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April 7, 2015

The day after

Filed under: Forex Strategies — Tags: — admin @ 4:43 pm

Sometimes, being left to ones own devices isn’t such a bad thing, as Macro Man found yesterday.   He started with a nice 55 mile bike ride, soaking up the sun and scenery of a glorious New England spring day (while avoiding the myriad of potholes littering the roads.)  He then made delivery on a Christmas present to Mrs. Macro, taking her into New York to see a great show from one of their favourite bands.  Oh, and while they were there, his alma mater managed to reel in some sporting hardware (the replay of which he plans to watch after finishing this post.)

Superstitious/dovish/equity bullish readers may wish to recall that the Fed has never raised rates in years in which Duke has won the NCAA basketball tournament (1991, 1992, 2001, 2010, and of course thus far this year.)  Of course, over the past 30 years, there haven’t actually been that many in which the Fed has hiked rates, so the correlation is as spurious as they come.

Nevertheless, the will they/won’t they debate has evolved from “foregone conclusion” to “well, I could envisage a scenario where they don’t.”  To be sure, June is almost certainly off the table, as there are just not enough datapoints between now and that meeting to meaningfully confirm that the recent bout of weak activity is indeed ephemeral.

Macro Man remains of the view that lift-off will occur later this year, and suspects that the bar for raising rates is probably lower than many think.  A hospital patient suffering from critical injuries or a virulent illness is placed into intensive care; once the acute phase of the threat to the patient’s health has passed, he is moved to a normal treatment protocol without the bells and whistles of the ICU.

After six years in intensive care, the time has surely come for Dr. Yellen and co. to shift the patient down the hall.   After all, you never know when you’ll need space in the ICU.  Macro Man speaks as someone who got off the Oxycontins within 24 hours of each of his ACL surgeries; obviously, some patients do not find it so easy to wean themselves from opiate-based painkillers, ironically developing new health problems from the treatment of old ones.

Similarly, over the last quarter-century, easy Fed monetary policy has been a sort of gateway drug for misallocations of capital, sowing the seeds for each successive iteration of financial crisis.  As some commenters have pointed out recently, corporate debt issuance has been roaring thus far this year in what looks to be largely an exercise in balance sheet leveraging to goose EPS.  That’s not necessarily a bad thing, a priori, if conducted within reason and from a healthy starting point.   Unfortunately, economic actors are not known for acting within reason when the tantalizing allure of financial leverage rears its head.

Sometimes you need to be challenged to ultimately succeed.  If you have too easy a ride for too long, as the Kentucky basketball team did, you can run the risk of failure when faced with the novelty of being under pressure.

9 Comments »

  1. CBs are not driving zirp. ZIRP terminates when the MM collateral is broadened and/or EU/Japan/Chinese markets are so beat-up that they big money likes the R/R and moves out of USD assets to another market that accounts in another currency.

    You really believe that? Fed has bought multiple $T in UST and that does not affect price? And there is nowhere for the capital to flow that is not already very high in price. Hell, JGB's are looking like a solid value now compared to Europe, but we are not supposed to point a finger at CB's?

    I think the underlying idea here, that markets drive rates not CB's, has a kernel of truth in it but that does not mean that CB's cannot effect rates. The whole fundamental idea driving global monetary policy, indeed the idea that monetary policy can be this powerful, is all from CB. Inflation targeting, deflation scare, pushing markets around, this is all CB. As will be the mess when something forces their hand to change policy.

    Comment by Mr. T — April 7, 2015 @ 5:10 pm

  2. Also, forget the pulling forward future demand idea WRT debt. Borrowing is really naked short-selling of a currency or, at best, a currency short-sale collateralized by an illiquid asset.

    Comment by Dan — April 7, 2015 @ 5:43 pm

  3. @FM

    If it isn't readily obvious, the BOJ and ECB have been selected as bagholders for private sector (risk) financial assets.

    CBs are not driving zirp. ZIRP terminates when the MM collateral is broadened and/or EU/Japan/Chinese markets are so beat-up that they big money likes the R/R and moves out of USD assets to another market that accounts in another currency.

    Comment by Dan — April 7, 2015 @ 5:48 pm

  4. @mm

    Correction

    The GLOBAL economy has been in the ICU courtesy of excess production capacity and debt saturation. The consequence is ZIRP. The prescribed treatment plan has been extraordinary national deficits and experimental CB QE to sustain financial asset prices.

    Comment by Dan — April 7, 2015 @ 6:25 pm

  5. Price adjustments fix liquidity problems.

    "shortages in the securities used as collateral in short-term money markets"

    "the broker-dealers that commit to buy, sell and hold portfolios of bonds so that institutional money managers can readily trade them in the secondary market aren’t doing so for anything less frequently traded than Treasury securities or large corporate bonds"

    "A lack of Treasury securities is creating bigger swings in short-term rates, making it more expensive and unpredictable for institutions that need overnight finance or which must put excess cash to work."

    "the Fed still regularly buys Treasurys and government-backed mortgages to keep a steady balance sheet as existing holdings mature. This privileging of government-backed securities over private debt means that as the European Central Bank now conducts its own government bond-buying program, money fleeing rock-bottom eurozone yields continues to disproportionately seek Treasurys and housing agency debt"

    Corporate debt is all priced wrong because they are dependent upon the federal deficit for earnings and their borrowing costs have followed the UST's down.

    Everyone has been (is) structurally short UST's and no one wants to admit it.

    LOL

    Comment by Dan — April 7, 2015 @ 6:27 pm

  6. I think we'd all agree that MM et al have forgotten more about Finance than I'll ever know, but I do believe that "this time its different".

    With the BOJ engaged in such extreme QQE, ECB QE and PBoC easing (not to mention the other 20+ central bank easings in Q1 this year) do we really think the Fed will go it alone with a rate hike?

    Consider the consequences to the USD & exports and thus US corp earnings. Consider the effect on rising rates to corp & govt bonds and equities. Once they correct heavily, consider the impact on jobs and retirement savings.

    Let me re-state the problem simply: there is a demographics & employment crisis in the developed world, and having pulled forward demand via a 20yr debt binge politicians and CBs (the two are not different) are now almost out of options. There is no way fin markets can normalise. CBs will keep ZIRP in place for at least another 10 years – maybe longer.

    When I hear sensible & intelligent people talking about rate normalisation etc I feel like the kid who shouted "the Emperor has no clothes". Ofc course everyone laughed at the kid until…

    Comment by FunnyMoney — April 7, 2015 @ 7:21 pm

  7. @ washedup…regardless of my view, I don't think there's much debate that the US economy has been in the ICU courtesy of ZIRP/QE for the last 6 years. And yes, I do think it should be booted to the normal wing post-haste, but acknowledge that the Chief medical officer prefers a cautious approach.

    Comment by Macro Man — April 7, 2015 @ 7:30 pm

  8. IG CDX now@ 61bps…SPX took a hit the last time it hit 60bps

    Comment by Anonymous — April 7, 2015 @ 7:51 pm

  9. hard not to envy that – potholes and allI

    Must say I was a bit surprised by your comparison of the US economy to a hospital patient needing to be moved away from the ICU – your previous posts have, shall we say, evoked more of an image of an already recovered patient needing to engage in minor physical therapy, or maybe even a supremely fit cyclist with minor equipment malfunctions.

    Perhaps Leftback ghostwrote this one – there was a game to be watched last night after all – congrats on the victory.

    I think punters want to run with this 'EM outperformance' ball for a few yards – any avid reader of this space would not be surprised by that, but looks like the mkt was – the problem with contra-secular trades, of course, is that one needs to get the timing of the exit perfectly rt, and I just don't think anyone is good enough for that. Atleast pick India instead of Brazil, for crying out loud..

    Comment by washedup — April 7, 2015 @ 7:59 pm

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