Thursday, September 23, 2010
Trade War?
Foreign Exchange – A House of Representatives committee scheduled a vote tomorrow on a China currency bill, and a Democrat aide said the full house was expected to vote on the measure next week. Critics inside and outside Congress say that China deliberately undervalues its currency by between 25% and 40%. Nancy Pelosi said “It is time for Congress to pass legislation that will give the administration leverage in its bilateral and multilateral negotiations with the Chinese government. If China allowed its currency to respond to market forces, it could create a million US manufacturing jobs and cut our trade deficit with China by USD100bn a year”. The proposed legislation, which is clearly gaining momentum, would essentially treat China’s undervalued currency as an export subsidy and allow the Commerce Department to impose counter veiling duties to offset the undervaluation. I wonder whether they know what kind of damage they would be releasing?
Friday, September 17, 2010
Noland
September 14 – Bloomberg (Marianne Stigset, Francine Lacqua and Meera Bhatia): “Norway’s sovereign wealth fund said it’s taking advantage of volatility to generate better returns as Europe’s largest equity investor adds risk. ‘If you look at what has happened during the financial crisis, a fund like ours actually came through it quite well and that to some extent increased our risk capacity and our risk willingness,’ Yngve Slyngstad, head of Norges Bank Investment Management, said… ‘In a 30-year horizon you are actually paid for taking volatility; volatility for us is actually a good thing.’”
Competitive Monetization:
Ireland’s 10-year government yields jumped 48 bps this week to 6.29%, with the spread to German bunds jumping to a record 386 bps. Portugal’s yields rose 31 bps to 6.07%, the high since near the peak of the Greek crisis back in early May. The European debt crisis remains unresolved. Yet this week the euro gained 2.9% against the dollar and 5.0% against the yen.
U.S. stocks were for the most part content to disregard the reemergence of periphery European bond stress. So far, the current environment seems to differ importantly from the late-April/May period of bond market contagion, de-risking, de-leveraging and global financial market weakness.
It is worth noting that the backdrop going into the Greek crisis was one of rampant speculation. Global risk markets were at the time a full year into a historic rally. Importantly, the leveraged speculators were at the time pressing bets on the “global reflation trade.” The world was positioned for a weak dollar and inflating prices for most currencies, commodities and securities markets. Complacency was running high, with the view that global policymakers were firmly in control and that global recovery was assured.
The rapidly escalating European debt crisis, sinking euro (spiking dollar) and dislocation in the Credit default swap market back in late-April caught the speculating crowd positioned poorly for the abrupt reversal in global markets. While there’s no way of knowing how the leveraged players are positioned these days, one would assume that the crowd has been dispersed and the amount of risk and leverage meaningfully reduced.
One could argue that policymakers had also succumbed to a bout of complacency earlier in the year. The Federal Reserve and ECB had their sights on reducing stimulus and implementing so-called “exit strategies.” Market tumult and attendant recovery fears now have American and European central bankers (indefinitely) focused intensively on quantitative easing and additional measures to assure the markets that liquidity will remain in ongoing abundance.
To this point, contagion effects from Ireland and Portugal have been minimal. I’ll assume this is explained by reduced systemic vulnerability to a leveraged community more cautiously positioned coupled with ECB market liquidity support mechanisms. Over recent months, buying from the Chinese and sovereign wealth funds have also bolstered European debt markets. And there is certainly the perception that any development that risks heightened systemic stress would be met head on by Federal Reserve monetization (“quantitative easing”). Recent and prospective dollar weakness has buoyed euro sentiment, which works to restrain de-risking, contagion effects and bouts of self-reinforcing de-leveraging (for now).
At home and abroad, there are indications of extraordinary marketplace liquidity abundance.
Today from Bloomberg: “Speculative-grade companies are selling leveraged loans at the fastest pace this year to pay for acquisitions and buyouts led by Carlyle Group as prices of the debt climb to a four-month high.” This morning from the Wall Street Journal: “One of the markets at the heart of the credit bubble has surged back with surprising speed as investors chasing yield are increasingly willing to finance riskier companies. Poster children of the mid-2000s credit bubble, leveraged loans are set to have their busiest year since 2008.” Also today from Bloomberg: “Average prices on high-yield debt rose above 100 cents on the dollar yesterday for the first time since June 2007 after falling as low as 55 cents in December 2008…” According to Bloomberg, this week’s $41.7bn of corporate bond issuance combined with about an equal amount from last week pushed two-week debt sales to the strongest level this year. With more than three months to go, year-to-date junk issuance is already well into new record territory.
In the face of enormous supply, corporate bond yields have remained extraordinarily low. Investment grade spreads (IBOX) were little changed this week at 104 bps, while junk spreads (IBOX) narrowed 8 to 546 bps. California Credit default swap prices fell 8 bps this week to 284 bps. Emerging market spreads increased 3 this week to 300 bps. Financial Conditions – while susceptible - remain loose.
The Japanese moved aggressively this week to stanch the yen rally. Japanese stocks surged. In China, the talk was of additional government measures to slow Credit growth and to contain mounting inflationary pressures. Chinese shares fell. The Reserve Bank of India raised rates for the fifth time this year (to 6.0%), as it continues to do battle with inflationary pressures. Shares, nonetheless, surged.
Here at home, those arguing that deflation holds sway as the prevailing risk have, for now, won the “debate” both in policymaking circles and in the bond market. All the same, watering down the analysis to some black or white “inflation or deflation” issue misses the complexity of risks today confronting an imbalanced global economy and unstable financial “system.” Clearly, much of the world (China, India, Argentina, Brazil, Russia and non-Japan Asia, to mention just a “few”) is facing mounting inflation problems. And if global markets don’t succumb to another period of de-risking and de-leveraging, it’s going to be fascinating to follow developments as global liquidity excess interplays with the robust inflationary biases that have taken hold throughout the “developing” economies/markets.
In the face of this week’s Japanese currency intervention and European debt worries, the dollar was notably unimpressive. Momentum building for additional quantitative ease is dollar unfriendly, especially with marketplace liquidity already overabundant. The last thing an unsettled world needs more of right now is additional dollar liquidity flows.
To be sure, prospective Treasury purchases will have much different effects than the Fed’s monetization of MBS, GSE debt and Treasurys had back in late-2008. That period’s massive expansion of Fed assets was executed in the midst of an unprecedented unwind of leveraged speculations. In particular, the Fed’s monetization occurred during the reversal of “dollar carry” trades, where unwind of bearish dollar positions incited a huge dollar rally and liquidity shortage. Moreover, the Fed’s ballooning balance sheet back then accommodated speculator (i.e. Lehman, hedge funds, etc.) de-leveraging. It was not a case of massive amounts of new liquidity being unleashed upon global markets.
Going forward, one can envisage a scenario where “QE2” is implemented right into a backdrop of faltering dollar confidence. In such a scenario, Fed-created liquidity just might seek an immediate exit from the dollar – only exacerbating both dollar weakness and general Monetary Disorder. It’s reasonable that one facet of such a scenario would have the Japanese, Chinese and other central banks buying/Monetizing an increasingly problematic global surfeit of dollars – creating additional destabilizing liquidity in the process. And, having watched the way things have tended to unfold, I would see a rising tide of Competitive Monetization as a high probability development.
Is the dollar a bigger story than Ireland and Portugal? Perhaps a rapidly rising tide of liquidity has something to do with Gold’s run toward $1,300. Such a scenario might also help explain surging prices for silver, copper, wheat, corn, rice, soybeans, cattle, hogs, sugar, cotton, coffee, cocoa, etc. And, for awhile, global liquidity excesses might even continue to inflate global bond prices. But if this is deflation, it’s an abnormally strange strain.
Competitive Monetization:
Ireland’s 10-year government yields jumped 48 bps this week to 6.29%, with the spread to German bunds jumping to a record 386 bps. Portugal’s yields rose 31 bps to 6.07%, the high since near the peak of the Greek crisis back in early May. The European debt crisis remains unresolved. Yet this week the euro gained 2.9% against the dollar and 5.0% against the yen.
U.S. stocks were for the most part content to disregard the reemergence of periphery European bond stress. So far, the current environment seems to differ importantly from the late-April/May period of bond market contagion, de-risking, de-leveraging and global financial market weakness.
It is worth noting that the backdrop going into the Greek crisis was one of rampant speculation. Global risk markets were at the time a full year into a historic rally. Importantly, the leveraged speculators were at the time pressing bets on the “global reflation trade.” The world was positioned for a weak dollar and inflating prices for most currencies, commodities and securities markets. Complacency was running high, with the view that global policymakers were firmly in control and that global recovery was assured.
The rapidly escalating European debt crisis, sinking euro (spiking dollar) and dislocation in the Credit default swap market back in late-April caught the speculating crowd positioned poorly for the abrupt reversal in global markets. While there’s no way of knowing how the leveraged players are positioned these days, one would assume that the crowd has been dispersed and the amount of risk and leverage meaningfully reduced.
One could argue that policymakers had also succumbed to a bout of complacency earlier in the year. The Federal Reserve and ECB had their sights on reducing stimulus and implementing so-called “exit strategies.” Market tumult and attendant recovery fears now have American and European central bankers (indefinitely) focused intensively on quantitative easing and additional measures to assure the markets that liquidity will remain in ongoing abundance.
To this point, contagion effects from Ireland and Portugal have been minimal. I’ll assume this is explained by reduced systemic vulnerability to a leveraged community more cautiously positioned coupled with ECB market liquidity support mechanisms. Over recent months, buying from the Chinese and sovereign wealth funds have also bolstered European debt markets. And there is certainly the perception that any development that risks heightened systemic stress would be met head on by Federal Reserve monetization (“quantitative easing”). Recent and prospective dollar weakness has buoyed euro sentiment, which works to restrain de-risking, contagion effects and bouts of self-reinforcing de-leveraging (for now).
At home and abroad, there are indications of extraordinary marketplace liquidity abundance.
Today from Bloomberg: “Speculative-grade companies are selling leveraged loans at the fastest pace this year to pay for acquisitions and buyouts led by Carlyle Group as prices of the debt climb to a four-month high.” This morning from the Wall Street Journal: “One of the markets at the heart of the credit bubble has surged back with surprising speed as investors chasing yield are increasingly willing to finance riskier companies. Poster children of the mid-2000s credit bubble, leveraged loans are set to have their busiest year since 2008.” Also today from Bloomberg: “Average prices on high-yield debt rose above 100 cents on the dollar yesterday for the first time since June 2007 after falling as low as 55 cents in December 2008…” According to Bloomberg, this week’s $41.7bn of corporate bond issuance combined with about an equal amount from last week pushed two-week debt sales to the strongest level this year. With more than three months to go, year-to-date junk issuance is already well into new record territory.
In the face of enormous supply, corporate bond yields have remained extraordinarily low. Investment grade spreads (IBOX) were little changed this week at 104 bps, while junk spreads (IBOX) narrowed 8 to 546 bps. California Credit default swap prices fell 8 bps this week to 284 bps. Emerging market spreads increased 3 this week to 300 bps. Financial Conditions – while susceptible - remain loose.
The Japanese moved aggressively this week to stanch the yen rally. Japanese stocks surged. In China, the talk was of additional government measures to slow Credit growth and to contain mounting inflationary pressures. Chinese shares fell. The Reserve Bank of India raised rates for the fifth time this year (to 6.0%), as it continues to do battle with inflationary pressures. Shares, nonetheless, surged.
Here at home, those arguing that deflation holds sway as the prevailing risk have, for now, won the “debate” both in policymaking circles and in the bond market. All the same, watering down the analysis to some black or white “inflation or deflation” issue misses the complexity of risks today confronting an imbalanced global economy and unstable financial “system.” Clearly, much of the world (China, India, Argentina, Brazil, Russia and non-Japan Asia, to mention just a “few”) is facing mounting inflation problems. And if global markets don’t succumb to another period of de-risking and de-leveraging, it’s going to be fascinating to follow developments as global liquidity excess interplays with the robust inflationary biases that have taken hold throughout the “developing” economies/markets.
In the face of this week’s Japanese currency intervention and European debt worries, the dollar was notably unimpressive. Momentum building for additional quantitative ease is dollar unfriendly, especially with marketplace liquidity already overabundant. The last thing an unsettled world needs more of right now is additional dollar liquidity flows.
To be sure, prospective Treasury purchases will have much different effects than the Fed’s monetization of MBS, GSE debt and Treasurys had back in late-2008. That period’s massive expansion of Fed assets was executed in the midst of an unprecedented unwind of leveraged speculations. In particular, the Fed’s monetization occurred during the reversal of “dollar carry” trades, where unwind of bearish dollar positions incited a huge dollar rally and liquidity shortage. Moreover, the Fed’s ballooning balance sheet back then accommodated speculator (i.e. Lehman, hedge funds, etc.) de-leveraging. It was not a case of massive amounts of new liquidity being unleashed upon global markets.
Going forward, one can envisage a scenario where “QE2” is implemented right into a backdrop of faltering dollar confidence. In such a scenario, Fed-created liquidity just might seek an immediate exit from the dollar – only exacerbating both dollar weakness and general Monetary Disorder. It’s reasonable that one facet of such a scenario would have the Japanese, Chinese and other central banks buying/Monetizing an increasingly problematic global surfeit of dollars – creating additional destabilizing liquidity in the process. And, having watched the way things have tended to unfold, I would see a rising tide of Competitive Monetization as a high probability development.
Is the dollar a bigger story than Ireland and Portugal? Perhaps a rapidly rising tide of liquidity has something to do with Gold’s run toward $1,300. Such a scenario might also help explain surging prices for silver, copper, wheat, corn, rice, soybeans, cattle, hogs, sugar, cotton, coffee, cocoa, etc. And, for awhile, global liquidity excesses might even continue to inflate global bond prices. But if this is deflation, it’s an abnormally strange strain.
Thursday, September 16, 2010
Forex Wars....Signposts
DJ* US Senator Dodd Criticizes Japan Currency Intervention
DJ* US Senator Dodd:Unilateral Currency Intervention A Concern
DJ* Geithner Sees "Substantial" intervention by China on Currency
DJ* US Senator Dodd:Unilateral Currency Intervention A Concern
DJ* Geithner Sees "Substantial" intervention by China on Currency
Tuesday, September 14, 2010
Tuesday, September 7, 2010
TUESDAY, SEPTEMBER 7, 2010
Hatzius of Goldman on QE2 (according to him, it's coming)
1. The headlines for last week’s first-tier US economic data releases were above expectations. And at least the employment report was genuinely better, with faster than expected private payrolls growth, significant upward revisions to past months, a 0.3% wage gain, and a firm household survey. The trends are still consistent with the gradual slowing in employment and wage income growth implied by our forecast, so the news is far from good in any absolute sense, but at least for now the deterioration in the labor market no longer looks as precipitous as it did after the last report. The somewhat better claims data of the past two weeks send a similar message.
2. The ISM picture was much less good, however. Although the manufacturing composite edged up from 55.5 to 56.3, the new orders/inventories gap fell again and taken by itself now points to a composite of clearly below 50 in a few months. Moreover, the nonmanufacturing composite dropped sharply, led by new orders, and the all-industry composite showed its largest month-to-month decline since November 2008.
3. The numbers over the next few weeks are likely to look decent. That’s partly because of the direct implications of the employment numbers for industrial production and personal income, partly because the housing indicators are likely to bounce from their extremely depressed current levels, and partly because the bottom-up indications for retail sales—the most important release in the next few weeks—are reasonably firm.
4. Overall the news is sufficiently mixed to make a big “QE2” announcement at the September 21 FOMC meeting unlikely. Although we suspect that the FOMC and the Fed staff will revise down their growth forecasts once more, the size of the revision is unlikely to be large enough to qualify as the “significant weakening of the outlook” identified by Chairman Bernanke as one key trigger for additional easing in his Jackson Hole speech. (The other was a meaningful drop in inflation and/or inflation expectations.)
5. Later this year or early next, however, we do expect a return to unconventional monetary easing. This is because we strongly disagree with the notion that the recent slowdown in activity is a temporary “soft patch” in an otherwise fairly decent recovery, which seems to underlie the Fed’s forecast of a reacceleration in 2011 after a modestly slower period in 2010H2. On the contrary, we believe that the stronger growth of late 2009/early 2010 was a temporary “firm patch” in an otherwise extremely anemic recovery, and there is a sizable (25%-30%) risk of a renewed recession. As this becomes clear, Fed officials are likely to act.
6. The most likely policy shift involves purchases of US Treasuries, although changes in the forward-looking language are also a possibility. Ultimately, any new purchases are likely to total at least $1 trillion, but today’s NYT interview with outgoing Vice Chairman Kohn suggests that Fed officials may only announce a smaller amount upfront and then adjust their plans in response to new information (seehttp://www.nytimes.com/2010/09/06/business/economy/06fed.html?_r=1&ref=business). The advantage of such a policy is that it may be an easier “sell” to skeptical officials, although the risk is that the markets will view it as half-hearted.
7. How effective is a return to QE likely to be? The uncertainties are enormous, butJari Stehn’s analysis of the first round of QE in late 2008/early 2009 concluded that it pushed down 10-year Treasury yields by 25bp and eased the GSFCI by 80bp per $1 trillion in purchases. We suspect the next round would be less effective in terms of easing financial conditions, not because of a smaller impact on riskless long rates but because there is much less room for spread compression in the credit markets. So a 50-60bp easing in the GSFCI (relative to what would happen without QE) may be a more realistic expectation. Based on historical linkages, this is worth about ½ percentage point on growth, or a bit less given that the mortgage refinancing channel of transmission is clogged by the large number of households in negative equity. If this is the right order of magnitude, a $1 trillion purchase would not have a dramatic effect on growth, but would not be insignificant either. Of course, Fed officials could buy more and/or supplement the purchases with changes in the Fed statement to reinforce the effect.
8. In the runup to QE2, communications will remain a challenge for the Fed. The problem is twofold. First, the FOMC is far from united, and participants (especially regional bank presidents) who are skeptical of the need for further action will continue to make their views known. This causes confusion in the markets, even if it ultimately has little bearing on the outcome. Second, the leadership wants to signal that more easing is on the table without talking too pessimistically, for fear of “scaring” those market participants who believe that the Fed has a privileged perspective on the fundamental outlook for the economy. The results are sometimes a bit odd—for example, the statement in the August 10 minutes that “…no member saw an appreciable risk of deflation…” which came just a few weeks after one member (President Bullard) had presented an analysis that strongly implied just such a risk. Given the range of different opinions and the conflicting objectives, the risk of further communication hiccups and resulting bouts of bond market volatility is high.
2. The ISM picture was much less good, however. Although the manufacturing composite edged up from 55.5 to 56.3, the new orders/inventories gap fell again and taken by itself now points to a composite of clearly below 50 in a few months. Moreover, the nonmanufacturing composite dropped sharply, led by new orders, and the all-industry composite showed its largest month-to-month decline since November 2008.
3. The numbers over the next few weeks are likely to look decent. That’s partly because of the direct implications of the employment numbers for industrial production and personal income, partly because the housing indicators are likely to bounce from their extremely depressed current levels, and partly because the bottom-up indications for retail sales—the most important release in the next few weeks—are reasonably firm.
4. Overall the news is sufficiently mixed to make a big “QE2” announcement at the September 21 FOMC meeting unlikely. Although we suspect that the FOMC and the Fed staff will revise down their growth forecasts once more, the size of the revision is unlikely to be large enough to qualify as the “significant weakening of the outlook” identified by Chairman Bernanke as one key trigger for additional easing in his Jackson Hole speech. (The other was a meaningful drop in inflation and/or inflation expectations.)
5. Later this year or early next, however, we do expect a return to unconventional monetary easing. This is because we strongly disagree with the notion that the recent slowdown in activity is a temporary “soft patch” in an otherwise fairly decent recovery, which seems to underlie the Fed’s forecast of a reacceleration in 2011 after a modestly slower period in 2010H2. On the contrary, we believe that the stronger growth of late 2009/early 2010 was a temporary “firm patch” in an otherwise extremely anemic recovery, and there is a sizable (25%-30%) risk of a renewed recession. As this becomes clear, Fed officials are likely to act.
6. The most likely policy shift involves purchases of US Treasuries, although changes in the forward-looking language are also a possibility. Ultimately, any new purchases are likely to total at least $1 trillion, but today’s NYT interview with outgoing Vice Chairman Kohn suggests that Fed officials may only announce a smaller amount upfront and then adjust their plans in response to new information (seehttp://www.nytimes.com/2010/09/06/business/economy/06fed.html?_r=1&ref=business). The advantage of such a policy is that it may be an easier “sell” to skeptical officials, although the risk is that the markets will view it as half-hearted.
7. How effective is a return to QE likely to be? The uncertainties are enormous, butJari Stehn’s analysis of the first round of QE in late 2008/early 2009 concluded that it pushed down 10-year Treasury yields by 25bp and eased the GSFCI by 80bp per $1 trillion in purchases. We suspect the next round would be less effective in terms of easing financial conditions, not because of a smaller impact on riskless long rates but because there is much less room for spread compression in the credit markets. So a 50-60bp easing in the GSFCI (relative to what would happen without QE) may be a more realistic expectation. Based on historical linkages, this is worth about ½ percentage point on growth, or a bit less given that the mortgage refinancing channel of transmission is clogged by the large number of households in negative equity. If this is the right order of magnitude, a $1 trillion purchase would not have a dramatic effect on growth, but would not be insignificant either. Of course, Fed officials could buy more and/or supplement the purchases with changes in the Fed statement to reinforce the effect.
8. In the runup to QE2, communications will remain a challenge for the Fed. The problem is twofold. First, the FOMC is far from united, and participants (especially regional bank presidents) who are skeptical of the need for further action will continue to make their views known. This causes confusion in the markets, even if it ultimately has little bearing on the outcome. Second, the leadership wants to signal that more easing is on the table without talking too pessimistically, for fear of “scaring” those market participants who believe that the Fed has a privileged perspective on the fundamental outlook for the economy. The results are sometimes a bit odd—for example, the statement in the August 10 minutes that “…no member saw an appreciable risk of deflation…” which came just a few weeks after one member (President Bullard) had presented an analysis that strongly implied just such a risk. Given the range of different opinions and the conflicting objectives, the risk of further communication hiccups and resulting bouts of bond market volatility is high.
What the Hero of the Big Short likes now.
http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=ayR3PjEbMErM
SUNDAY, SEPTEMBER 5, 2010
Dylan Grice, SocGen
Excerpt:
The pedestrian ‘push’ buttons at New York’s intersections don’t actually work. They were deactivated in the 1970s when computer-controlled automatic traffic signals were installed but left in place because removing them is too costly. Apparently most ‘close door’ buttons in lifts don’t work either. But give us a button and we’ll press it, not because the button works but because the sense of being in control makes us feel good (when subjects are crammed into a lift for example, those closest to the controls show lower stress levels). Feeling in control doesn’t mean that we are in control, but who cares? As Slartibartfast said in Hitchiker’s Guide to the Galaxy, “I’d rather be happy than right!”
Goldilocks is carrying a concealed weapon
Dangerous Defeatism is taking hold among America's economic elites
GOLDILOCKS HAS PLAYED A TRICK ON AMERICA. GROWTH IS NOT WARM ENOUGH TO PREVENT HARD-CORE UNEMPLOYMENT CLIMBING TO POST-WAR HIGHS AND STICKING AT LEVELS THAT CORRODE THE BODY POLITIC, BUT NOT YET COLD ENOUGH TO OVERCOME THE FIERCE RESISTANCE OF THE FED'S REGIONAL HAWKS FOR A FRESH BLAST OF STIMULUS.
Double Trouble
No defence left against double-dip recession, says Nouriel Roubini
THE UNITED STATES, JAPAN AND LARGE PARTS OF EUROPE HAVE EXHAUSTED THEIR POLICY ARSENAL, LEAVING THEM DEFENCELESS AGAINST A DOUBLE-DIP RECESSION AS RECOVERY SLOWS TO ‘STALL SPEED’.NOURIEL, CLICK HERE
SATURDAY, SEPTEMBER 4, 2010
AS PAY FALLS, BORROWERS LOSE GROUND. NYTIMES
http://www.nytimes.com/2010/09/05/realestate/05mort.html
WEDNESDAY, SEPTEMBER 1, 2010
Jeffries on the FOMC minutes....quite good
From: DAVID ZERVOS (JEFFERIES & CO., INC)
At: 9/01 9:20:13
This is the key passage from the minutes on the thought process driving the reinvestment strategy decision – “members generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated. Against this backdrop, the Committee discussed the implications for financial conditions and the economic outlook of continuing its policy of not reinvesting principal repayments received on MBS or maturing agency debt. The decline in mortgage rates since spring was generating increased mortgage refinancing activity that would accelerate repayments of principal on MBS held in the SOMA. Private investors would have to hold more longer-term securities as the Federal Reserve's holdings ran off, making longer-term interest rates somewhat higher than they would be otherwise. Most members thought that the resulting tightening of financial conditions would be inappropriate, given the economic outlook. However, members noted that the magnitude of the tightening was uncertain”.
So the idea was that an estimated 20b/month in mortgage paydowns (which I would say is very much on the high side) was about to wreck the long of the bond market (excuse me???). Immediate action was apparantly necessary to stem this “massive” flow which equates in duration terms to about half of a monthly 5 year note auction!!! This was needed even though a few members correctly - “worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee's readiness to resume large-scale asset purchases” (ya think??). The decision for the committee was to stem this HUGE leak in the balance sheet and not wait another month to look at the data and better prepare the market for more material changes if they were needed. I stand by my earlier assessment that this was one of the top 10 worst communication decisions in FOMC history. It just makes no sense to confuse a fragile market over something so small and meaningless from a policy perspective. The probability of sending the wrong signal was way too high, as only a few of the clued in Committee members acknowledged.
So let’s look at what this signally move actually accomplished. Did the FOMC “ease” financial conditions as they had seemingly hoped to do?? NO, they tightened them. Equities are lower, credit spreads are wider and the dollar is stronger since August 10th – NICE JOB. Further, and more importantly, break-even inflation expectations have fallen 30bps and REAL short term rates (4/13 Tips) are 20bps HIGHER in yield, while longer term real rates are flat. The FOMC managed to raise the real short rate with this "easing" move - it is mindblowing how bad this decision really was! The probability of sending the wrong signal with this decision was not just high it was 1!
I will requote my favorite line ever from a Ben Bernanke speech in 2003 – “when nominal interest rates are at or near zero, the central bank can lower the real rate of interest only by creating expectations of inflation on the part of the public”. Ben alluded to this in his speech last Friday so I remain hopeful that we will see something from the FOMC in coming months on a plan for potential easing action that does not involve buying loads of long term US Treasuries. Hopefully the Committee is looking at what they did to real rates and inflation expectations after this meeting as a signal back to them that this was a horrific communication decision. From my perspective, the only truly effective easing strategies from the Fed going forward involve the funding and/or purchasing of riskier assets. Fed buying of government bonds outright (or promising to buy them in the event the economy slows further) will only fuel a bond bubble that feeds off of rapidly increasing deflation expectations. This is the Japanese path!
Finally, turning to one of my other favorite topics, Im doing a little work on breaking down the effective mortgage rate outstanding by product type (conforming fixed, conforming adjustable, prime, alt a, subprime etc etc). Tomorrow I should have some really interesting numbers for everyone to chew on. Also, I have been reading research from a lot of other dealers that suggests only congress can generate a government induced refi wave. I will discuss tomorrow why that logic is flawed. Good luck trading.
Thursday, September 2, 2010
Fed vs Romer. Maybe this is why she quit?
Dallas Fed President Fisher said that uncertainty over the potential cost of healthcare reform and future taxes is preventing businesses from investing and adding staff. “I believe that monetary accommodation alone cannot buy happiness”. Unfortunately, there wasn’t the same sense coming from the departing White House economist Christina Romer who urged more fiscal expansion; “The only sure-fire ways for policymakers to substantially increase aggregate demand in the short run is for government to spend more and tax less. In my view we should be moving forward on both fronts”
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