MORNING BID — Breaking it down, Fed style

Sep 17, 2014 14:58 UTC

It’s all over but the dissection of the Fed statement, due later today, which will follow with a Janet Yellen press conference after the U.S. markets get word of whether the Fed did or did not eliminate the “considerable time” bit from its statement that saw markets go into a tizzy all of Tuesday. At this point the market believes that phrase now may *not* be eliminated, which marks the second reversal in about a week on this point. No matter what, somebody is going to be caught leaning in the wrong direction, but if the latest intelligence is that the Fed’s statement won’t change materially until the October meeting, then the freshest bets are probably in the direction of those betting on that much. So if the statement does cut out that language or modifies it in any way, you could see a selloff in equities, the dollar and bonds.

The meeting also brings with it the update on the Fed’s “central tendencies,” that is, its sure-to-be-incorrect projections on where the economy is going. Given the rebound in the second quarter that seems to have at least been somewhat sustained in the third quarter, it wouldn’t be surprising to see the Fed outlook for GDP bumped up for 2014 (currently 2.1 to 2.3 pct) and 2015 (at 3.0 to 3.2 pct – the Fed will predict 3 percent growth for the year-out period until we’re all Morlocks), and the unemployment rate expectations are projected to drop to maybe 5.7 to 5.8 percent from the current 6 to 6.1 percent expected at year-end. Which is all well and good, but it doesn’t give us a good sense, really, of what’s to happen going past the meeting.

What we may be looking for over a longer time frame is an elevation in volatility. Richard Leong, in a story last week, pointed out that the market is starting to see more options-related buying that suggest rising rates in the federal funds and eurodollar markets. In a Tuesday story he noted that various measures of volatility – including the Merrill Lynch MOVE Index, a measure of fixed-income volatility, is at levels not seen since mid-summer. The dollar is showing similar activity, with volatility in the currency markets finally picking up after being stagnant (ok, about as exciting as watching grass grow) for a good long period of months now. Nomura strategists are anticipating a further pickup in volatility post-Fed meeting among currencies, judging by options positioning.

The equity market isn’t quite there yet – the VIX still remains low, trading below 13, but volatility would be expected to pick up in other risk markets if the interest-rate arena begins to exhibit more gyrations. That’s because the moves in that market make it more difficult to fund carry trades to buy other assets – the dollar remains a cheap source of funds right now, but the cost of carrying such bets increases as rates rise and more importantly as the market gets more volatile. Where that leaves investors is unclear – Bank of America/Merrill Lynch notes that credit investors are going with shorter durations (which adjust more quickly as rates rise) and leveraged loans as the best choices over the next 12 months, and are a bit less sunny on high yield, which has the potential for some ups and downs in coming months.

MORNING BID – Just our imagination

Sep 10, 2014 12:46 UTC

Something has changed in the bond market in some ways – but it’s a bit difficult to tease out when you’re talking about yields still near very low levels. But there’s a sense that the San Francisco Fed’s paper on the way in which economists are underestimating the Fed’s own view of interest rates is a game-changer, or maybe it’s just that people are waking up to the idea that the Fed really does have to raise rates eventually, or even more so, that it’s an overreaction to a previous overreaction: backlash to the idea that the August jobs report was so lousy that the Fed was still firmly in “not doing anything ever” mode.

The dynamics of the long-dated market haven’t been altered all that much just yet – or rather, it’s a bit early to declare that. The 10-year is still hovering around 2.50 percent, and the spread between that and 10-year Treasury Inflation Protected Securities stands at about 2.11 percent, and it’s remained in a steady range for the last year-plus as well, actually trending lower in the last few months.

That may in some ways be a product of the expectation that the Fed is preparing to get moving on maybe changing its language related to keeping rates low for a “considerable period” of time at its September meeting next week. Given, again, that short positions have been substantially worked off in recent weeks, the bond market no longer has the same kind of knee-jerk reaction to rally drastically in the face of evidence saying the Fed is going to keep rates low.

The weak jobs report has kept the consensus pretty much intact – that the Fed is going to make a move at some point, and so the bull case for bonds loses a bit of its luster (if only a little) IFR notes that lots of corporate debt offerings and the reduced short base contribute mightily to this, but the action in two-year and three-year notes, where yields are closing at highest levels since 2011, does give weight to the idea that markets are ready to start shifting yields higher.

Of course, this bet has made widows and orphans out of many in the last year or so, which makes people reluctant to declare that this is the big one, a la Fred Sanford. The fed funds market isn’t suggesting much yet in this area, and eurodollar futures still show something similar to what was expected a few months ago – short rates in late 2016 look to be about a percentage point higher than where they’re projected in 2015 – so the inflation bug isn’t out there yet, and this slow, steady gradual shift is on its way.

The problem with all of this, of course, is that the Fed is in blackout mode – next week’s meeting will reveal much, everyone hopes, but without Fed speakers expected and a dearth of economic figures to come, it leaves the market to its own devices, on its own to try to game out what might be said. Markets have a way of letting their imagination run away with them, though.

MORNING BID – Sound as a pound

Sep 9, 2014 14:01 UTC

Global ructions are dominating asset flows right now, and we’re not even talking about violent events such as the ongoing Russia-Ukraine conflict, the rise of Islamic State in Iraq and Syria, or the Israel-Palestine situation. Right now smaller events – yet uncertain ones – seem to be affecting the larger markets a bit more, contributing to a decided shift in factors that U.S. assets are reacting to.

The bond market is no longer just about a steady belief in lower-for-forever activity from the Federal Reserve, but about the expectation for more flows from overseas as U.S. assets look more attractive and the U.S. dollar continues to strengthen. The dollar had a banner session against the pound with the threat of Scottish independence growing more and more possible (cue everyone yelling “Freedom!” while being drawn and quartered), as the messy considerations surrounding what happens to oil revenue and the diminution of the U.K. economy is considered. It also threatens to drive more flows toward the dollar as the Bank of England might be expected to hold off on raising interest rates when they had been expected to be the first central bank to act.

Still, the overall level of interest rates from the world’s four major central banks (including Japan and the ECB) is still quite low – about 200 basis points lower than where the 2000-2004 cycle troughed (the real rate is somewhere between 0 and -1 percent right now). Even as the Fed starts to bump rates higher next year, at the earliest, the accommodative nature of the other major banks should investors fully invested in various markets, including the United States. Rates are more likely to come under pressure – the expectation has been for bond yields to rise, a losing bet for months on end now, and yet it persists.

It’s even spread to Fed officials, with the San Francisco Fed noting in a paper that Fed projections are for the fed funds rate to be around 1 percent at the end of 2015 (private economists think about 0.8 percent), and to 2.5 percent at the end of 2016 versus a 1 percent rate thought logical by economists. That does set up the possibility of disappointment, although it’s fair to say the Fed is often a bit too optimistic about expectations for the economy, inflation and other indicators – they’ve been known to regularly overestimate how growth is going to strengthen over the last few years. It’s possible that the fact that the Fed has its hands on the lever means the staff forecasts about rates should be taken somewhat more seriously, but since they’ve been wrong as much as they have, we won’t.

MORNING BID – Down in the Jackson Hole

Aug 15, 2014 12:43 UTC

The markets ease into a traditionally slow period with not much to look forward to other than the Federal Reserve’s Jackson Hole conference due next week, where the highlight, naturally, will be anything Janet Yellen says regarding the state of the labor markets. The chances of the Fed signaling a new shift when it comes to policy are slim – Yellen has proved to be a cautious speaker thus far, interested in furthering Ben Bernanke’s way of telegraphing as much as possible when it comes to policy alterations, and Yellen is more so, her “six months” comment from a few months ago notwithstanding. As Jonathan Spicer and Howard Schneider reported a few days ago, Yellen is much more interested in fighting an inflation war than dealing with a persistent deflationary/lousy economic environment to dominate the headlines, so the expectation should be for lower rates for longer, and not to expect a lot of surprises out of Wyoming next week.

Goldman Sachs economists not that Yellen had sounded a bit more positive on the labor market in July, but even still their belief when it comes to the slack that exists in the jobs market is still too great to bear much more than the end of quantitative easing/bond buying and perhaps a move to a couple of small rate increases around the middle of next year that, well, won’t hurt too much given the Fed’s policy rate still sits between 0 and 25 basis points. The forecasts from Reuters most recently put the first rate hike somewhere in the April to June range, which fluctuates depending on the strength of the economic figures.

The markets still haven’t entirely shed the notion that a more permissive Fed is a good thing, and so bad-is-good reactions still are more frequent than one might want. Still, Goldman notes that various labor force indicators still point to a jobs market operating far below capacity or the level of strength that the Fed wants. Some aspects have improved – job openings are rising, which points to desire for more employees, and payroll growth compared with potential labor force growth has been solid, but the hiring rate, quits rate, wage growth figures and participation rate still remain on the low side – so there’s just not the kind of job growth that will push everything else forward too. Morgan Stanley analysts recently noted that the University of Michigan’s final survey of consumers still finds ordinary folk not that enthused about spending in part because of labor-market weakness.

How the market positions headed into the last part of the year also depends on the Fed. Merrill Lynch data shows a net 78 percent of investors polled in one of their surveys expect higher rates in the next 12 months, the highest level since 2011, which is likely to affect positioning and result in more curve-flattening activity.

(This column will be on hiatus for a week next week)

MORNING BID – Shorting a dull market, and other cliches

May 28, 2014 13:43 UTC

There are a million cliches people lean on to explain some aspect of the market that’s otherwise baffling, and the key one this week – the cliche du semaine – is something along the lines of, “You don’t want to short a dull market.”

And indeed this has been a bit of a dull one lately. The S&P 500 grinds to new highs, accompanied by the Dow transports, with the industrials not that far off.

Even the much-maligned Russell has outperformed the S&P on a relative basis for the last four days, so some of the divergence between the small-caps and the big caps has been worked off to bring valuations a bit more in line (even if the Russell’s weakness stands as one big counterpoint to all the kumbaya talk we’ve been having lately).

Recent volumes have been really weak – trading last week was 22 percent less than the average week, per Mike O’Rourke of JonesTrading.
So there’s some concern that a breakout in the stock market – which we’re seeing now – accompanied by lackluster volume somehow means it’s not “real” in a sense. But try telling that to anyone who bought into the market two or three years ago and has watched it do almost nothing but ride higher since. At this pace, corrections become much less frightening and the worrying only increases when things get truly hairy.

Which brings us to another cliche – the one about too much complacency. A look at volatility right now does underscore the way in which the market is in full Hakuna Matata mode, with one-month VIX implied volatility falling to 38.9 percent, the lowest ever, according to Credit Suisse. VIX options, therefore, are near their cheapest levels ever, and the cash VIX is hanging around the 11 range, so it’s not even ready for its Bar Mitzvah.

(And three-month implied volatility of about 12.5 percent is actually a bit rich, given realized volatility has been a bit more than 10 percent in the last three months – traders are betting on a somnambulant market and getting a market that’s the functional equivalent of rotting tree bark.)

The constructive part of all of this is that the market continues to rotate through various sectors. Old technology like Microsoft had a turn leading the way, which followed good gains for utilities, and the financials were stronger on Tuesday.

Dennis Dick of Bright Trading LLC in Las Vegas pointed out some of the cliches that keep him a bit worried – the lack of worry in total and no real catalysts to keep these things moving – but said, once again, that it’s a difficult environment to make the short selling work.

Which, of course, is only an issue if you’re a die-hard short.

MORNING BID – Janet Yellen’s rain (snow) check

Feb 27, 2014 14:16 UTC

This is the thing about delaying the new Fed chair’s follow-up testimony by two weeks due to bad weather, you actually make the second hearing something that’s potentially interesting. (It will depend, of course, on whether members of the Senate Committee ask provocative questions, and while you can lead a horse to water, well, you know.)

In the interim two weeks since Janet Yellen last appeared before Congress, the U.S. economic picture has gotten much more muddled. That’s mostly because of poor retail sales and employment figures, and the out-of-control situation in Ukraine which has led to a regional flight of some assets. There’s also been some interesting comments from the likes of Fed Governor Daniel Tarullo, who suggested the Fed should be paying more attention to the formation of asset bubbles and the use of monetary policy to curb them. That anyone is surprised at this shows how pervasive the “Fed put” option has become in the discussion of Fed activities, so we’ve really lowered expectations here.

Meanwhile, Boston Fed head Eric Rosengren said the Fed is looking very closely at activities in emerging markets, which is sort of obvious in a sense but contradicts, if only modestly, Yellen’s thoughts two weeks ago. And really, the Fed’s ability to influence economic activities overseas in some of the world’s developing markets or troubled spots is even weaker than what it can exert over U.S. demand. So maybe it’s just one to grow on.
Either way, Yellen would probably want to comment on the situation, if, again, a smart senator would think to … well, never mind.

Overnight, the situation in the Ukraine has worsened, with armed gunmen taking control of regional government headquarters in Crimea, vowing to be ruled from Russia. The Ukrainian hryvnia continues to sink while the Russian ruble plumbs new five-year lows, surpassing the previous day’s losses, and a bit of risk-off action can be seen in the zloty and a bit of better buying in Treasuries, where the 10-year yield was lately at 2.66 percent. Fund flow figures will be key to watch here to see if overseas flows increase to the U.S. or at least to the developed areas of Western Europe and Japan.

Morning Bid — The Minutiae of the Minutes

Jan 8, 2014 13:52 UTC

December’s last salvo before going into holiday mode was the surprise Federal Reserve decision to trim its monthly $85 billion in bond buying to a more modest (but still enormous) $75 billion, that helped balloon its balance sheet to north of $4 trillion.

Suffice to say, on some levels, there was a bit of a disconnect here: The Fed’s inflation outlook showed inflation not getting back to its 2 percent target for a long time (like, forever; several years out, it was seen as just sneaking its way over 2 percent, never mind what Charles Plosser of Philly says).

With the Fed’s minutes due out later Wednesday, there are a number of unanswered questions about the Fed’s decision as Ben Bernanke exits and Janet Yellen (confirmed on a 56-26 vote, with “OMG IT’S COLD” coming in third place with 18 votes) enters the scene:

THE SCHEDULE OF REDUCING STIMULUS
There’s been no guidance on this so far. Ben Bernanke, in his final press conference as the Fed head, said he could envision a steady reduction in $10 billion increments at each meeting, which would drop the monthly buying to nothing by the end of 2014. Richard Fisher, Dallas Fed head and now a voting member for 2014, said he would be comfortable with a more accelerated rate of purchases. And dovish John Williams of San Francisco said yesterday he’d expect to see the end of buying by year-end.

So it will be interesting to see any commentary on this – whether a faster pace was considered or not. (There will probably be some boilerplate on the Fed saying it could ‘reduce at a faster pace’ or ‘resume additional purchases’ or something. Just as a warning.)

But the October minutes provide some clues, as the Fed said some participants “mentioned that it might be preferable to adopt an even simpler plan and announce a total size of remaining purchases or a timetable for winding down the program. A calendar-based step-down would run counter to the data-dependent, state-contingent nature of the current asset purchase program, but it would be easier to communicate.”

ECONOMIC EXPECTATIONS
Recent inventory figures, construction data and durable goods orders point to better-than-expected figures for the fourth quarter, and a first quarter where the economy gains momentum. The baseline projection for GDP growth in the fourth quarter has been for around 2.5 percent, but it could be higher thanks to a boost in exports.

The Fed sees 2014 GDP growth of 2.8 to 3.2 percent, which may end up being optimistic, while they see inflation as not much of a threat.
Yellen, in the past, has been more explicit about the idea of living with additional inflation, if needed, to help reduce unemployment, so there’s that. Again, that central tendency only ticks up to 2 percent in 2015 and 2016, and that’s the just the upper end of the Fed’s forecasts.

THE CONSUMER OUTLOOK
October’s minutes sounded a note of caution when it came to regular people, saying that “consumer sentiment remained unusually low, posing a downside risk to the forecast, and uncertainty surrounding prospective fiscal deliberations could weigh further on consumer confidence.“

Said fiscal shenanigans have receded for the time being (give it a day or so), which has removed a layer of uncertainty, though it’s debatable that consumers make decisions based on what’s happening in Washington to begin with. But a weak September payrolls figure and a few limp sentiment surveys put the Fed in a mind to be more concerned, and later economic figures don’t show a similar kind of worry.

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