Abby Normal

The central theme of this week’s note is that IF the change in perception of central bank policies is edging toward a tipping point, then violent re-pricing is possible across many asset classes.  The market has become so used to the idea of central bank backstops that there’s institutional amnesia about how things *could* shake out.  Once again, IF perceptions change, then economic data like the weak Service ISM released Tuesday won’t make much of a difference, as seen on Thursday and Friday (as tens rose 14 bps and SPX fell 2.5%).  “But,” one might argue, “the Fed continues to talk about ‘data-dependency.’”   Right, that’s something you’re going to have to ignore. This note may seem a bit long, but there are plenty of pictures and charts.

Is it too late for a ‘Young Frankenstein’ tie-in in honor of Gene Wilder?  I think not.

You are talking about the nonsensical ravings of a lunatic mind.  Dead is dead. –Dr Frederick Frankenstein.



Dr Frederick Frankenstein: [to Igor] Now, that brain you gave me.  Was it Hans Delbruck’s?

Igor: [pause, then] No.

Dr. FF: Ah! Very good. Would you mind telling me whose brain I DID put in?

Igor: Then you won’t be angry?

Dr FF: I will NOT be angry.

Igor: Abby someone

Dr FF: Abby someone.  Abby who?

Igor: Abby… Normal

Dr FF: [pause, then] Abby Normal?

Igor: I’m almost sure that was the name.


On Thursday, much attention was focused on the unexpected scheduling of a speech to be given Monday by Fed Governor Lael BRAIN-ard.  (See how cleverly I worked that in?)  As Barron’s noted,” It’s not often that a simple press release announcing that a Fed governor will be delivering a speech the following week is enough to spark a selloff in Treasuries.  But that’s apparently what happened Thursday.”  The theory is that Brainard has been quite dovish, and if she signals comfort with the idea of normalization (just prior to the Fed’s blackout period) then the market will HAVE to price increased odds of a hike, even for September.   Note that Oct FF settled 99.550 Friday; the lowest settle was 99.520 on the Friday of Jackson Hole.  At 99.550 the odds of a Sept hike are just north of 20%.

Below are a couple of quotes from Brainard’s last speech on June 3.  (Emphasis added)

The fragility of the global economic environment is unlikely to resolve any time soon. Growth in the advanced economies remains dependent on extraordinary unconventional monetary policy accommodation, while conventional policy continues to be constrained by the zero lower bound. Conventional policy, whose efficacy is more tested and better understood than unconventional policies, can respond readily to upside surprises to demand, but presently would be constrained in adjusting to downside surprises. This asymmetry in the capability of policy effectively skews risks to the outlook to the downside.

“DEPENDENT on extraordinary unconventional monetary policy.”  You might even call it Abby Normal.

Thus, although some signs point to a firming of inflation going forward, I view the persistently low level of inflation during the recovery together with some signs of a deterioration in inflation expectations as suggesting that the risks to the return of inflation to our 2 percent target over the medium term are weighted to the downside.

It’s not going to take much of a change in tone from the cautiousness LB expressed in the beginning of summer to convince the market of a sentiment change.  In that speech she talked about risks related to Brexit and China, from which fallout so far seems negligible.  GDP estimates from Atlanta and NY for Q3 are still solid, at 3.3% and 2.8% respectively.

Perhaps more important than Brainard’s speech was this item from Reuters: The Bank of Japan is studying several options to steepen the bond yield curve that might be debated at this month’s rate review as part of measures to fine-tune its massive stimulus programme, say sources familiar with its thinking.  They are brain-storming ways to cut short- to medium-term bond yields, which affect corporate borrowing costs the most, while pushing up super-long yields from undesirably low levels, the sources said on condition of anonymity. (Link to article at bottom)

“Brain-storming”.  Very reassuring.  Note that 10 yr JGB yields have already jumped over the last month from around -30 bps to just under zero at -2 bps on Friday.  As Draghi this week declined to add stimulus through additional bond buying, the German ten year bund yield crossed the zero axis to close at +1.1.  There’s a chance this whole monetary experiment that’s been cooked up and stitched together in the castle laboratory may run amok.

Earlier in the month Bloomberg noted that Blackstone was shunning long term Treasuries:   “We think the Fed is likely to allow inflation to run hotter than its target for a while,” Rick Rieder, the chief investment officer of global fixed income in New York, wrote in a report Sept. 2. “While we have believed that there was more value in longer-end interest rates over the past year or so, we are more comfortable holding shorter, or belly, interest rate exposure.”

Take a look at the chart below of the ten year treasury yield.  On a technical basis, a double bottom has formed with lows in 2012 of 1.39% and in July of this year at 1.36%.  The two lows look quite similar in terms of formation, and in 2012, the yield ran up to 2% by the beginning of the next year.  In the current rendition, the 2% area is where a descending trend line comes in; approx. 127-24 basis TYZ6.

However, the key take-away is what happened in the middle of 2013, the infamous “Temper Tantrum” as Bernanke hinted at an end to bond buying.  Once again, the point to be aware of is that in the current case, it’s not simply the Fed that’s trying to ‘fine-tune’ policy, it’s also the ECB and the BoJ, and to some extent the BoE, where Carney ruled out negative rates in August:  “I’m not a fan of negative interest rates,” said Carney. “We see the negative consequences of them through the financial system; we’ve seen that in other jurisdictions; we see the issues with savers.”















Note as well the incipient break out of the 2/10 treasury spread.















There’s a tendency to think that stocks and bonds will continue being negatively correlated.   Actually, in 2013 as bonds sold off, stocks were able to trade higher throughout the year.  However, all asset classes have since been supported by central banks.  If that support looks fragile, it can all come down together.

And finally, to wrap up with another brain reference (supposedly from an actual trial):

Attorney:  Doctor, before you performed the autopsy, did you check for a pulse?

Doctor: No.

Q: Did you check for blood pressure?

A: No.

Q: Did you check for breathing?

A: No.

Q: So, then it is possible that the patient was alive when you began the autopsy?

A: No.

Q: How can you be so sure, Doctor?

A: Because his brain was sitting on my desk in a jar.

Q: But could the patient have still been alive, nevertheless?

A: Yes, it is possible that he could have been alive, practicing law somewhere.


9/2/2016 9/9/2016 chg
UST 2Y 79.0 78.8 -0.2
UST 5Y 118.8 122.3 3.5
UST 10Y 159.6 167.1 7.5
UST 30Y 227.0 239.0 12.0
GERM 2Y -63.0 -63.1 -0.1
GERM 10Y -4.3 1.1 5.4
EURO$ Z6/Z7 17.0 16.0 -1.0
EURO$ Z7/Z8 12.5 14.0 1.5
EUR 111.56 112.34 0.78
CRUDE (1st cont) 44.44 45.88 1.44
SPX 2179.98 2127.81 -52.17
VIX 11.98 17.50 5.52


Posted on September 11, 2016 at 8:51 am by alexmanzara · Permalink
In: Eurodollar Options

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