecasting, but that only works in free markets, when markets are smarter than people. I watched the stock market, how equities reacted to change in levels of economic activity and I could understand how price signals worked and how to forecast them. Today, all these price signals are compromised and I’m seriously questioning whether I have any competitive advantage left.”

Well Stan, we’ll join you at the sidelines; just for now.


Robert Craven

Child's Play

Following April NFP, May/3, and that day’s debt sell off, our advice was to look to own US debt (after the dust settled) as we predicted that key releases just ahead would disappoint.  We also predicted that Fed commentary just ahead would not support the view for an early withdrawal.  Holy cow folks! Pickett’s charge comes to mind; we feel Lee’s pain just after.

But then we should have known better – the rules have changed. This is crazy-making; it is nonsense – the worse the economy looks for example, or may look, the better equities perform. Witness this headline in today’s financial press – “US stocks advance on stimulus bets ahead of payroll report….,” the story elaborating on what may be a weak report and extended Fed generosity.

Or is it “generosity” at all? By misdirecting resources; that is, by individuals directing resources at their whim, a rotten under-core begins to form in any economy once anchored by a rule-of-conduct. 

A freely functioning auction market has been replaced by a government sponsored institution.  Blockages form and eruptions result.  That is market violence – great for some street types but corrosive for the rest of us.

This is child’s play but the kids are armed and dangerous.


Robert Craven 

Hell To Pay

We predicted in our last post that Fed commentary over the near term would not support the notion of an early withdrawal, a near-term change in policy; that policy makers would hold the course – known hawks would remain hawks, and know doves would remain doves. That worked. The April 30 - May/1 FOMC minutes released 5/22 supported our notion even further.  Fine.

Then things went haywire. We witnessed Bernanke’s testimony yesterday, which was consistent UNTIL the q&a, half an hour later, when Bernanke said, “If we see continued improvement and we have confidence that that’s going to be sustained, then we could in the next few meetings, we could take a step down in our pace of purchases.”   Bond prices collapsed.

What a mess. Central bankers do not understand how to communicate with the market crowd and they never will. Thus, discretionary policy making is a fool’s errand.

Bernanke doesn’t know any more than most of us what to expect of the economy just ahead. But any crowd demands a god; the days of the Bastille and butchery on the streets have passed but there is still butchery to what was once a thriving economic machine, where decisions were based on known rules, and supply and demand were the clearing mechanisms. Now we have the decentralized auction arena replaced by a command center. Bernanke is the market’s god and when he is wrong, and he will be, the market will turn on him with a vengeance.

Market violence is good stuff for Street types, who buy and sell volatility for a living for example. But there is a higher calling. This higher standard is not a dream; it is a realty, one 226 years of age; it is that insight of a few individuals placed on paper one muggy summer in Philadelphia, from which we understand that we Americans can expect to conduct our lives free of constraint, free of discretionary government, free of interventionism, with anchorage provided by a rule of law; and, that we are to respect the intent and the property of those others so occupied.

With a government agency (independent or not) picking winners, there will be hell to pay.


Robert Craven
 

Unhinged?

Early on we predicted a slowing for H1, and lower interest rates; that is, a sub-read, most key releases. April NFP and the Feb/Mar revisions seemed to make us out to be unhinged.

Naturally it is easy to cherry pick, to fetch results which fit a bias.  In economics, it becomes an addiction for many, a drug to ease the pain of being wrong. Guarding against just that, let us state that the April NFP read does not indicate better times ahead, but is consistent with a slowing economy, thanks partly to the big drop in hours worked. We all know about this one – private hours were off 0.4% and manuf hours were off 0.2%; aggregate hours for all employees were off 0.4%.  Finally, an outdated seasonal added about 50M jobs.

Background: We have an administration hostile to job creation, actually hostile to free enterprise. You’ll find that out personally if you’re the fiftieth worker to be hired (sorry) or think you might receive credit at the I-Hop for working over thirty hours.

So past Friday’s celebration, prepare for this reality – a slowing into H2. One way to do that is to expect the recent, substantial losses in longer FI prices, to be reversed. The market crowd detected that such a “robust result” as that of Friday will persuade the Fed to reverse course sooner than expected. Fed commentary over the near term will do nothing to support that premise.


Robert Craven
 

US Strategy

We can expect our anchor to hold – economic reality over the near term will disappoint. Thus prepared, traders can set up for key releases. We may miss a few as there are no straight lines in this business, but this represents the trend, as predicted earlier.

The general flaw common to street analytics was birthed not by analysts’ failure to capture traditional relationships but by their failure to understand that traditional relationships no longer matter.

The economy is rigged; it is phony. Risk takers in this democracy are accustomed to a rule of law; when there is none, when planners are at the helm, risk takers withdraw. Central bank policy making in the US is 1) discretionary and 2) unpredictable. The Fed has eviscerated traditional and essential market functions. Nothing good can come of this and nothing good will, especially when compounded by the administration’s interventionist policy making - if the Fed don’t scare ya dear CEO, then Obamacare will.

From late Q4 we advised readers and clients to look for “surprising” weakness, H1, and presented a detailing of the reasons why.  We were a tad quick on the draw; events did not initially cooperate but most are now cooperating rather nicely. 

Translation: Early and mid Q1 we suggested using the simplest of spreads – the term structure – to translate. This spread was sold or could have been sold at levels approaching 112, 5-10 yr, and 290, 2 – 30.  Last, 99, 264.  The spread is not as useful now as it is more directional; no matter; there exists a galaxy of other tools available to translate a withering US economy to the bottom line.


Robert Craven

US - Near Term Anchor

We noted in our Sunday sketch that the clear risk is for key releases to disappoint, to fall south of expectations, and that traders were to prepare for that reality. Given we have in hand that flaw common to most models we have a major leg up on the market crowd.

Since Sunday of course this anchor has held. It will continue to hold, most releases, until economists catch on. That will take a bit.

Friday we have the Q1 GDP advance. This is the one release which may not fit; that is, consumption may push the headline just a tad north of consensus, but if so - odds, 40% - only a tad. Because Q1 is ancient history and because our anchor will likely hold for the near term, counter-trade such a result.
This is true even if the Consumption component of the advance is through expectations.


Robert Craven

UK - Stay With It George

We have in the UK an enlightened administration. Not perfect, just enlightened relative to what went before. 

Now those in the cheap seats can’t restrain themselves, beating Osborne about the head and shoulders at every opportunity (and looking like morons in the process) for his “severe” cuts to public spending and just at the worst time. They are not severe and any time is a good time.

In 1939, ten years after the crash on Wall Street, FDR’s Secretary of the Treasury, Henry Morgenthau, Jr., told the House Ways and Means Committee:

“We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong…somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises…I say after eight years of this administration we have just as much unemployment as when we started…And an enormous debt to boot!”

Any fool knows this stuff does not work. You don’t have to be a Wall St type (many recently bailed out for poor decision making) to understand this reality. If it’s fluff, and it is, do away with it.

We asked an average citizen – a Fresno, California cattleman - what he thought about the issue. “Well, sort of like taking water out of the deep end of the pool, and pouring it back in the shallow, ain’t it?” Exactly so.

Is there some sort of slush fund reserved for public emergencies? No. The money comes from 1) taxes, or 2) borrowing or 3) a complicit central bank (inflation). All three rob from the private sector, which is infinitely more productive than the public.

Public spending – at best a wash.  Get rid of it.


Robert Craven

Throw Out the Toolbox

It is important to understand economic reality just ahead. A re-tooling is a necessary if we want to get it right.

Early Q1 we predicted a slowing for H1, the reasons why and finally, the impact on the US term structure.  Our Mar/7 sketch entitled Lament presented first a distillate of our reasoning, but then the possibility that in fact we might be mistaken.  In this case it simply took a tad longer for dynamics to impact than we had expected.

Discard conventional tools. We have. Street economists/observers avoid politics like the plague, at least in print. But this time, understanding risk takers’ response to 4-more-years is key. 

Next, economic theory and price relationships of past years are no longer reliable guides. Traditional clearing mechanisms are not in play. Instead, planners are in control.

Part of the puzzle for many has been the general euphoria tagged to the equity market, as if this might be a reliable leader, some sort of indicator of the whole.  It can be, but not this time. Companies are more efficient, can get along with less - including fewer employees - but this dynamic was not birthed by some sort of renaissance or corporate awakening, but fear of a regulatory nightmare ahead. Given that the Fed – a partner in crime with the administration - has targeted equities, the false signal has been amplified. Even seniors with limited means are tempted, as the Fed has eviscerated traditional vehicles.

Although we had the current slowing in hand we should have done a better job at conversion. For example, we advised selling the curve in early Jan, and again in early Feb, something like 112 on the 5-10, 290, 2-30, average. Yet the market crowd had yet come to agree and the position moved slightly against us by mid-Feb. We suggested risk control might dictate an exit.  Hopefully, most discarded that advice!  Last - 100, 264.

Now there is a growing temptation to reverse, especially considering rumors of a spurt in Q1 GDP (4/26 release). That may be, but it’s ancient history, and, likely priced in.

Instead, look for more of the same; that is, look for “surprising” weakness, key releases, balance of Q2.


Robert Craven

US - Perspective

Typical headline today – “US market worried on signs of slowing global economy.”  That may be, but our concern, our purpose is to fetch or discover the US fixed income landscape just ahead. The rest of the world doesn’t count much in that exercise.

Clients and readers have come to understand that the US economic ship is freighted with such a cargo of retardants that what would otherwise have been a sparkling performance has been nothing more than a reefing down, a standing by.

The US does well when she is unhindered. Planners at the Fed and the administration stand in the way. Their retardants are invented, completely discretionary.

As we highlighted in our last sketch there is an awful unpredictability about it all - the lack of an economic rule of law. There is only chaos and madness. Fiscal programs are temporary; no one knows what fate the river may offer up at the next bend, a journey which could easily resemble that of Marlow’s descent into Hell. Reckless gov’t spending calls for out sized future taxes, thus the disincentive, the danger to engage.

More, the economy is phony – a false hope, a house of cards. And that is not limited to rotten institutions judged “too big to fail,” a nonsense birthed from the incestuous joining of the Fed and its flock, and then the ability of Washington to manifest this lie to an unsuspecting and gullible public. There is indeed more – normal, market-driven clearing mechanisms have been replaced by the Fed. Money is either staying idle (reserves at 0.25%) or is directed to targeted activity; that is, the activity the planners have deemed worthy. Thus, individuals are making our choices for us, not normal market forces.  None of this can end well; and, it most certainly won’t.

The course-of-least resistance for the US term structure – further contraction.

Robert Craven

The Horror, the Horror

We noted end of 2012 that there was a “governor” attached to the US engine which would prohibit that otherwise resilient and vibrant economic machine from doing much past 55 mph, H1.  We expected the impact to be more immediate; nevertheless, it is upon us now.

An immediate payroll tax increase on the middle class and an outright tax increase of higher income types is part of the story naturally. And Obamacare’s taxes hit consumers and businesses 2014 with a wallop. Employers adjust – less hiring.  Consumers adjust, or will – less spending.

It is the ant-business agenda of the current administration which plays a large part to be sure and is represented through the impact of the “governor.”  But there is more; there is the awful unpredictability; actually, there is the madness of it all, this radical and failed experiment. We recall the words of Conrad’s Mr. Kurtz, the ivory trader in Heart of Darkness – “The horror! The horror!” referring to the damning madness about him. In economic terms this is the lack of an economic rule of law, both at the Fed and in Washington and is as much a horror as that delivered by the Congo interior, where there was no order and no control, only the omnipresent threat of death. Thus, many simply refuse to take to the field, refusing to be a part of a radical experiment less they become its victims.

In anticipation of this reality we had advised that clients sell (S-L) the term structure Jan/10 (5-10, 110, 2-30, 285) and again Feb/6 (113, 294) looking for that spread to contract substantially; but then the market crowd did not come to agree right away, and we recommended an exit Feb/13 (111, 295) not knowing just when the herd would turn. Now of course it has, in stampede-fashion, last 103, 267.

Finally, wild cards are always a threat; we all know that. Yet we may have one of a home-brewed variety just around the corner - the threat of bubble creation tied to planners at the Fed.  Readers may recall our Q1 survey where we reported that some staffers registered a concern, especially regarding real estate and stocks. Such a burst might just eclipse anything Iran, or N Korea or the E-Z can deliver.


Robert Craven

UK Interest Rate Environment – Near Term

Let’s take a quick look at where we’ve been, our track record. For purposes of this blog we limit strategy to an item or two. Thus, readers were advised to own (L-S) the UK term structure or something similar on Jan/10, 5-10 then 109; 2-30 then 288, and, the reasons why.  Readers were advised Feb/13 to realize half the gains - 5-10 then 121, 2-30 then 310 – and stay with the balance.

Last, 106, 285; that is, just about where the curve was when we originally bought it.

Now what?

The E-Z remains a wild card; we’ve never pretended to know what these folk may do next. Flight to sanctuary may continue to retard progress; UK fundamentals will not. 

We have price pressures which accelerated at the fastest pace in 9 months and a central bank which has just been given the ok by Osborne to ignore the same. We have a situation where most observers continue to under-estimate the consumer and the services industry, and export potential. We have short lines at the unemployment office. A dead-cat bounce is already priced in for manufacturing. 

What is there not to like about this spread? Well, maybe US contagion. Readers may recall that we had expected more of a negative reaction from the US consumer and corporate planner to events in Washington than did indeed materialize, at least so far. We expected more weakness in consumption and capital spending plans and employment. We still do.  But not being journalists, we need to abide by some standard of delivery, and so our plan was to sell the US term structure early Jan.  This was taken in for a very modest loss, early Feb. The idea was to have the UK and US positions on at the same time, then snub the looser and remain with the winner.


Robert Craven

Just a Bit on Bernanke

Observers have come to understand that Bernanke is not concerned, or at least pretends not to be concerned with the size of the open market account; nor is he concerned with finessing a reversal.

Fed studies such as this one http://www.federalreserve.gov/pubs/feds/2013/201301/201301pap.pdf provide the support for such a view.

When the time comes the plan is to 1) stop reinvesting open mkt account payments of principal, 2) change “forward guidance” rhetoric in preparation for lifting FF’s, 3) lift FF’s or perhaps interest on reserves, 4) sell securities and 5) keep it up until the balance sheet is “normalized,” in two to three years.

Key for most of us is to convert any policy change to the bottom line. That exercise lies ahead. It will be centered on exploiting the world market crowd’s over-reaction to change in Fed intent.

And finally, Bernanke in recent testimony denied any concern with bubble creation – naturally. In fact his experiment was never worth the cost, for how much more economically vibrant we would be today if we had been spared an activist Fed - a Fed which for example blows out its balance sheet but pays banks to do nothing with the dough (stealth bailout); a Fed which on a whim targets housing and forces funds in that direction, postponing the market-based adjustment in housing prices that is needed to balance supply and demand; a Fed which in keeping US borrowing rates in the cellar enables politicians to go on as before. 

This stuff amounts to little more than a sedative.


Robert Craven

UK Alert

Today’s Jan Ind Production print (-1.2%) with manuf down 1.5% triggered analysts to call for the end of the UK economic world as we know it – “It’s all over,” chimed in one economist, who along with the rest missed the result by a country mile.

That’s fine.  But we’re responsible for the bottom line; we’re not immune to results, but like a plumber or roofer, are held accountable. And that is why we have highlighted one very logical way to make good through the storm – avoid outrights like the plague and concentrate on the UK curve.  We have not been handed opportunity like this every day.

Our clients (and hopefully our readers) have been long this spread from early Jan.  Results have been quite satisfactory.  Still, course of least resistance remains wider.  Thus, today’s print is an excuse to look to set a long position (or related trade), not to look for a contraction.  And why is this?

The view will grow for further accommodation from the Bk of England. And further accommodation in the face of gathering price pressures means an expanded term structure.

Don’t over-intellectualize this one. Back away. Sense the forest for the trees.


Robert Craven

Backstage at the Fed - Q1 Edition

Each quarter we survey old friends at the Fed (those still with the living!) and some new, and then gather it all together. Contact is at the district banks. That exercise was completed last week.

There is nothing official about our “survey” nor is it necessarily statistically significant but the exercise is fun, and, we sometimes come up with an item or two which prove to be useful. A bit we share in this blog (see our Q4/2012 edition, Nov/22).

We noted in November that most at the Fed felt the power lifting was to be done by Congress, some comparing Fed policy to cheerleading. For example, many felt that “twist” represented nothing more than a change in the makeup of the Fed’s portfolio.

Similarly, many felt then that mopping up some mortgage debt would make little difference to the economy as a whole, and that Bernanke was making the equivalent of fiscal policy in the fear that Washington would not.  But then again, most felt that none of this could hurt.  This leads us to the Q1 exercise.

One focus was naturally the discussion of “the reversal”; that is, how best to finesse the ship up to the dock, without tearing up the whole works.  Most agree with staffers’ recent research that it can be done without much damage. That may be. The surprise, the key change in focus this go around however was the fear of bubble creation.  Some staffers cited the Mar/5/13 testimony of John Taylor, Allan Meltzer and David Malpass before the monetary subcommittee of the US House Committee of Financial Services. All three warned of the potentially disastrous results of arbitrary policy making, where money is printed and then channeled into favored sectors of the economy, thus bypassing market-based capital allocation. “By replacing large decentralized markets with centralized control by a few government officials, the Fed is distorting incentives and interfering with price discovery with unintended consequences throughout the economy,” warned Taylor.

Many staffers agree, fearing their employer may be in the process of authoring a bubble (housing / gov’t debt mkt / equity). This concern among staffers is new, at least from what we can determine; we did not detect a major concern along these lines, Q4.  And of course these folk are not alone.  Others have voiced similar concerns. The difference is that now these concerns appear to be widespread, backstage. If we are right, this will accelerate policy change.


Robert Craven
 

UK Fixed Income Mkt at a Glance

Let’s refresh.  We know we have a central bank that is inclined to ease in the face of price pressures.  Sure, the Bank held fire today but accommodation remains the course of least resistance.  This is the recipe for an expanded term structure.

We are not launching a satellite here folks. Every major security firm has tons of models and a chorus of analysts. Discard the whole bunch and think like a farmer, or mechanic; that is, discard complexity - the refuge of scoundrels (and overpaid street types).

Naturally we can witness today’s price reaction to a steady Bk of England – prices weakened and the curve expanded. This seems contrary to our advice.  But things are not as they appear. The mkt crowd’s initial reaction is almost always reversed. And this is exactly why so many missed this year’s major expansion, and why we and our clients did not.

The first reaction is to sell the longer end, given the Bank will not visit this maturity. This is fine for day traders but no one else.

Assume the Bank announced a huge expansion and targeted 20 – 30yr.  What would any sober trader do?  Hesitate, and then SELL that maturity, and with abandon.  Why?  Because things are not as they appear.  Such a major bloat would fire price pressures, overwhelming any pure supply considerations.

OK, let’s see now.  Last recommendation was to buy (L-S) the curve, Jan/10 (5-10, 109 / 2-30, 288). We recommended half the gains be taken Feb/13 (121/310).  Last, 113, 310.

Now what?  Simple. To repeat from Feb/20 – look for the chance to own the curve, and since we have come in a tad, mid-section, look to do so now.



Robert Craven

Lament

Considerable distaste for both administration and Fed policy may have corroded our judgment in the exercise of US strategy making, recent weeks.

We expected an activist Fed and a statist administration to act as a governor on real sector activity - the Fed has sabotaged market-based capital allocation and the administration is simply hostile to free enterprise.  

We predicted that consumer activity would wilt; we predicted that risk takers would shy, that job creation would disappoint.  Based on this, we had predicted a contraction in the US term structure and advised trading desks to set trades with this in mind. Thus, we advised selling (S-L) the term structure early Jan; however, that had to be taken in, mid-Feb, at a modest loss.

We had expected that 1) the payroll tax hike and 2) publicity surrounding job cuts tagged to ObamaCare would hit the consumer with a wallop.  Income has been going nowhere, even before taxes so we calculated the consumer was ripe for a fall; but instead, consumption grew a tad in January.

We had expected a guaranteed four more years of regulatory nightmare to discourage risk takers, and job creators.  Instead, jobs creation did not nosedive; at least not higher paying jobs. And recent measures indicate manufacturers continue to invest in their future; in fact some are downright optimistic.

So we cannot claim ownership to a leg-up over the market crowd and will reconsider over the near term.


Robert Craven 
 

FOMC Intent and FI Price Change

The Fed’s not making it easy on us. 

The recent case with the Bank of England was straightforward – when a central bank is intent to ease in the face of price pressures it means that, unless that economy is in an absolute free fall, the term structure will expand. That was the result.

We can’t as readily translate current Fed policy to FI price change. There is a good deal of confusion and disagreement back stage at the FOMC as we all know now; fine, but that doesn’t help us.  We cannot predict price change now even if we knew policy change a year or so out, even the exact day and increment of change as we don’t have a sense of tension in the auction market at that forward time.

What we can do is join the rest of the noise makers and offer our two cents on the evolution of policy, from that which was very effective - through the 80’s and much of the 90’s - to that which we are visited with today.

As Hayek, Friedman and others knew all too well, the road to despair is littered with good intentions. Bernanke is a fine guy; he intends for the best but his activist, interventionist campaign along with his fetish for transparency has got the Fed and most of the rest of us in a mess.

History shows us that planners fail; no one individual or collection of individuals can substitute for the unseen hand of the free marketplace.  This is true for any economy; this is true for any central bank.  Adherence to a rule of law ensures a free and prosperous society where people are free to choose and prices reflect relative values that consumers place on alternatives.

Central banking is not immune, nor is it exempt – rule-based policy making embraces interest rates that reflect time preferences and the productivity of capital. The Fed's job is simply one - target stable prices, and the rest will take care of itself.

In time of crisis, central bank activism may be required; our problem is that the activism implemented in 2009 has been stamped into the Fed procedural manual.  For example, printing money to buy debt from state-owned enterprises (Fannie / Freddie) to target a segment of economic activity may be fiscal policy making but it is contrary and corrosive to a free private market. The Fed in this case has  politicized an investment decision that they have no business making in the first place. The Fed’s job is not to make choices, but to offer stability for others to do so.

The Fed governors and a few presidents railroaded the QE saga last year; now some sober bank presidents are wondering just what in the world they’ve acquiesced to.

We’ll see.


Robert Craven

UK

Let’s take a quick look at the UK term structure.

We had recommended on Jan/10 that strategists look to own (L – S) this curve, with a reminder on Jan/28 that “any sober trader” wants to look for further expansion; under no circumstances look to sell the spread. The 5 – 10 spread is some 18 wider, 2 – 30 some 30 wider, with generous price gains on both wings of the trade.

Now what?

Central bank generosity in the face of price pressures is the recipe for an expanded term structure; this is especially true when policy makers make no secret that above-target inflation prints will be tolerated.  We did not predict that King, Fisher and Miles would argue for an increase in purchases; however, we always maintained that the Bank would remain biased for further accommodation through H1. 

Those who may have been long from early Jan will want to take in half the gains, maintain the balance.  For those who may have hesitated, our view is that the course-of-least resistance for this spread, H1, remains wider. No need to be in a rush (never a good idea) but consider an entry point ongoing.


Robert Craven

Central Bank Intent, the Market Crowd, and the Bottom Line

We have on deck the content of both the Fed and the Bank of England’s recent deliberations. These "minutes" are sometimes useful.

In the most general sense we can do well in making FI strategy if we remember that crowds demand a god. Whether an antebellum lynch mob or those who stormed the Bastille, or, that bunch waiting breathlessly for the next central bank minutes, all crowds look for leadership; they willingly surrender their individualism for the collective mind of the mob, that which was molded by the leadership of the daring.

This then explains the sometimes violent price change following the giving up of central bank policy intent, whether the Fed, Bk of Eng, ECB or Bk of Japan.  Exploiting this behavior can provide a useful boost to bottom-line results.

Central bank leadership is mainly made up of economists.  Economists understand how to analyze but not how to close a pattern for developments just ahead; most that try, forecast with their eyes squarely in the rear-view mirror.  Since central bank policy making is birthed by just these types, we are gifted with a leg up, if we will only pause, and make it simple.


Robert Craven

A Tale of Two Curves

Early January we recommended clients sell (S-L) the US term structure, then 285, 2-30, 110, 5-10.  That exercise has come against us, last 295,111.  The position should be closed.

Early January we recommended clients own (L-S) the UK term structure, then 288, 109.  The UK exercise has worked satisfactorily, last 311, 121; half the gains are to be realized and the balance taken forward.

In the US we had expected a consumer wilt tied to the administration’s tax policy; that is, we had expected something less than was priced in. There was a consumer pause in January but nothing like we expected. Second, we had expected less job creation than materialized, the large revisions to Nov and Dec catching us flatfooted.  Both of these factors may well kick in for Feb and March; that’s fine, but risk control has us out as the market crowd did not come to agree, for now. There is the ever-present chorus from the poor house of those who were right, simply “right” at the wrong time.

In the case of the UK, the recipe for an expanded term structure – central bank generosity in the face of building price pressures – was well in place early January; in fact, had been since early December. And of course recent Bank of England comments that inflation will overshoot the 2% target for several more years, in fact breaching 3% later this year, are made to order. There was something else that motivated this strategy and that was a modest under-estimation by most economists of reported, real-sector vigor.  We suspected for some time that perhaps one cannot take all official UK releases at face value, GDP being a prime culprit. We of course are not alone in this; what was provided was then the “surprising” prints in Payroll and particularly in Services.  Thus we had a bit of a leg up in understanding the risk to these key releases.


Robert Craven

Politics and Strategy

Risk takers will listen, sort of, to Obama’s State of the Union tomorrow.  Nothing good can come of it, explaining the “sort of.”

Obama’s focus on things economic is driven by ideology, not the bottom line.

Some say Obama is clueless on the economy. No. He knows for example that taxing the rich makes little difference to the US bottom line; in fact, he knows that taxing the rich may even prove corrosive to the revenue take.  That is not what his crusade is about; it is about the exercise of leveling, an exercise cloaked in the notion of enforced fairness.

Obama has a second term because a good portion of the electorate is not engaged. Next, things that may sound absurd to most of us get a pass from gender-studies coeds and the faculty-room anointed. And the rest who pulled the trigger?  Well, they just want stuff.

Obama’s goal, actually a stealth goal birthed by exposure to his Marxist father is not about all of us having a freedom of choice in order to thrive, but simply about ensuring that someone else does not have more.  Obama is American perhaps by birth but certainly not by spirit.

Thus, for all the reasons detailed in earlier posts, readers are not to succumb to what looks easy, what in the past was in fact near-automatic – a robust recovery.  Instead, readers are to look for both consumer and corporate risk takers to shy just ahead. For the consumer it is taxes; for the risk taker, it is a reluctance to enter the game, knowing the rules will change every quarter.

That is why we have set levels on the term structure, a handy little spread for purposes of illustration.   Course-of-least resistance – narrower over the near term.


Robert Craven

A Glance at the UK

We may simply repeat instructions from recent sketches – traders are to look for opportunity to own (L-S) the UK term structure, most certainly not to sell it; the course-of-least resistance will remain wider, Q1.  That advice was highlighted Jan/10 (2-30 @ 288 / 5-10 @ 109) and again Jan/28.  Last, 301, 117.

It is true we mostly confine illustrative strategy to the term structure but then this simple little spread embraces more of the dynamics - the existence or lack of tension in the FI market - than any other; and, with this outcome in hand, the experienced trader can do well.

Key is that the central bank will remain generous in the face of price pressures, in the act of providing cover for government policy, and the desire for a weaker pound.

Finally, although the UK economy is not in the best of shape, most observers continue to over-estimate weakness for H1.

Carney’s testimony today disappointed some as he appeared to be a tad stingy. If Carney would have come right out and targeted nominal GDP our spread would have come in for a bit, and then exploded. Carney will error to the side of generosity anyway; July is not that far off.


Robert Craven
 

Taking Our Medicine

In late November we wrote that what is not on most radar screens, what observers have yet to come to fully appreciate is the corrosive impact of the regulatory cliff birthed by an interventionist and redistributionist administration, and, the desultory impact on CEO attitude, on job creation and on consumer activity. We particularly looked for business investment and consumer spending to disappoint, Q4, Q1.  However, real events did not especially cooperate, Q4. Now what?

We continue to expect a dampening impact provided by Washington, meaning US powers-of-resuscitation will be hampered by the uneven playing field just ahead.  Thus, early January we recommended that readers look for the opportunity to sell the US term structure (or a related strategy).

We also recommended that readers look to take advantage of any market frenzy following last week’s Payroll release, and if not already short the curve then to look to pricing vulnerability post that release to set that position, or something similar.

Thus, Jan/10 we had the Treasury 5-10 at 110, 2-30, 285. The pricing was 112 and 291 following Payroll (and further encouragement from that day’s Jan ISM Manuf and Michigan sentiment reads, both through consensus) and readers who took our advice would be short from roughly those, if not earlier levels.  Last: 113, 293. 

We all know risk aversion has receded a tad given recent events offshore. Thus, the reversal of quality flight has worked against us (until the next E-Z bout that is).  Still, we think the world market crowd remains “keyed” into the wrong fly. This consideration eclipses all others.

Our “governor” then remains in place; thus, it is not a good idea to look for further FI price weakness just ahead.  Look instead for a modest contraction in the term structure from present levels.


Robert Craven

The Governor (lawn-mower variety)

While awaiting tomorrow’s payroll number (as always, given too much credence as a leading indicator) it is useful to consider a very distinct change in the way America goes about its business.

We were discouraged by the November elections results.  There will always be another Obama; it is instead the lack of engagement, the better portion of the electorate, that so disappoints.

The masses are being served up redistributionsim as a diet and for the most part, do not seem to mind. The example of an imploding EU, of a near-bankrupt California or Illinois does not register.

Nothing in the past could diminish, at least for very long, the animal spirits of America. A leader was just a leader, soon to be gone if too extreme. A dalliance with bits of political adventure was tolerated; a effort to eviscerate the vision of the Founders was not.  Until now.

This is why the typical economic resuscitation, that something that most of us strategists could count on, is no more. The rules have changed. American-style risk taking is hampered, is corroded when planners invade not only the political body, but also the monetary authority.   

This then is the key, for both FI investor and trader. We have a new element, and it acts as a governor on real sector activity; and, it will continue to do so until the masses finally sicken of their diet, and retch up the whole mess.


Robert Craven

At Stream Side

In performing a 180 from our view of H1 and Q3, 2012, we have highlighted since the election that the overall key to FI types now is to look for “surprising” weakness, not vigor in the US real sector vs than built into most models; this is tied to our view that corporate planners (regulatory cliff) and consumers (taxes, uncertainty) will both be discouraged just ahead.

We’re not especially pleased with results so far; certainly today’s advance Q4 GDP print is not a fit nor a reason for us to celebrate; yes, defense and inventory were a drag but that is not telling. Consumer activity was decent; business investment was more than decent, especially the increase in equipment and software investment. We had looked for something less (and still do for Q1).

We are no doubt at the cusp of a major turning point and want to get it right. We continue to feel something lurks just back stage.

Experience at stream side translates very well to market-crowd behavior. Trout “key in” to a certain insect, either floating just overhead or subsurface and completely ignore other, even more delectable treats although they may be easily obtainable. Trout look for certain clues as to insect body type and ignore the rest, temporarily. Then after a time, the principle hatch being finished, they will “re-key.”  This describes the mkt crowd’s present mentality - ignoring anything that may indicate weakness ahead.

We may be wrong; maybe we need to re-key, but probably not.  Thus, the preferable way to react to Friday’s Jan NFP read is to leave it if weak but to pause, and then strike on FI pricing vulnerability if the headline is well through expectations. 


Robert Craven

UK Term Structure - A Refresher

From our sketch of Jan/13 – any sober FI trader wants to look for a further expansion of the UK curve. 

Earlier we has worked this spread from 270, 2 – 30, 100, 5-10 with an exit for clients, Jan/10, at 288, 109 but with the caveat that nothing had changed, that course-of-least resistance would remain wider, Q1.  Last, 297, 111. 

Traders were to look for the chance to own the spread, most certainly not to sell it. Nothing has changed.

It is clear that the government favors central-bank activism (austerity cover).  Although King recently took issue (Belfast) with the more active process of intervention and although he and others have indicated that they are perhaps less impressed than before with its effectiveness, it remains on the table; that is, in providing cover for gov’t policy, including the desire for a weaker pound, the Bank is still willing to look past current inflation reads.

As long as these dynamics remain in place our strategy is the correct one.


Robert Craven

A handy little tool

The growing mkt view is that US pent-up demand will kick in Q1 and, with a bit of an assist from a recovering E-Z, a Japan where Abe plays the part of the Prince in Sleeping Beauty, and good ‘ol China, which having dodged the great contraction through massive floods of liquidity, comes away from the experience with a smile.

Some of this may be true. But key is that the regulatory cliff is not accounted for, is not priced into Street models; that another four years of rampant interventionism from both the administration and central bank will prove to be corrosive to corporate risk taking. This represents a major potential drag. We are not referring to upcoming congressional negotiations but to something that will be with us notwithstanding the vote: there is no longer a connection between interest rates and corporate investment decisions.

Witness recent January Fed-district manufacturing reads. They have been miserable, headline through the components, especially forward looking components, and especially employment. Most believe these prints are tagged to temporary headwinds. Beg to differ. They are tagged to something structural.

It is true that manufacturing has accounted for only say 12% of jobs growth, recent years; yet past many years we have noticed a respectable correlation between the national manufacturing survey reads and GDP, perhaps something on the order of 70%.

And for US rates? We recommended early Jan that readers look for a contraction in the term structure, 2-30 then 285, 5-10, 110.  That spread came in but then opened on last Friday’s better than expected German IFO print and news that E-Z banks would repay ECB loans ahead of schedule. Fine. There is the window, for this or a related strategy.


Robert Craven

Plan for Less, not More

Risk takers will be inclined to “take less” as a result of Obama’s inaugural speech. This speech was a reminder that planners are still all the rage in Obama’s Washington. Part of this can of course be explained by Obama’s ignorance of the world of commerce; the rest is pure intent. The masses are bored with things economic so Obama was gifted with the opportunity for an end run.

From Stephen Hayes of the Weekly Standard, “Strikingly, Obama’s allusions to the nation’s asphyxiating debt and the entitlement programs driving it accounted for just 94 words of the 2,142 he spoke in his second inaugural – less than one percent of the speech. (Obama’s section on climate change was twice as long.) Both times the president spoke of entitlements and deficits, Obama defended the programs but gave no hint at the steps he would take to address the rising debt.”

For potential job-creators, for the consumer, there can be nothing good come of this.

Short of a rescue from more sober quarters we will now begin the final leg of the journey to a European-style social democracy – a continuing “dumbing-down” of the US meritocracy that last existed in the 80’s and 90’s; at least, and key - that will be the growing view.

What then can we expect just ahead from the US real sector? 

We had earlier told clients to look for corporate financial commitments to shrink; that is, corporations would reduce spending on industrial equipment, computers and software.  That is exactly the result for Q3 and will be the result for Q4 and H1, especially now that corporate strategists understand there to be no end in sight. Indeed, from the Philly Fed print last week we saw that the boom in capital equipment investment that so many predicted for Q4 was a fairy tale.

Part of this is due to weakness offshore, but only a small part. The answer to the lack of corporate interest in investing in the future, this tendency to remain at the sidelines is to be found by the example of an activist administration and the threat of four more years of a failed experiment.

Translation for the strategist, for the desk FI operation is to look for less, not more from key sectors. It is easy to cherry pick. With that in mind, it is true that recent Retail Sales and Claims prints have not fit our view – both through consensus. There will be misses, but for Q1 we expect that the trend in job creation and consumer activity, if placed on a graph, would be well below the line representing that which is now built into most Street models.

Set your trades accordingly. For purposes of this blog we generally illustrate with the term structure. Jan/9 we recommended clients look to sell (S-L) this spread, 5-10 then 110, 2-30, 285.  If not short the spread already, look to get that way, or, set trades with this dynamic in mind.


Robert Craven

Leave Milton Friedman out of this.

Some observers, including some official Fed observers have fetched the memory of Milton Friedman, this great and gifted man, to further their own ends; specifically, support for the recent Fed agenda. Radical Muslim types too have an agenda - to rid the world of us infidels, bringing God into the act for support, with the ever-present chant, “God willing.” God’s not been willing fortunately; nor would be Freidman, to endorse the current reckless ways of the central bank.

Friedman would counsel the Fed to continue to provide high-powered money, but it stops there.

The Bank of Japan’s Shirakawa is about to learn that lesson - a zero interest rate policy does not necessarily mean easy money.  Curiously, in a speech in Canada, six years before his death, Friedman addressed this very dynamic for Japan. And now Abe will “encourage” the Bank towards that end.

Yet Friedman would be revolted by the evolution of central planning at the Fed. Certainly the “dual mandate,” a modest form of central planning, he would question; more extreme forms of planning he would reject outright.  And we should too.

The dual mandate has been around for 35 years, since the Humphrey-Hawkins act of 1978 which established a goal of “maximum employment and price stability.”  But policy makers ignored the "maximum employment" portion of the mandate, at least in their FOMC deliberations. Dan Thorton of the St Louis Fed in an article in their Mar/April 2012 Review examined FOMC transcripts, and not once was the “maximum employment” goal mentioned; not that is until Dec/08. The reason is that policy makers, correctly, believed these this to be a redundancy. It is price stability which is the prerequisite for full employment. Easy. This has been demonstrated time and time again.

Now, with inflation tame, and nobody else up to the task, policy makers have moved to pursue fiscal policy - the Fed is targeting unemployment at 6.5%, an out-of-the-hat number. 

But much worse is the current policy favoring homeowners at the expense of seniors. "Deliberately tilting the flow of credit to one particular economic sector is an inappropriate role for the Federal Reserve," Richmond Fed pres Lacker said, adding that trying to influence credit allocation within the economy was a function of fiscal policy. Duh!!

The ultimate end of economic planning is the end of consensual government because planners make arbitrary decisions, favoring some and penalizing others, without the guiding hand of the auction market.

What we have now as a result of Fed planning is a phony economy, with a safety net for government and big business, and a minefield for the rest. What is real, and what is simply Fed-birthed? This, combined with the regulatory cliff (over the past 12 years, the number of provisions of the tax code expiring annually has increased tenfold; the number of federal workers engaged in regulatory activities has grown by 25% from 2007) explains why job-creation will disappoint, 2013.

Friedman would have none of this. He spent the better part of his career (along with Hayek, Adam Smith, Lord Acton, Taylor and many others) exposing the putrid underbelly of an activist state; we doubt he ever dreamed we would one day encounter an activist Fed.


Robert Craven

A Bit More on the UK Curve

The last sketch was perhaps a tad brief by the way of explanation. 

Most of us understand that although central bank generosity - in the form of so-called QE- may have been necessary in ’08 and ’09, that now, after repeated doses, financial institutions / equity types have become addicted; the Fed and the Bank of England at this point are mere enablers. This is a deleterious situation.

Journalists too argue as to the wisdom of these measures, some pointing out correctly that QE, both in the US and UK represents simply a stealth variety of bank recapitalization.  The banks can postpone writing down the garbage they own. Also in the US and UK, QE represents fiscal-policy making by the central bank because rock bottom, sovereign-debt interest rates allow the key fiscal decisions, which should be made by the elected body, to be kicked down the road.

But alas, we are not journalists. Our job is not to be depressed or buoyant about any economic policy or outcome, not to judge it but to anticipate it and its impact. And this is exactly why any sober FI trader wants to look for a further expansion of the UK curve. This is because the time has yet come when the Bank of England will see the error of its ways. Plus of course part of the deal is that the Bank will provide monetary cover for the administration’s fiscal consolidation. The correct approach (for both central banks) is to sit on their hands but that suggestion falls of deaf ears. Thus, given the weak Manufacturing print on Friday and then the National Institute’s grim prognosis for Q4, the mkt view will grow for the Bank to intervene yet again, and key - doing so in the face of building price pressures. This means an expanded term structure.

Keep it simple.


Robert Craven

UK - A Broad Strategy

Understanding FI price change for this credit, either intra- or inter-UK seemed a whole lot easier in the good ‘ol days. But we make due.

For purposes of this humble little blog, we confine strategy to a spread or two.  From mid-summer we advised that readers look to own (L-S) the UK term structure in the neighbourhood of 270, 2-30, 95, 5-10. Thus, serious investors should have been in July/16 or thereabouts. We next highlighted something on the order of 290, and 105, give or take, as a target.  That worked by late Fall.  Then re-entry was possible early Dec (270, 100).  Last, 109, 288.  Modest progress, but better than a stick in the eye.

Motivation for this exercise was (and still is) as follows: inflationary pressures would remain; the BofE would not rule out further firing; and finally, the flaw to most economists’ estimates for H2 2012 was an under-estimation of economic activity; these, caught up by the crowd.

Naturally we did not expect real strength, just something more than the analytical horde had in mind.  This did not work perfectly. There were plenty of key releases which came in south of expectations; but, there were more which did not, including of course employment, Q3 GDP, and then the recent, better-than-expected Manuf PMI print (10% of the economy).

Then just when folks are ready to embrace a bit of resuscitation, two days later (Jan/4) we had the Services PMI print (75% of the UK economy) well below expectations, at 48.9, indicating a contraction.  The services print has observers running to revise their forecasts. Now of course the view is for a contraction, Q4.

The UK real sector will continue in this vein – hit and miss.  But key for any desk operation is to know that the course-of-least resistance for the term structure is wider, H1.  Thus, one is to look for vulnerability in pricing, for the opportunity to strike. With the latest print we want to be out, but only to wait at the sideline to own the spread all over again, and for the simple reason that more weakness is priced in at our entry levels, than will materialize. The odds favour our approach.


Robert Craven

Just Ahead

In the largest sense, desk strategy should be to look for US real sector “surprising" weakness, not vigor.  This is so because job creators will continue to be discouraged; because consumers will remain concerned and their activity will wilt relative to expectations.

Past the orgasmic response to the “cliff compromise” most anchored observers understand that little has changed; the spending fight is merely postponed for two months; only higher taxes are baked in the cake.

“I think this deal’s a disaster,” said Peter Huntsman, chief executive of chemical producer Huntsman Corp. “We’re just living in a fantasy land. This did absolutely nothing to address the fundamental issues of the debt cliff.”

But the fact that the debate exists at all is key; it is this change in electorate attitude, as demonstrated Nov/6, that most discourages risk takers. They see no end to what is rapidly becoming the "Europeanization" of America - the regulatory cliff, and the now-popular style of redistribution that remains on the horizon, even past any short-term fix. That is why small business owners’ net capital spending intentions in November fell to the lowest level in two years as recorded by the Wells-Gallup Small Business Index. And that is why the Dec NFIB small-business optimism index, at 88, is the second lowest since Mar/10. Seventy percent of owners surveyed characterized the current period as a bad time to expand.

We have highlighted these developments in more detail, past sketches. And sure enough, as predicted, business investment has contracted; sure enough, consumer retail activity has come in south of expectations (exception - vehicle sales).

One way to capture this reality is with the spread we often use in this blog – the term structure. Look for opportunity to sell (S-L) this spread, not to own it. On a sudden expansion, something past 285 perhaps, 2-30, the spread is to be sold; then to be taken in at 255 or so.  A multitude of other strategies can be tethered to this exercise. We want to harvest the bounty provided by an overly-exuberant market crowd.

One observer noted that, “If there were a scientific method of predicting whether political drag will offset the private sector’s inclination to go about the business of investing, creating jobs…I would use it. There isn’t. All I can offer is my guess that event an inept government cannot for long stifle the animal spirits of America’s investors and consumers…”  Irwin Stelzer may be right; after all, this was the default, past years, for most of us of the old school. 

We would like to agree on this occasion but for the first time in nearly two decades, we are reluctant to do so.


Robert Craven