The Five-Tool Bond Market

By Danielle DiMartino Booth

The Five-Tool Bond Market, Danielle DiMartino Booth, Money STrong

Willie Mays, Duke Snider and Ken Griffey, Jr.

It’s no secret that these bigger than life baseball players are all Hall of Fame legends. But what about Mike Trout of the Los Angeles Angels? Or the Pittsburgh Pirates’ Andrew McCutchen or Carlos Gomez of the Texas Rangers? What do all six of these greats have in common?

If you guessed that none of them were pitchers, you would definitely be on to something. If you’ve really been doing your homework in the preseason, you would patiently explain that all six were “complete ballplayers,” with above-average capabilities in hitting, hitting for power, fielding, throwing and running. If you wanted to show off, you could elaborate that each has at least three qualified recorded data points in one season in each of the five areas rendering them “five-tool players.” These are the well-rounded players of field scouts’ dreams.

The idea of this quintessential, albeit exceedingly rare player, harkens to another picture of perfection – the bond market. After peaking above 15 percent in 1981, the yield on the benchmark 10-year U.S. Treasury fell in July of last year to a record low of 1.36 percent. That there is what we call the rally of a lifetime. A major contributor to the mountains of wealth that bonds have generated include the venerable inflation-fighting of one Paul Volcker. The three subsequent boom and bust cycles, largely engineered by Volcker’s successors at the Federal Reserve, each made their own contribution and brought greater and greater degrees of intervention to bear on the market and helped push yields lower and lower. In bondland, that translates to prices soaring higher and higher.

Over the years, the castigators were cast aside time and again. As for the few with steel constitutions, who quickly drew parallels between Japan’s intrusions and those of the Federal Reserve, let’s just say they can retire and rest in peace. They bought 30-year Treasury Strips and buried them, giving new meaning to the beauty of buy and hold. To keep the analogy alive, let’s say that at that juncture, the bond market was a four-tool player.

But then suddenly, last summer, something gave way.

Since July, the conventional wisdom has held that bond yields have finally troughed, bringing a denouement to the 35-year bull run. Of course, those comprising the consensus collided in arriving at their conclusions.

Market technicians, aka the chart-meisters, provide the simplest explanation. In 2016, the 10-year yield sunk below 2015’s low of 1.64 percent and rose above its high of 2.50 percent. Technicians refer to such boomerang behavior in short spaces of time as “outside events” that mark the beginning of the end of a cycle.

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Upending the Fed: The Administration Redemption

By Danielle DiMartino Booth

Danielle Dimartino Booth, Money Strong, The Administration Redemption

“Remember Red, hope is a good thing, maybe the best of things, and no good thing ever dies.” 

Wiser words were never spoken on the big screen than those of The Shawshank Redemption’s main character Andy Dufrense. We are none of us beyond redemption, so we are taught by this banker from Maine, even when we are punished for crimes we did not commit. In briefly researching the movie, one comes to learn that it is based on Stephen King’s 1982 novella Rita Hayworth and Shawshank Redemption. No doubt, Hayworth’s role in the movie stands out in all our minds, which is saying something as the superstar was no longer with us.

Dig deeper and you learn that King’s longer than a short story, but shorter than a novel, was part of a series called, Different Seasons, subtitled Hope Springs Eternal. How reassuring if enigmatic. More perplexing still is this master of the horror genre’s inspiration — Leo Tolstoy’s God Sees the Truth, But Waits. It would seem that Carrie has met Anna Karenina.

Clearly, it’s easier to judge those who write books by their most famous covers. But why not set such preconceived notions aside. You too can bask in King’s gorgeous prose from Shawshank and even Tolstoy’s beautiful words of inspiration: “If you want to be happy, be.” And redemption: “Everyone thinks of changing the world, but no one thinks of changing himself.”

These words resonate so against the backdrop of a country that remains intent on fomenting division, on splitting itself at the seams, bent on self-destruction. Perhaps it will have to come down to one man and his ability to change himself, to draw in more than his avid followers but his doubters as well.

For yours truly, it has thus been curious, nay fascinating that on matters of the Federal Reserve one Donald J. Trump has been silent as a mouse whose paws cannot bang out 140-character rants. Perhaps, just maybe, he is busy doing late night reading on the foundations of this venerable institution. If that’s the case, maybe he came across this little gem that was passed along recently:

“In selecting the members of the Board, not more than one of whom shall be selected from any one Federal Reserve district, the President shall have due regard to a fair representation of the financial, agricultural, industrial, and commercial interests, and geographical divisions of the country.”

Maybe that’s why the media has begun to dispense with the labels “hawk” and “dove” and is beginning to replace the aviary with simple human beings who have been there and done that, who have been on the receiving end of Fed policy for their entire careers. Take this from Kate Davidson at the Wall Street Journal:

“After his campaign criticism of the central bank’s low-interest-rate policies, many observers speculated he would seek more “hawkish” candidates who would favor higher borrowing costs. But his choices may be driven less by these issues and more by their practical experience, judging from his early picks for other top economic policy posts in the administration—drawn from investment banking, private equity and business—and the pool of early contenders for the Fed jobs.” 

Meanwhile, the Financial Times’ Gavyn Davies had this to say:

“The last four Fed Chairs have all been clearly on the economist side of the line, and because they have all bought into the Fed’s economic orthodoxy, their actions have been considered somewhat predictable by the markets. A business person or banker might be less predictable, at least initially, and more prone to shake up the Fed’s orthodoxies, for good or ill.”

With deference to Mr. Davies, there can be no ‘for ill’ in shaking up the Fed’s orthodoxies, if you can call them that. Orthodoxy, from the Greek word orthodoxia, implies officials are cleaving to a correct creed. But what if policymaking has devolved from correct to simply accepted?

That would imply a good dose of heterodoxy, also Greek from heterodoxos, was in order, as in a departure from the official position. To be crystal clear, heterodoxy does not equate to heretical, from the Greek hairetikos, (pardon the digression but who gave the Greeks a monopoly on multisyllabic, cool words?). Even so, a bit of heresy would also do the Fed a world of wonders. The literal Greek translation means ‘able to choose.’

A recent study determined the study of economics in academia had itself become incestuous with a great preponderance of students being trained in the same school of thought. This determination was not only disturbing and dangerous, it demands politicians introduce a bit of heresy into our nation’s central bank.

Perhaps President Trump, his administration and all members of Congress should sit down for a tutorial on Heterodox Economics (nope, not making that one up), which refers to schools of economic thought which fall outside of mainstream — read Keynesian – economics, which is predictably referred to as orthodox economics. Maybe, just maybe, it’s high time a variety of schools are incorporated, as in the post-Keynesian, Georgist, social, behavioral and dare say, Austrian approaches.

That last one, the Von Mises-inspired Austrian school of economics is apparently public enemy number one. The FT’s Davies goes on to warn that some candidates up for those open and opening positions on the Fed’s Board of Governors are ‘Austrian’ economists, a school that has apparently influenced Vice President Pence. An “Austrian” candidate would certainly alarm the markets.”

Davies has apparently done his homework. Back in 2010, one Mike Pence was serving in Congress as a representative of Indiana. In response to the Fed’s insistence on launching a second round of asset purchases, which the markets adoringly embraced as QE2, he blasted back that, “Printing money is no substitute for pro-growth fiscal policy.”

Pence’s words certainly ring Austrian, as the school considers malinvestment to be a menace, as well any rational person would. Malinvestment (we can finally score one for the Latins!) is defined as a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses.

And we wonder why we’ve had such a long run of jobless recoveries that happens to coincide with the post-Greenspan era. Why would the markets abhor an Austrian? Clearly, we would not have starved productivity by overbuilding residential real estate in the years prior to the crisis. Nor would companies have gorged on record share buybacks in the years that followed. Agreed, these phenomena juiced returns. But to what end aside from protecting the legacy of the mythological ‘wealth effect’?

As my dear friend Peter Boockvar wrote of the wealth effect in response to the Fed’s meeting minutes from its January meeting: “The concept, invented by Alan Greenspan, and carried on by Mr. Bernanke and Mrs. Yellen, is the unspoken third mandate of the Fed. Well Fed, you certainly got what you wanted in terms of a dramatic rise in asset prices over the past 8 years (just look at the value of equities relative to the underlying US economy) but a wealth effect did not happen if the pace of personal spending in this expansion is any indication. For many, it’s the wages they earn and the savings they keep that drive spending decisions, not the value of their stock portfolios.”

For taxpayers’ money, because they will pay in the end, it would seem we need Peter to fill one of those vacancies on the Fed’s Board. Just sayin’. Would the man who coined the term, ‘monetary constipation’ to describe the, “constant hemming and hawing over a rate hike…even in the face of a world that clearly changed on November 8th  and as we approach the 8th  year of this expansion.”

President Trump, can you hear Peter?? This is not the time to be obtuse. This is the time to bring back the good things in life, beginning with the best – hope. Dig as deep as you can and ask yourself some probing questions. Can you stand up to the orthodoxy that’s robbed the business cycle of its very cyclicality? Are you man enough to populate the Fed with leaders who are so strong there’s no need to audit the out-of-control institution? Pray God, does Mike Pence have your ear? You may be a debt kind of a guy, you’ve said so yourself. But you’re also beholden to no one and have a once-in-a-century opportunity to reshape the world’s most powerful central bank and in doing so safeguard the sanctity of the U.S. dollar.

As Andy Dufrense explained to us all, “I guess it comes down to a simple choice, really. Get busy living or get busy dying.” It’s time we got back to the business of living in this country, every single one of us. Who are we to question if it takes a heretic to get us back to where we need to be?

Fed Up: Culture Shock

By Danielle DiMartino Booth

“If it were possible to take interest rates into negative territory, I would be voting for that.”

— Janet Yellen, February 2010

Photo Credit: Howie Le

As her fame has grown, Janet Yellen is recognized in restaurants and airports around the world. But her world has narrowed. Because the Fed chairman can so easily move markets with a few casual words, Yellen can’t get together regularly and shoot the breeze with businesspeople or analysts who follow the Fed for a living. She must rely on her instincts, her Keynesian training, and the MIT Mafia.

“You can’t think about what is happening in the economy constructively, from a policy standpoint, unless you have some theoretical paradigm in mind,” Yellen had told Lemann of the New Yorker in 2014.

One of Lemann’s final observations: “The Fed, not the Treasury or the White House or Congress, is now the primary economic policymaker in the United States, and therefore the world.”

But what if Yellen’s theoretical paradigm is dead wrong?

The woman who “did not see and did not appreciate what the risks were with securitization, the credit rating agencies, the shadow banking system, the SIVs . . . until it happened” has led us straight into an abyss.

It’s time to climb out. The Federal Reserve’s leadership must come to grips with its role in creating the extraordinary circumstances in which it now finds itself. It must embrace reforms to regain its credibility.

Even Fedwire finally admitted in August 2016 that the Federal Reserve had lost its mojo, with a story headlined “Years of Fed Missteps Fueled Disillusion with the Economy and Washington.” In an effort to explain rising extremism in American politics in a series called “The Great Unraveling,” Jon Hilsenrath described a Fed confronting “hardened public skepticism and growing self- doubt.”

Mistakes by the Fed included missing the housing bubble and financial crisis, being “blinded” to the slowdown in the growth of worker productivity, and failing to anticipate how inflation behaved in regard to the job market. The Fed’s economic projections of GDP and how fast the economy would grow were wrong time and again.

Continue reading Fed Up: Culture Shock

Slapped in the Face by the Invisible Hand

By Danielle DiMartino Booth

Slapped, Danielle Dimartino Booth, Fed Up: An Insider's Guide to why the Federal Reserve is Bad for AmericaFor those of you who subscribe to the Wall Street Journal, please link on to today’s story on the book: A teaser in the form of a quote from Richard Fisher who the Journal interviewed for the article. “The book’s greatest value is in describing ‘the hubris of Ph.D. economists who’ve never worked on the Street or in the City, as well as flagging the protected culture of Fed officials in Washington. Many central bankers are, ‘not going to like the book.”

Former Fed Staffer Says Central Bank Is Under the Thumb of Academics, Wall Street Journal

Not that Mr. Fisher asked for an answer. But to those who ‘don’t like it,’ I say, “So be it.” With that, please enjoy an excerpt from Fed Up, Chapter 11: Slapped in the Face by the Invisible Hand.


You want to put out the fire first and then worry about the fire code.”  — Ben Bernanke, December 1, 2008

Among the economists at the Dallas Fed, Bernanke’s optimism prevailed. The Bear Stearns rescue was the punctuation mark that ended the paragraph. Bernanke would trim the sails to right the foundering ship.

I disagreed. The demise of the Bear was a flashing red light that shouted “danger.” My colleagues rolled their eyes.

Rosenblum treated me with a new respect. The chain of events was playing out as I had predicted. He and I began collaborating on a paper on moral hazard. It would make Rosenblum no fans at the Board of Governors.

The bailout both relieved and alarmed the financial press.

The Economist wrote that the Fed was “taking the unprecedented (and, some say, disturbing) step of financing up to $30 billion of Bear’s weakest assets. This could cost the central bank several billion dollars if those assets fall in value.”

The fear of the unknown prompted the Fed, for the first time ever, to extend lending at its discount window to all bond dealers.

Under previous rules, only institutions offering depository insurance or under strict regulatory oversight were allowed to use the discount window, paying a penalty fee for the privilege. Now any distressed investment bank, broker, or commercial bank was allowed to come, hat in hand, to use the window.

The Economist expressed skepticism at this development, saying that fear persisted because the “new Fed window is untested and the very act of drawing on it could rattle markets.” No bank wanted to be perceived as the next sick buffalo.

Continue reading Slapped in the Face by the Invisible Hand

The Yield Curve is Critical of Fed Credibility

By Michael Ashton

If your forecasts are frequently wrong, it is important to shut up and stop trying to move markets where you want them with “open mouth” operations

I was planning to write an article about the shape of the yield curve. Since the Global Financial Crisis, the Treasury curve has been very steep – in early 2010 the 2y/10y spread reached almost 300bps, which is not only unprecedented in absolute terms but especially in relative terms: a 300bp spread when 2-year yields are below 1% is much more significant than a 300bp spread when 2-year yields are at 10%.

2s10s

But what I had planned to write about was the phenomenon – well-known when I was a cub interest-rate strategist – that the yield curve steepens in rallies and flattens in selloffs. The chart below shows this tendency. The 5-year yield is on the left axis and inverted high-to-low. The 2y/10y spread is on the right axis. Note that there is substantial co-movement for the recession of the early 1990s, throughout the ensuing expansion (albeit with a general drift to lower yields), in the recession of the early 2000s, the ensuing expansion, and the lead-up to the GFC.

and5yyields

I was ready to point out that the steepening and flattening trends tend to be steady, and I was going to illustrate that they feed on themselves partly for this technical reason: that when the curve is steep, steepening trades (selling 10-year notes and buying duration-weighted 2-year notes, financing both in repo) tend to be positive carry and therefore easier to maintain, while on the other hand when the curve is flat the opposite tends to be true. So the actual causality of the relationship between steepening and rallies is more complex than it seems at first blush.

It would have made a very good article, but then I noticed that since 2010 or so the tendency has in fact reversed!

Specifically, from 1987-1995 the correlation of the level of the 5-year spread to the level of the 2s/10s spread was -0.78. From 1995-1999, the correlation flipped to +0.48 (but I didn’t bother to de-trend the data and I suspect that correlation stems more from the strong, 350bp decline in interest rates from 1995-1999). From 1999-2009, the correlation was -0.81. Since 2010, the correlation is +0.60: the curve has tended to flatten in rallies and steepen in selloffs. And, in the recent bond market selloff, the curve steepened as long rates rose further than short rates.

This is interesting. Clearly, carry dynamics cannot explain why the relationship is inverted. I think the answer, though, is this: since 2010, the overnight has been anchored. That isn’t different than in the past – from late 1992 to early 1994, the Fed funds target was anchored at 3%. But the difference is that back then, traders acted as if the Fed might eventually move the overnight rate in a meaningful way. Since 2010, investors and traders have attributed no credibility to the Fed, with virtually no chance of a substantial move over a short period of time. Accordingly, while short interest rates historically have tended to be the tail wagging the dog, while longer-term interest rates move around less as investors assume the Fed will remain ahead of the curve and keep longer-term inflation and interest rates in a reasonable range…in the current case, short term rates don’t move while longer-term rates reflect the market belief that rates will eventually reach an equilibrium but over a much longer period than 2 years as the Federal Reserve is dragged kicking and screaming.

I happen to agree, but it isn’t a great sign. I suppose it was destined, in a way – “open mouth” operations can only work in the long run if the Fed is credible, and the Fed can only be credible in the long run if it delivers on its promises. But it hasn’t. This is probably because the Fed’s forecast have been worse than abysmal, meaning its promises were based on bad forecasts. In such a case, changing one’s mind when the data changes is the right thing to do. But even more important, if your forecasts are frequently wrong, is to shut up and stop trying to move markets where you want them with “open mouth” operations. I have said it for 20 years: the worst thing Greenspan ever did was to make “transparency” a goal of the Fed. They’re just not good enough at what they do to make their activities transparent…at least, if they want to maintain credibility.

Administrative Note: On Monday I will be conducting the third and final in a series of webinars on inflation and inflation investing. This series will be done on the Shindig platform, sponsored by Enduring Investments, in cooperation with Investing.com. This webinar is on “Inflation-Aware Investing.” You can sign up directly with Shindig here, or find the webinar link at Investing.com.

Fischer Says Fed Needs Help Regarding Low-Rate Risks

By Chris Ciovacco

What Message Was Embedded In Fischer’s Entire Speech?

Human beings tend to look for data that supports their personal bias. This concept applies to interpreting information coming from the Federal Reserve. It would be easy to find portions of Vice Chairman Stanley Fischer’s remarks that support the case for raising rates as well as the case for holding rates steady for the remainder of 2016.

Fischer Says Low Rates Are Concerning

In Monday’s speech, Fischer enumerated concerns that are tied to an extended period of near-zero interest rates:

There are at least three reasons why we should be concerned about such low interest rates. First, and most worrying, is the possibility that low long-term interest rates are a signal that the economy’s long-run growth prospects are dim.

A second concern is that low interest rates make the economy more vulnerable to adverse shocks that can put it in a recession.

And the third concern is that low interest rates may also threaten financial stability as some investors reach for yield and compressed net interest margins make it harder for some financial institutions to build up capital buffers.

Does It Imply The Fed Needs To Hike Rates?

If the Fed Vice Chair comes out and says there are serious concerns about having low interest rates for an extended period of time, then it is logical to imply the Fed’s Vice Chair is in favor of hiking rates in December. However, the text of Fischer’s speech makes it clear that it is not that easy:

Now, I am sure that the reaction of many of you may be, “Well, if you and your Fed colleagues dislike low interest rates, why not just go ahead and raise them? You are the Federal Reserve, after all.” One of my goals today is to convince you that it is not that simple, and that changes in factors over which the Federal Reserve has little influence–such as technological innovation and demographics–are important factors contributing to both short- and long-term interest rates being so low at present.

Some Areas Are Outside Of The Fed’s Control

If Fischer believes successfully pushing interest rates higher is not as “simple” as the Fed hiking rates, what areas did he focus on during Monday’s speech? Excerpts from his prepared remarks provide some insight:

What might contribute to raising longer-run equilibrium interest rates?

  1. An improvement in animal spirits
  2. Expansionary fiscal policy (examples: boost government spending by 1 percent of GDP or cuts taxes by a similar amount.)

In summary, a variety of factors have been holding down interest rates and may continue to do so for some time. But economic policy can help offset the forces driving down longer-run equilibrium interest rates. Some of these policies may also help boost the economy’s growth potential.

Fed Desperately Wants Higher Rates

With rates near zero, central bankers are probably not sleeping very well given the limited ammunition they have to fight the next recession. The Fed wants to raise rates to put some bullets back in their chamber, but they don’t want to push the economy into a recession via an ill-timed rate hike. Based partly on the fear of hiking too soon, Janet Yellen’s remarks last Friday contained an easy to discern dovish tone. Fischer’s speech basically asked for fiscal help from Congress, something that has been absent for quite some time.

Stock Market Maintains Indecisive Stance

An October 12 article contained four charts outlining some key areas for the stock market. An updated version of one of the charts is shown below. Early in Tuesday’s session, the S&P 500 remained above several “we will learn something either way” levels.

Passive Investors Unite: We Blind Mice

By Daniel DiMartino Booth

Passive Investors Unite: We Blind Mice

Throughout man’s bloody history of conflict, time and again it is the hand defending the faith that lights a fuse. Is this because, by its very nature, faith is blind and can only promise abundant spiritual rewards for the here and now, while saving its true rewards to bestow in the afterlife? Does it take the strength of a warrior to defend and die for it? Name a faith and you are sure to encounter a struggle.

The Protestant Reformation certainly had its fair share of strife. In 1517, Martin Luther, angered by the selling of indulgences, pounded his 95 theses on a chapel door. Aided by the advent of the printing press, he began spreading the word and paving the path to Protestantism. He could never have guessed that less than a century later, the defense of his faith would spawn ghastly nursery rhymes that were anything but spiritual.

One of those rhymes is the well-known, but perhaps not deeply pondered, Three Blind Mice of so many a nursery setting. Before Queen ‘Bloody’ Mary I inspired that spicy drink with a side of celery to be concocted in her gory memory, she stirred 17th century nannies to seemingly innocent singalongs. Written in 1609, the mice are said to represent three loyalist Protestant noblemen or bishops, depending on history’s recollection, who dared to question the Papist queen’s mental state and thus attempt her overthrow. The farmer’s wife in the nursery rhyme was of course the queen who with her husband, King Philip of Spain, owned many large arable estates. Being less than amused by the Protestant’s fervor, the farmer’s wife chose for their demise not a knife, but a burning stake. From whence, we must ask, does blindness enter the unseen picture? Historians suggest the author to have been a crypto-Catholic alluding to the inherent blindness of Protestantism’s proselytes. Clever indeed.

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The QE Premium

By Michael Lebowitz, CFA

Equity valuations are grossly dislocated from supporting fundamental data

It has been eight years since the great financial crisis of 2008, and the Federal Reserve (Fed) is still maintaining an unprecedented level of accommodation in monetary policy. The Federal Funds rate has been pinned at or near zero since 2008. Recent discussions on raising the rate a mere quarter of a percent are met with a palpable level of angst and incredulity by economists and investors alike. Since the crisis, the Fed quadrupled their balance sheet using printed money to buy U.S. Treasury and mortgage securities. The economic results, supposedly the justification for these aggressive actions, have mostly been disappointing. That said, one can credit Fed policy actions for driving financial asset valuations to historic levels.

Over the last eight years investors have adopted a mindset that Fed intervention is good for asset prices, despite clear evidence that it has contributed little to the fundamental rationale for owning such assets.  Fixed income yields are at or near record lows and stock indices trade at valuations that have only been eclipsed twice in history, just prior to the great depression (1929) and at the height of the technology bubble (2000). High end real-estate and various collectables trade at unparalleled levels. The eye-popping valuations on these less liquid assets further confirm how impactful Fed policy has been on asset prices.

We have written numerous articles highlighting rich valuations and the infectious behavior that can compel investors to make investment decisions that they would not otherwise make.  In this article we employ a cash flow model to quantify the potential ramifications on the equity market. The goal is to provide investors with a simple tool to calculate total return outcomes that could occur if investors were to lose confidence in the Fed and as a result stretched market valuation premiums built up since 2008 diminish or vanish altogether.

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