July 18, 2020 – Weekly comment

“This attracted a large youtube following, with thousands of views.  Young men were particularly attracted to his message, which promised a new order, and a rejection of the suits who ran investment funds.”

I know.  It sounds a little bit like Portnoy.  But the actual quote refers to a date long ago.  There is no shortage of historical periods of upheaval where a disenfranchised public succumbs to a message in which the old symbols and rules are excommunicated.  In this case, 1497. 

Savonarola spent the early 1490s working crowds in Florence, introducing into his preaching set apocalyptic prophecies and fiery exhortations for listeners to free themselves from the burden of sin.  This attracted large crowds, who regularly attended his sermons.  Young men were particularly attracted to his theology, which promised a new world order and a rejection of the old men who ran the city.

Savonarola Preaching Against Prodigality

The city was Florence.  The Dominican friar was Girolamo Savonarola.  The message was righteous indignation with the trappings of social excess and privilege: artwork, sculptures, tapestries, ancient books and poetry, musical instruments, fine clothing and cosmetics.  His followers, known as the Piagnoni (weepers), collected these items from the public, including paintings by Sandro Botticelli, and on February 7, 1497, a pyre was constructed in the Piazza della Signoria and all was set ablaze.  The Bonfire of the Vanities. 

Interestingly, Lorenzo de’Medici was one of Savonarola’s original benefactors, but in 1494 mobs inspired by the friar burned down the Medici’s bank and the family fled the city. (Sound familiar?)  Shortly after the Bonfire, in May 1497, Pope Alexander VI excommunicated Savonarola, and in another year he was executed, burned to death on a cross in the same piazza.

Now the righteous indignation is leveled against all perceived transgressions past and future.  I am just going to touch upon the vanity of the Fed in thinking it can save the world, while in reality the heavy hooded robes of that sanctified institution are muffling the sounds of capitalistic cues.

Here’s a tweet from David Rosenberg: “Core retail sales are up while 14M jobs and $726B in wages have been lost.  How?  Personal income has RISEN at a 12% annual rate in 2020 (a $933B surge) – gov’t transfers have ballooned at a 229% annual rate (by $2T), funded by the Fed.  It may be “money” but it’s not “income”.  Big difference.”

That, I think, is the core problem.  As Dire Straits would put it, “That ain’t workin’ that’s the way you do it/Money for nothin’ and chicks for free.”  There is a difference in how money is earned, and what sectors of the economy attract flows, thus creating further productive investment.  It’s the core of what constitutes a healthy economy with organic growth rather than one riddled with malinvestment.  Chicks AREN’T free.    

Some might say there’s no difference at all.  Wealthy flight from formerly cosmopolitan and cultured cities to suburbs?  Sure, it results in economic transactions, but is it positive?  Expanded employment benefits filtering into stocks through Robinhood accounts?  Sure, it helps boost ‘the market’ but is it a positive?  Guns and ammo all out of stock.  Sure, it represents consumer demand, but is it positive?  It might seem great for the guy that was making $400 a week part-time now hanging out at home and getting $600/week, but the guy who is still working making $800 a week feels like a sap.  Low interest and/or forgivable loans to maintain employees are surely a benefit, but it can’t simply go on forever.  Or can it? 

Here are a couple of excerpts of Lael Brainard’s speech last week along with my bracketed comments:

Several measures of default probabilities are somewhat elevated. It remains vitally important to make our emergency credit facilities as broadly accessible as we can in order to avoid the costly insolvencies of otherwise viable employers and the associated hardship from permanent layoffs.[viable or zombie?]

And with inflation exhibiting low sensitivity to labor market tightness, policy should not preemptively withdraw support based on a historically steeper Phillips curve that is not currently in evidence. Instead, policy should seek to achieve employment outcomes with the kind of breadth and depth that were only achieved late in the previous recovery.[credibly irresponsible?]

With the policy rate constrained by the effective lower bound, forward guidance constitutes a vital way to provide the necessary accommodation. For instance, research suggests that refraining from liftoff until inflation reaches 2 percent could lead to some modest temporary overshooting, which would help offset the previous underperformance. [forward guidance with inflation make-up]

Tim Duy wrote a BBG piece saying Brainard’s speech represents a major policy shift, and that the Fed will now choose to let the economy ‘run hot’.  “Brainard is saying the Fed should not tighten policy until actual inflation reaches 2%. Policy lags — the time between the Fed’s actions and the resulting economic outcomes – mean inflation will subsequently rise above 2%. The Fed would thus overshoot the inflation target and then return to the target from above.”  How realistic is that?

This to me seems like a move towards the self-righteous Paul Krugman *shudder*.  In 1998 he argued that when a central bank (in this case BoJ) hits the zero-bound in a slump “the central bank needs to credibly promise to be irresponsible”.  This theme was later expanded upon by Michael Woodford in a 2003 paper and alluded to by Bernanke in 2002 and 2003, and then echoed by Paul McCulley.  The “piagnoni”.  “Bernanke recognized that such a policy could unmoor long-term inflation expectations, creating a deleterious rise in long-term interest rates.  But in his view, this was a risk worth taking…” 

The markets have responded to the promise of undammed liquidity with flows being channeled into the quest for wealth of the damned.  Gold and silver are making new highs.  Stocks have responded.  Yields are at rock bottom lows to encourage leveraged consumption.  Real yields have descended to…you know… lower.  On Friday the ten-year inflation-indexed note made a new low of -84.6.  The lowest level in 2012 was -91; closing in.  The thirty year tip is at a new record low of -28.7 bps.  The five year is -108 bps.  That’s well away from the 2013 low of -177, but it’s rapidly moving in that direction.  Since the Fed’s aggressive response to the virus, the U of M survey of inflation expectations surged higher and hasn’t pulled back, in spite of every Fed official weeping about the possibility of deflation taking hold.  The one-year expectation reported Friday was 3.1% with the 5-10 year at 2.7%. 

The Fed’s core purpose is to foster maximum employment and price stability, with the vow to be a lender of last resort to viable entities.  The embodiment of narrow and trusted responsibility.  The leadership is now abandoning those core values like the Medicis fleeing Florence.  Markets have sniffed out the initial ramifications: higher prices for financial assets, higher prices for commodities, risks being shunted aside for the shiny promise of quick returns associated with malinvestment. But risks have a way of flaring up like an out of control bonfire.

“I am the hailstorm that shall break the heads of those who do not take shelter.” –Girolamo Savonarola


As mentioned last week, “It has been sheer folly to bet against SPX or Nasdaq in the face of gigantic amounts of monetary and fiscal stimulus.”  However, I thought NFIB optimism might push towards 90. It didn’t, coming out stronger than expected 100.6.  I also though congressional dithering on an extension of benefits would cast a negative pall on the markets.  It didn’t.  Therefore, the ES end-of-month July 3000/2750/2500 put fly which I touted for 14.0 settled 5.95.  I suppose that means the USU 175/172 put spread for 21 worked out then, right?  Not really, it settled 17.  But the inflationary push from the Fed should work to weaken the long end further.   

Volumes have been light.  Treasury vol is near historic lows.  Gold and silver are breaking out to the upside.  The dollar index closed the week below 96, poised to make a run for the March crisis low of 94.65.  As the dollar declines, a lot of assets priced in dollars rise.      

UST 2Y15.314.3-1.0
UST 5Y29.627.9-1.7
UST 10Y63.262.5-0.7
UST 30Y132.3132.70.4
GERM 2Y-68.9-66.42.5
GERM 10Y-46.5-44.71.8
JPN 30Y55.657.92.3
EURO$ U0/U1-8.0-7.50.5
EURO$ U1/U25.54.0-1.5
EURO$ U2/U314.513.0-1.5
CRUDE (active)40.7640.75-0.01

Posted on July 18, 2020 at 9:14 am by alexmanzara · Permalink
In: Eurodollar Options

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