April 2. The Usual Stuff Isn’t Working

Moreover, at times, we have observed cases in which financial conditions did not move in the same direction as the monetary policy stance. From Bill Dudley’s March 30 speech about Financial Conditions

I read Dudley’s Thursday speech as being fairly hawkish, and indeed interest rate futures were a bit lower early Friday. In a way, his comments could be summed up as saying, we want to gradually tighten policy, but financial conditions have actually loosened up in the wake of recent hikes [and we want to lean against that]. Dudley once again appeared Friday morning, this time on a Bloomberg interview. This appearance was a slight change in narrative with an explicit mention that balance sheet reduction could occur at the end of 2017 or beginning of 2018. He also said there was ‘no urgency’ to get to the neutral rate, and further, termed changes in Fed Funds versus cutting back reinvestment as substitutes.

The chart below contains the five factors that Dudley mentioned in terms of financial conditions: short and long term rates (I used 3m Libor and 10y treasury yield), the trade weighted dollar (I used DXY), equities (SPX) and corporate spreads (BBB spd).

There were hikes in December and March. Short rates indeed increased, but equities are higher from December, the dollar is lower, ten year yield and corporate spreads are about the same. That is, financial conditions aren’t really restrictive…”not moving in the same direction as policy stance.” Of course, rather than straining at the chart above, one could glance at any one of the regional Fed’s financial conditions or stress indices, for example this one from Chicago. None show meaningful changes. In fact, they all just sort of bounce along the bottom. Like VIX. https://fred.stlouisfed.org/series/NFCI

The broad outlines of this discussion echo Greenspan, as mentioned in a Bloomberg article (link below). “In February 1998, Dudley and his team at Goldman took a cue from then-Fed Chairman Alan Greenspan, who had just testified before Congress that although inflation-adjusted interest rates had risen, ‘in virtually all other respects financial markets remained quite accommodative and, indeed, judging by the rise in equity prices, were providing additional impetus to domestic spending.’’

Greenspan didn’t have the balance sheet reduction arrow that the current Fed has. And nearly every Fed official has recently mentioned ending reinvestment. I saw comments from Bullard, Mester, Williams, Kaplan, Rosengren, Harker, and even Kocherlakota, oops, I mean Kashkari. For example, here’s Rosengren from Jan 9: “If you think the economy is growing more rapidly then you want, you can either continue to raise short-term rates, or you can also do balance sheet in conjunction with that.”

I was going to say that the balance sheet discussion represents a nuanced change in policy. But nuanced is too weak of a word, because there have been many explicit references. However, the market won’t seem to take the bait. With balance sheet reduction, I would think the curve would steepen, and it’s quite flat, from 2/10 at 114, to 5/30 at 109, to red/gold euro$ pack spread at 71. Is the idea of a more aggressive Fed ‘in the market’ and simply being discounted because the economic data appears to be faltering? Or is this like the period leading up to the March hike when Fed officials had to beat the market over the head to signal an imminent hike?  Is the idea of BSR (balance sheet reduction) more of a negative for stocks and therefore supportive of treasuries?  I’m not sure. This past week we had ECB officials saying the market had misconstrued communications. I don’t think Dudley is going to walk back any of his comments.

There is one other quick note about Dudley’s comments regarding BSR. In the interview he said, “I don’t think there is a strong need to differentiate between mortgages and Treasuries”. This is interesting in the context of Fannie and Freddie which back about 40% of the nation’s home loans, and which are required to sweep profits back to the US Gov’t. A Bloomberg article notes: “A Fannie-Freddie fix, promised since they were seized by regulators in 2008 and sustained with $187.5 billion in Treasury funds, has taken on increased urgency as the companies face the threat of needing more aid. Under the terms of their bailout, they can’t retain any capital starting next year, meaning taxpayers would have to cover any losses.” (link below). These issues may foretell a widening of mortgage spreads, which could negatively impact housing.


There is a lot of news out this week that could rattle markets. The employment report is Friday. Prior to that, ISM on Monday, Auto sales on Tuesday (much more important now given loan deterioration), FOMC minutes Wednesday afternoon, and a meeting between China’s Xi and Trump at the end of the week. One note regarding this last item (which Trump already framed as being difficult). I hadn’t realized that the Li Keqiang Index, (which measures readily observable data in China: rail shipments, power usage and lending) hit a five year high at the end of February of 12.85. I would think end of March data would be out this week.


I have a friend from the old Bankers Trust days who is a professional poker player. He graciously gave me a few books on the topic a long time ago, thinking that he could impart some wagering wisdom to me. That bet turned sour. However, I do recall a passage from one of the books that stuck with me (and I have to paraphrase here because I have been hunting around my house for the book and can’t find it). The author related this bit of advice from a poker ‘professor’: “When it’s just you and another player and the odds on a given hand are simply too close to call, go ahead and make the bet. It’s more fun that way.”

The Fed is telling us BSR is on the table. Grab a chair and ante up.





Posted on April 2, 2017 at 11:42 am by alexmanzara · Permalink
In: Eurodollar Options

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