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