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Interested Rates

3 Jun

The most recent backup in rates across the long end of the U.S. Treasury curve has prompted much speculation as to the exact cause. The general group -think credits the strength in the U.S. economy, particularly the housing market, as the most likely culprit. However, we would argue that the sharp rise in yields that we have experienced over the past several weeks have really been driven more by the Fed’s ambiguous comments as to the ultimate disposition of their burdensome balance sheet.  Chairman Bernanke’s May 22nd testimony was particularly troublesome to the Treasury Market, as it introduced the possibility that the Fed reserves the right to resurrect QE at any time should conditions warrant, even in the event that near term tapering might be soon forthcoming. The subtle message to the market was ‘ we may take away the punch bowl, but at the slightest hint of  market DT’s, that punch bowl will be right back’. While the stock market enjoyed  such overt support for market “calm”, the Treasury Market seemed to convulse at the message sent  by a Central Bank so seemingly obsessed with healthy ( a.k.a. rising) capital markets. We recently spoke to the burgeoning credibility gap that the Fed is creating with such comments, and we believe that the rise in rates substantiates the Treasury Markets increasing distrust. Some in the gold market have commented that the movements in gold reflect an increasing/decreasing trust in fiat currencies. We would maintain that, much like Gold, interest rates are now becoming a barometer for the Treasury Markets view on the soundness/saneness of Central Bank policy.

What should happen doesn’t , What could happen might

23 May

We read this quote recently  from someone that covers the platinum industry in South Africa. This quote specifically referred to the cutbacks in production that producers were forced to rethink by the Government, in spite of economics which dictate that these, and other , cuts take place. Essentially, when looking at the platinum industry in South Africa, and elsewhere, any analysis is torn between the pragmatic and the dogmatic.  Government represents the dogmatic side, arguing for full employment, and a maximization of indigenous mineral rents. Industry, on the other hand, represents the pragmatists which emphasize profit and shareholder value maximization. In a perfectly capitalistic world, pragmatism would far surpass dogma, however it would appear that the environment in South Africa dictates otherwise. As we have discussed in earlier blogs, the capital markets have weighed in on how they view this particular battle playing out in South Africa.

This battle of dogma versus pragmatism got us thinking about the Fed and the effectiveness of the various QE’s. The dogmatic Fed believes that low interest rates are the single greatest cure for what ails the global economy. In their mind, low rates: drive asset prices which in turn drive spending which in turn ultimately drives employment gains. The pragmatic Fed also understands that, above all else, their greatest influence must be manifest in general psychology (business and investor). However, the pragmatic Fed  also probably understands that this influence is tenuous at best. Increasing amounts of the same medicine,  somewhat counter-intuitively, undermines their ability to continue to affect this psychology. This diminished influence will prove critical, particularly in the event of another  six sigma event ( you know, the ones we get every few years).

Risk On- More Risk On

21 May

We were waxing nostalgic recently for the bygone days of risk on-risk off. Our affinity for such periods does not stem from some kind of masochistic love for extreme volatility or a desire to feed our inner trader, but rather we miss the days when people actually gave some credence to the latent risks that still exist out there. While markets may ” climb a wall of worry”, todays’s markets prefer to leave the worrying to the Central Bankers and focus solely on the climbing part. It never ceases to amaze us how quickly perception changes in markets. It seemed like only yesterday we were dealing with a budgetary crisis which threatened to push us into another recession. However, today I read an analysis which argued that the Treasury  Market, and the economy,  should be able to withstand any Fed tapering given the shrinking budget deficits. While it is true that the sequestration has allowed both sides to make progress on the budget, it was only supposed to be a stop-gap measure designed to get both sides more actively engaged. In fact, Moodys just commented on the lack of real discussions, saying that the U.S. is risking another downgrade if no real progress is made on budgetary talks. While a downgrade may be irrelevant in a world where the Fed is the largest captive buyer, we assume that this will matter at some point to non- Central Bank buyers.  It is curious that the more voluminous the talk on deflation becomes, the more amped up the capital markets become. We wonder whether these same markets truly grasp what the ramifications of a deflationary spiral would mean,  particularly in the context of a still over-leveraged global economy.

Pay no attention to the man behind the curtain

16 May

This title really says it all when it comes to the recent action in capital markets. Market excess is not hard to find in any part of the capital markets as they exist today: high yield, government bonds, equities, leveraged loans, etc.. But, when it comes to Central Banks, the phrase ” ask and yee shall receive” has never been more true. However, just like the great and wonderful Oz, it is important that markets not delve too deeply behind the curtain because such exploration would suggest that the benefits of Central Bank actions have mostly been psychological in nature, with very little proven outcomes to date. We understand the talking points quite well, nearly 5 years into this grand experiment, Low rates: boost corporate profits, equity prices, perceived consumer wealth, spur hiring, etc.. However, this experiment in yield curve support, has morphed into a feeling by all investors in all disparate parts of the capital markets that the man behind the curtain has things covered. We were blown away by a recent article in the NYT in which Bernanke (remarking on the possible bubbles in todays environment) stated ” Microsoft ‘s stock is worth well more than it was some time ago, and it could still prove to be a bubble” He chooses Microsoft as an example? It is interesting to note that he did not use the high yield market as an example, particularly since spreads over treasuries are below where we were pre-2008. The Fed is de-facto encouraging not only a reach for yield, but a completely reckless reach for yield. No doubt, this type of behavior always ends badly, however in this latest episode the blame (as it should be) will be placed squarely on the Fed. Their ability to, once again, “save the day”  will be severely hampered under such a scenario. Forget the short term oriented deflationary chatter: BUY STUFF, SELL PAPER.

Timing is Everything

21 Mar

Our experience in asset management over the years has shown us, if nothing else, that the most recent market action sows the seeds of the next most likely counter trend. Thus, the “great moderation” led to something much more chaotic in the aftermath, permanently rising home prices led to an environment which virtually guaranteed prices would no longer maintain their stair step rise, and ever rising commodity prices led to unsustainable new production efforts which are now being written off. My point is that markets, built on human nature, assume that tomorrow will look much like today, when in reality the inverse tends to be more the norm. What implicit market assumptions are being priced into todays economic DNA.  1) Global rates will stay low as long as Central Banks are committed to such 2) Inflation is not a problem for the foreseeable future 3) Liquidity is abundant, particularly in public capital markets. 4) Global liquidity is not only central bank driven but central bank channeled. The challenge is to try and ascertain when these “truths” have simply become self-fulfilling prophecies, because  violent inflection points typically accompany such sudden realizations.