Tonight is a brief set of bullet points as I have been sidelined with a sinus infection from the high pollen counts. But the world continues to spin (as does my pillow). The Greek situation continues on with the same cast of characters shouting at each other about prior promises made and the need to adhere to the previous economic and political efforts for Greek solvency. We are getting close to the end because Prime Minister Tsipras launched his final salvo with the Brussels Brigade. It is what NOTES FROM UNDERGROUND offered up as the third rail of European politics: SYRIZA WILL CALL A REFERENDUM ON ANY DEAL STRUCK WITH THE TROIKA.
Bill Gross was the darling of “access media” for promoting his favorite trade (what he called the short of a lifetime), the German bund. It captured the headlines on financial blogs but it is the wrong trade. If an investor wished to trade the “short of a lifetime,” the more appropriate tool would be the FRENCH OAT (the name for the French 10-year bond). It seems that Gross’s logic is based on the fact that the German BUND can only drop to -20 basis points because the ECB has determined that it will not purchase sovereign debt yielding less than its official reserve rate so over the time the BUND has a ceiling on its potential value. Gross is making the case that the ECB has so badly distorted the sovereign debt markets through its QE program that valuations are badly misaligned, BUT THE FRENCH OAT IS MUCH MORE OVERVALUED.
Indulge me, my readers. When I saw the movie Fiddler On the Roof 43 years ago with my now-wife, there was a line that made me laugh for it mirrored conversations that we shared about my nose always being buried in a book about history, economics and probably politics. In the movie, the young radical Perchik wishes to ask Tevye’s daughter, Hodel, to marry him. The question takes place in this dialogue:
It is the day before the beginning of the IMF and G20 meetings in Washington,D.C. In preparation for dissecting the communiques that will be released this weekend it is important to digest some of the key data and speeches that have forced the markets to rethink some of its previous certainties.
Another day of market volatility caused by __________ (fill in the blank). It seems that many pundits and talking heads have a cacophony of excuses for the recent bout of market moves that seem to be random and non-correlative. Poor economic news begets DOLLAR SELLING, SPOOS RALLYING AND BONDS GOING EVERY WHICH WAY. Throw in the recent erratic behavior in OIL and PRECIOUS METALS and all previous relationships are, for the moment, non-existent. The FED has been warning that BOND markets are subject to severe volatility because markets fail to respect the FOMC‘s views on economic growth and the need to raise rates sooner than investors appear to want to believe.
In the 1980s it was very popular to use of ZERO COUPON BONDS. The name was derived from the idea that bonds didn’t pay regular interest but rather the instrument was purchased at a steep discount and the interest accrued all the way to time of the BOND maturing: No coupons to clip but aggregated interest to collect. Now the idea of ZERO COUPONS has morphed into ZERO COUPONS, meaning that all interest payments are virtually ZERO, or maybe even less. Anyone buying the new mode of ZERO COUPON is hoping that interest rates go negative and the BOND itself has some capital appreciation. The world has changed dramatically and the beauty of the original zero coupon has morphed backed into a caterpillar. All bondholders are insects in search of the cocoon of equities.
The Fed released the minutes from the March 17-18 FOMC meeting and we would all do well to remember to be PATIENT and not be so quick to react to the headlines. (Again, I am going on record to plead that the Fed not release any data early to journalists so they may be able to release their headlines in unison with the actual Fed release. Many journalists write headlines that are misleading and allow the HFT algorithms to exploit key word phrases that are not substantiated by the actual story.) A case in point is the CNBC headline that appeared at the moment of the Fed release: “Several Participants Judged That Economic Data And Outlook Were Likely To Warrant Beginning Normalization At The June Meeting.” Yes, this is a direct quote from the minutes but it comes with a QUALIFIER. Following that line is this: “HOWEVER [emphasis mine], others anticipated that the effects of energy price declines and the dollar’s appreciation would continue to weigh on inflation in the near term, suggesting that conditions likely would not be appropriate to begin raising rates until later in the year, and a couple of participants suggested that the economic outlook likely would not call for liftoff until 2016.”
In the song “HOW” from John Lennon’s Imagine, he asks:
How Can We Go Forward When We Don’t Know Which Way we ‘re facing?How can we go forward when we don’t know which way to turn?How can we go forward into something we’re not sure of?Oh no, oh no.
The most important interview held on ACCESS JOURNALISM TV was the Squawk Box interview with former FED Governor Kevin Warsh. When I say access journalism I mean: The compromises journalists must make in order to have access to sources and places that would be denied them. For years mainstream financial media would treat Alan Greenspan with great deference and the result was a cult of personality that led to the “oracle” falling in love with a flawed policy. If Sir Alan was attacked it may mean that he would never grant another interview to the offending media outlet. The same holds for the Bernanke and Yellen Fed,e specially as the mainstream media wants access to Fed officials and to be invited to all the relevant press conferences. So my point is this: It took a former Fed official to attack the policies of the FOMC for the established media has not the gumption to challenge those sitting on the throne of power. Kevin Warsh criticized the present policies from multiple perspectives:
- Policy cannot be based on what is happening on our ticker machine. “The Fed should be focused on what’s happening three or four years out…” This is a justified criticism and certainly pertains to James Bullard. It was October 15 that the St. Louis Fed President spoke out about a new round of QE in an effort to the counter the sell off taking place in the equity markets. Bullard’s comments caused the massive rally in the bond markets and eventually led to the beginning of the recent six month rally in stocks. Fed policy cannot be a minute-to-minute, day-to-day, month-to-month affair;
- Central banks need humility. The Fed has provided the impetus for all the world’s central banks to embark on QE even though the exit strategy is uncertain and its outcomes not riskless. FED Chair Yellen suffers from the effects of the “taper tantrum” and now the “dollar tantrum” for these have caused the Fed to be fearful of any misstep. If the FED raises rates and the DOLLAR has a sizable rally the FED worries about headwinds for the economy. As Warsh so elegantly stated: “The financial markets have Fed Chair Janet Yellen’s number.” This is a very dangerous development for as Warsh argued, “The tail is wagging the dog”;
- Most importantly ,markets are not setting rates but rather central banks. This is in direct contradiction of what Ben Bernanke posted on his blog yesterday. Bernanke wrote, “The bottom line is that the state of the economy, not the Fed, ultimately determines the real rate of return attainable by savers and investors. The Fed influences market rates but not in an unconstrained way; if it seeks a healthy economy, then it must try to push market rates toward levels consistent with the underlying equilibrium rate.” Warsh believes that the Fed and other central banks have to give the market a chance to determine rates and not be afraid of every selloff in equity markets. The May 2013 taper tantrum was a classic example of the FED being afraid of the market beginning to set a real rate of interest based on underlying market forces. A real-time example of the flaws in Bernanke’s post is the level of interest rates in Germany. Today German unemployment made a new low and housing prices are rising as the weak euro strengthens all segments of the German economy. It is because of the ECB policy that interest rates in Germany are artificially low by any economic metrics. Therefore, central bank policy and not market dynamics are instrumental in determining interest rates and financial outcomes.
In summation: Kevin Warsh took the FOMC to task for policy flaws, which is something the new blogger on the block Ben Bernanke will never do. The Bernanke blog will be educational but don’t look for it to be an honest voice in the discussion of Fed and central bank policy. The previous Fed Chairman cannot criticize the Board he was so instrumental in constructing.