As rising Taper (and QE unwind) uncertainty, the biggest trade driving the rate complex, and by implication, the entire risk complex, is being put (no pun intended) to rest. As BofA explains: "the FOMC (the biggest buyer of duration and convexity risk in the world) is long the option to taper asset purchases (and eventually raise rates) if the data improves. That leaves the market short the option that the Fed may decide to taper. The market has looked to hedge this “short gamma” exposure by selling duration and buying vol."
"The latest numbers that we have received, in particular from Germany, are encouraging, whether it's manufacturing, whether it's service activity, whether it's exports. That is heading in the right direction, but it needs to be sustained over time. And I'm crossing fingers for the eurozone..."
The 10Y Treasury yield has jumped nearly 130bp from its low point in early May. Given the tight ranges and low volatility of yields during the most of QE era, this kind of move in just over 3 months seemed stunning to some investors. Consequently, the question that has come up often recently is: what has been driving Treasury yields? As UBS' Boris Rjavinski notes, several years ago a rate strategist would give you a straightforward and predictable answer: inflationary expectations, economic growth projections, and current and future monetary policy. But now, as Rjavinksi notes, central banks and politics in the driver seat. Volatility will remain elevated as we await key messages from the Fed in September, and U.S. political calendar will start to heat up as we approach the “drop-dead” dates to fund the government and extent the dent ceiling.
The challenge to the world's credit cycle comes from both ends. An increasingly sluggish growth outlook creates downward pressures on earnings and internal cash generation. The slowdown is fairly widespread. In addition, the cost of funding is on the rise. Downside skews begin to emerge in the later stages of a cycle when leverage has already increased and the cycle turns more adverse, and that is happening in Asia right now. This is critical in our current benign default environment because the combination of highly leveraged firms, slowing GDP and rising real rates was exactly what created the spike in defaults in 2007-2009 (that only the largest monetary policy bailout in history was capable of kicking down the road).
In spite of the prime-dealers seeming agreement that SepTaper is most likely; judging by the plethora of talking-heads and research pieces hitting in the last few days, the idea that a Taper was a good thing (Tepper) and in fact indicates 'health' appears to be on the back-burner as almost every sell-side shop is out with a discussion of just how potentially bad things are macro-economically and that a taper should be off the table. Below is BofAML's Ethan Harris' seven reasons to delay the taper following today's "punch in the stomach for the economic recovery story" (and our 4 reasons why they can't or won't).
Jackson Hole Presenter Warns: "Bottom Could Fall Out Of The Economy As It Did In The Great Depression"Submitted by Tyler Durden on 08/23/2013 12:49 -0400
"So far, inflation has fallen only slightly and remains in positive territory. Fears in early 2009 that rapid deflation might break out and cause the economy to collapse as in 1929 to 1933 proved unfounded, luckily. I have advanced the hypothesis that rampant price-cutting has failed to appear because businesses are in equilibrium and perceive that price-cutting has bigger costs than benefits. If the hypothesis is wrong and businesses are finally responding to five years of slack by cutting prices, the generally optimistic tone of this section could be quite mistaken. The bottom could fall out of the economy as it did in the Great Depression."
- Cease Treasury purchases;
- Sell Treasury portfolio;
- Sell older MBS;
- Cease new MBS purchases
From Indian leases to negative GOFOs, from Chinese physical demand to Western bank paper gold deleveraging, and from practical mining cost floors to the ongoing playing out of the grandest experiment of monetary policy in history; there are a plethora of drivers for the price of the precious metal. But, for now, the only thing that counts is the 100-day moving average as gold prints its first positive closing breakout of 2013.
The world of Industrial Design is often useful to assess everything from the Federal Reserve's current monetary policy to equity market structure (particularly timely given today's total SNAFU) to the timeless debate over the real value of gold. As ConvergEx's Nick Colas reminds, good design is innovative, useful, aesthetically pleasing, honest and durable, whether those attributes relate to a new electronic gadget or any 'Product' in the world of high finance or economics. Examples of "Good design" include stocks, bonds, and options – all simple, durable constructs. "Bad design" would be the Fed’s "Taper" and current equity market structure.
While we found it modestly comedic (and certainly ironic) that CNBC's crack team celebrated the recovery from the initial knee-jerk drop in stocks after the FOMC by top-ticking that suspension of reality; we suspect the following post-mortem from Goldman on the minutes is what confirmed concerns across the street... "Minutes from the July 30-31 FOMC meeting were generally consistent with our view that tapering of asset purchases is likely to occur at the September meeting, coincident with an enhancement of the forward guidance."
While some read the FOMC statement in July as more 'dovish' than expected - even though the market's performance since suggests otherwise -, it appears the actual conversations from the minutes point in a more 'Taper'-on direction (though clearly uncertainty remains high):
- *A FEW ON FOMC URGED PATIENCE, OTHERS FAVORED QE TAPERING SOON
- *FOMC MINUTES SHOW BROAD SUPPORT FOR BERNANKE TAPERING TIMELINE
- *FOMC PARTICPANTS SAID SEQUESTRATION 'CLOUDED THE OUTLOOK'
- *FOMC PARTICIPANTS PREDICTED GDP TO PICK UP IN 2ND HALF 2013
- *ALMOST ALL FOMC PARTICIPANTS BACKED 'CONTINGENT OUTLOOK' FOR QE
- *FOMC SAID JUNE PAYROLL REPORT SHOWED 'CONTINUED SOLID GAINS'
Pre-minutes: S&P (Fut) 1646, 10Y 2.8125%, USD 81.2, WTI $104.11, Gold $1371
The July FOMC statement was a bit more dovish than expected, including (1) an explicit reference to the risks posed by higher mortgage rates, (2) more dovish language on below-target inflation, and (3) a statement that the Committee "reaffirmed its view" that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends. We will read the minutes from the July meeting with an eye toward any clues on the likelihood of near-term tapering and potential changes to the forward guidance.
There is still no official public schedule for the Kansas City Fed's annual Jackson Hole Economic Symposium, anticipated to begin on Thursday. However, as we noted previously, the schedule will not include a keynote address from a high-ranking Federal Reserve official. Furthermore, as Goldman notes, in contrast to tradition, Chairman Bernanke will not be in attendance (Yellen will but Summer won't). However, Jackson Hole has historically been an event where the latest thinking on monetary policy has been debated by academics and central bankers, and this year will be no different. Perhaps, Goldman points out, most interestingly, some of the research to be presented finds that MBS purchases had a disproportionate effect on depressing MBS yields, while Treasury purchases did not seem to have a similar benefit - perhaps hinting at the form the 'taper' will take.
The Rupee has taken a severe hammering and has lost 44% of its value in the past two years. It was at its lowest point yesterday against the Dollar.
The current belief is that rising interest rates are a sign that the economy is improving as activity is pushing borrowing rates higher. In turn, as investors, this bodes well for corporate profitability which supports the current valuations of stocks in the market. While this seems completely logical the question is whether, or not, this is really the case? Increases in interest rates slow economic activity, with a lag effect, which negatively impacts earnings, margins and forward guidance. Ultimately, and it may take several quarters to manifest itself fully, the fundamental deterioration leads to a reversion in stock market prices which, ironically, will then lead to the next decline in rates.