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