Notes From Underground: Nothing Focuses the Mind Like a Hanging

First things first, let’s talk about the gorilla in the room, former Richmond Fed President Jeffrey Lacker leaked confidential information and the entire FED has had its reputation tarnished (stifle your laughter). The bigger question is how much is being covered up. Who else was involved in discussing matters of great sensitivity? As my readers know I have raised the issue of the G-30 and Davos being convocations for the exchange of very privileged information. Just google the G-30 and look to see its membership. The dissemination of potentially sensitive market-moving information to highly paid analysts raises serious questions of impropriety. In an effort to the level the playing field (and yes, I was most probably harmed by the leaks to Medley), the FED should not release its speeches or market information to any journalists covering the Federal Reserve.

Journalists do receive all FED communication before its release to the public so they can prepare their stories, but of course the articles are embargoed until the actual release time. There have been instances where news was inadvertently released a few minutes early.

(Steps on soap box) In today’s algo- and high frequency trade-driven markets the media organizations shouldn’t have a 30-minute lead time in order to CRAFT headlines that are volatility drivers for the word-driven algo traders. This creates volatility that rewards the HFTs while punishing other investors. It is time for the FED and SEC to wake up and protect the integrity of the markets. Also, Jeffrey Lacker should serve a long prison term and anybody else who is involved in leaking market-moving information.

***After staring at the U.S. 2/10 yield curve for days on end, I offer readers some perspective to stem the nonsense that fills the airwaves about flattening and steepening, and the yield curve’s impact on the banks’ stock prices and other asset classes. In looking at a 25-year chart of the 2/10 curve I discovered that the overall average price during this long time period is 127.286. Today’s close is 110.3 so over this time period we are close to the average, an indication we are neither flat nor steep but fairly  average. In this same period  the high was 293.93 (steep) and the low was -56 basis points (inverted) and this inversion took place 17 years ago, April, 10, 2000. This gives us  a perspective so we will know how to monitor the coming moves by the FED to either raise rates or shrink the balance sheet. If the FED were to hold rates while it began shrinking the balance sheet the CURVE OUGHT TO STEEPEN.

WHY? Because the FED‘s decision to wind down its balance sheet will REMOVE a large buyer from the market and should result in long-end yields moving higher. The FED believes that if they start shrinking its balance sheet there will be little disruption to the market, at least that is what their models predict. But the market, where it is practice not theory that rules, may exact a far greater price than many FED members believe. Currently, the yield curve has recently flattened a wee bit as the FED has raised rates twice in the last four months.

The FED‘s models are predicated on economic data and fail to acknowledge the financial nuances of the real economy. In a March 19 Financial Times piece by Gillian Tett, “A Blind Spot Masks the Danger Signs In Finance,” Tett cites the work of Hyun Song Shin, an economic adviser to the BIS. Shin questions the secular stagnation theory as the reason for continued low interest rates. In picking up on a regular theme in NOTES FROM UNDERGROUND Shin thinks ” … we are misguided to believe in that ‘signalling’ power of low rates, or blame them just on secular stagnation fears.” Further, “Mr. Shin believes that modern economists have a crucial blind spot: They tend to ignore how the financial system really works, since they operate with idealised models of money and investor incentives.” Shin said the falling rates in Europe between 2014-2016 were a result of gloomy investors but the BIS found that rates were extraordinarily low due to “accounting rules and solvency regulation.” German insurers were buying massive amounts of bonds in order to match asset to liabilities, all the time in competition with the ECB’s quantitative easing program.

Tett’s summary of Shin’s research: “It suggests that western banks may have been misguided to keep rates so low for so long; instead of curing economic gloom, quantitative easing may have reinforced market unease by making insurance companies and other behave in perverse ways. “The importance of  Shin’s work will certainly be relevant as the market takes its measure of the FED‘s efforts to deal with 2% inflation and full employment. The FED presumes minimal impact but the markets may have a different outcome in mind. In noting the impact of the FED‘s QE programs on future interest rates Shin said: “It would be foolish to assume that the future trajectory of rates will be smooth and gentle–never mind that Fed ‘dot plot.’ The ‘amplification mechanism’ that pushed rates lower could equally work in reverse. Fed interest rates might unleash new feedback loops, pushing rates much higher than expected, echoing the pattern seen, say, in 1994.”

Whatever trades or investments you choose to make understand that the FED‘s theoretical analysis of it policies will have a far different market outcome. As I am wont to say: Monetary policy is, unfortunately, not rocket science. More to come.



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11 Responses to “Notes From Underground: Nothing Focuses the Mind Like a Hanging”

  1. Stu f Says:

    FYI Shin in Chinese is somewhat equivalent to True in English.


    • yra Says:

      Stu—Mr.Shin is one of the best analysts of the global financial plumbing so when he writes I pay close attention to his views

  2. chems Says:

    Yra – what is your preferred way to play this steepening of the yield curve?

    • yra Says:

      Chems—working out how i will play it but being very patient as this spread is very rangebond and has not giving me any definitive signal.This curve ought to steepen if the fed begins shrinking the balance sheet but I am being very patient to wait and get a sense for with the ECB and BOJ still heavily involved this is a difficult trade for the moment

  3. Asherz Says:

    The “market’s integrity” has been an oxymoron for some time. Honest market pricing has been long gone with QE affecting interest rates, equity prices affected by zero rates and central bank asset policies (BOJ AND SNB) while the Fed added this as a third mandate, precious metal pricing capped by bullion banks, etc. The Schiller CAPE index nears highs as the economy continues to stall. If Fed minutes on balance sheet adjustment is not just another head fake ( I wouldn’t bet against that) the chimera achieved by gross asset inflation will come to an end with rapid market integrity truly restored.

    • yra Says:

      Asherz—really good point on the head fake concept.I certainly take everything from the FED with a “grain of salt” unless Lacker is the one telling me–ha

  4. Guy Williams Says:

    Yra, Great commentary; thank you for including me in your email. Regarding Lacker, amen.  The lack of accountability for malfeasance among the “elite” has long troubled  me -and has amplified the general public’s disdain for American institutions- for far too long.  That erosion of faith has been cancerous, and continues to metastasize.  I know military analogies are judged effete and no longer resonate for most civilian Americans who never served, but I will say this.  The old Navy ethic of the Captain going down with the ship, mandated by traditions of personal honor and ultimate accountability, is vastly preferable to today’s society of “you rate what you get away with.” In my opinion, the decline of  public virtue -indeed, the fashionable ridicule of virtue- is among our America’s greatest threats.  I lament it all.  I apologize  if my words edge toward rant. Again, thank you for including me among those you sent your learned thoughts. Kind regards, Guy Williams

  5. Rob Syp Says:

    Yra: With the 10 year at 2.28% in your opinion is next stop 2% or climb back to 2.5%.

    Thanks and anyone can chime in if they like.

    • yra Says:

      i think they may make 2.5% but it is a guess at these levels but the curve with the 200 day at 105 basis points is more directional—so let’s see what takes place –as Frankie Pantaglia would say” you will have no trouble from me” if they head back to 2.5%

  6. Chicken Says:

    Today the 10yr rate opening gap down was filled, and then some. Despite the military action in Syria AND the softer March employment report.

    This, following Monday’s plunge, which was reversing up until reports of the gas attack.

    A tell of sorts for tendency to lean towards a rising 10yr rate?

    • yra Says:

      Chicken—a good point you make but it is far too early to tell which is why I am monitoring the yield curve as a key to the next move

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