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