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.
A reader of NOTES suggested that the current state of affairs as presented Monday by System Open Market Account (SOMA) chief Simon Potter suggests that liquidity constraints could pose a problem for the FED‘s ability to affect its O/N RPP and IOER efforts in soaking up excess reserves in the system. (HAT TIP KM FOR SUGGESTING THE FED IS SIMILAR TO THE SORCERER’S APPRENTICE.) As Mr. Potter told a group of primary dealers: “Whether a firm has a large position, or represents a sizable share of market activity, it has the responsibility to help support market functioning and liquidity. Making significant changes to either such a position or trading activity could disrupt market functioning and liquidity if not done with care, and the Treasury Market Practices Group calls for such positions and activity to be managed with particular vigilance.”
The FED has worked its magic and waved a wand in the image of the SORCERER in its effort to control interest through three QE programs and Operation Twist. But as Mr. Potter warns, the FED is nervous about traders not cooperating with the SOMA when it attempts to rein in excess reserves. Mr. Potter states that the FED is still trying to understand what caused the extreme volatility of October 15 when the 10-YEAR NOTE had a 30 basis point range in a one hour period. A further conundrum for the FED is the market’s reaction to the “taper tantrum” in response to Ben Bernanke’s May 2013 speech, in which the Fed Chair suggested curtailing the QE program.
The SORCERER’S APPRENTICE has learned to cast its spell to ward off the threat of DEFLATION but as Wikipedia so aptly defines Goethe’s Poem: “Tired of fetching water by the pail, the apprentice enchants a broom to do the work for him–using magic in which he is not yet fully trained. The floor is soon awash with water, and the apprentice realizes that he cannot stop the broom because he does not know how.” Perfect allegory for the position of the FED. It wants to stop the liquidity from spilling out into the real economy and fears that the market won’t allow it.
The FED and other central banks have created a situation in which they have punished the markets if they failed to heed the demands of the FOMC, ECB and BOJ. What market forces are not to be held at bay forever. Simon Potter may think that market participants have a responsibility to support market functions but let me be clear: THE BOND VIGILANTES HAVE BEEN SIDELINED BY THE FED BUT THEIR DAY OF RETRIBUTION IS NIGH. THE LONG-DENIED BOND MARKET MAKERS WILL EXTRACT RETRIBUTION FROM A FED POLICY CONCEIVED IN FANTASIA LAND. Yet again, QE1 was necessary but the additional QEs were an experiment with unknown repercussions. Market forces will be subdued but not denied. While some may argue it is DODD-FRANK causing the violent action I will not be one of those for liquidity is plentiful but the market forces are a harsh dealer of punishment.
***Today there was more from James Bullard operating in a similar vein to Simon Potter. Speaking at the Minsky Conference in Washington, D.C., Bullard opined (as reported by Alex Harris of Bloomberg–and one of my progeny), “The difference of views between financial markets and FOMC is a problem because those views will have to be reconciled in some way and you’ll get a lot of volatility in financial markets. The ‘right thing’ for markets to do is price to Fed’s expectations and that’s what I’d like to see.” Again, the FED wants markets to perform to its expectations (to which Minsky must be laughing from above).
***Finally, on the international front. The ECB held rates steady and President Mario Draghi took his curtain call for a job well done. No surprises as the ECB has a lower EURO and zero rates out to eight years in Germany. The most interesting statement came from the IMF IN DIRECT CONTRAVENTION TO SIMON POTTER AND JAMES BULLARD. Mr. Jose Vinals, the director of the IMF’s monetary and capital markets department warned of a “super taper tantrum” and spiking yields as the FED nears raising rates. In an FT article from Sam Fleming and Shawn Donnan, Mr. Vinals is quoted as saying, “Shifts of this magnitude can generate negative shocks globally, especially in emerging economies.”
The IMF also stated in contravention to the FED, “This exit is a lot more complex to figure out and this is behind the uncertainty that there is in the markets.” It will take Simon Potter to work some magic if the IMF and other market participants are proved correct. Can the liquidity spilling all over the global financial system be returned so orderly to its bucket of central bank designs? Maybe only the shadow banks KNOW.
Tags: ECB, Euro, Fed, FOMC, IMF, IOER, James Bullard, Mario Draghi, O/N RRP, QE, Simon Potter, SOMA
April 16, 2015 at 1:50 am |
Very simple to explain the Bond move in October last year.
This is what you get when governments try to force the markets to their will and in turn create both highly strung market participants and highly strung positions.
The move was pure stress caused by human stress (with some robots thrown in for that bit of extra spicy sauce). It doesn’t take a genius to work it out nor 101 meetings.
So expect more moves like this in virtually every market.
April 16, 2015 at 9:04 am |
Yra- You posted “Simon Potter suggests that liquidity constraints could pose a problem for the FED‘s ability to affect its O/N RPP and IOER efforts in soaking up excess reserves in the system.”
Question…….. The Fed is awash in excess balances (excess reserves), the overall system is awash in liquidity, and the financial system ( as Jamie Dimon pointed out last week) is short of Treasuries.
Matched sales drain excess reserves/liquidity and add Treasuries to the system.
To mean, matched sales seem to help both the problem of too much liquidity and a shortage of Treasuries.
What’s the rationale behind what Potter is saying?
April 16, 2015 at 9:17 am |
Shocked–i keep asking myself the same question you pose.Yesterday,when it read the newest Bernanke post it confused me even more—there is no problem with the excess reserves until the economy picks up at which time the banks will stop giving cash to the Fed and put it to work thru lending –that is when the FED will get tested for its theories—the problem for the Fed is the Banks have lessened their treasury holdings in response to regulation but the shadow banking system is loaded with collateral and willing to enter investment streams where banks are fearful of treading–the short issue of Treasuries is also due to the massive holdings of the Fed of good collateral on its balance sheets which it seems the Fed should be willing to sell into the market to drain reserves and lighten the balance sheet–but the Fed seems to believe this would cause a real taper tantrum–i saw it is time to test those fears
April 16, 2015 at 10:08 am |
Yra- The FED acts scared, and this could affect the markets. When they removed “patient”, they accompanied it by buckets of doveish propaganda..
It seems to me that there is something going on, that we are not being told.
IOER has become a seemingly permanent subsidy to the banks.
If things are going so swimmingly, why continue to pay IOER.
April 16, 2015 at 12:07 pm |
Traders should cooperate, that’s pretty rich. Yra, I truly appreciate the eye-opening insights you share with us.
In the spirit of contributing something I fixed this passage, pretty sure this is what you really meant?:
“The FED has been warning that BOND markets are subject to severe volatility because markets fail to respect the FOMC‘s CONFLICTING views on economic growth and the need to raise rates sooner than investors appear to want to believe.”
April 16, 2015 at 3:29 pm |
Chicken–you feathered it nicely–many thanks