An Unhealthy Obsession

The Federal Reserve now spends over 1/3 of its time talking about financial markets in the minutes. That’s more than trade, monetary policy & employment combined.
This unhealthy obsession has become a distraction – and it’s leading financial markets down a dangerous path.

Currency Krav Maga

There’s been a lot of discussion recently about $ strength preventing risk assets from making new highs. I don’t dispute the fact – it’s pretty obvious that we’re losing badly in the battle for competitive devaluation that global central banks have embarked upon. But it's even worse than the headlines might suggest.

To refer to this as a “USD bull market” is not correct. As others have correctly pointed out: it’s a bear market for $ funders. Typically, we’d see this manifest in overnight repo rates, but that’s not really happening. We might also see this show up in LIBOR/OIS spreads (and cross-currency basis) & it has, but to a fairly limited extent.

Where this is showing up instead is in FX forwards. In times of trade war, this is currency krav maga - the art of self-defense.

"Impossible" Events are on the Rise

A 4-sigma event would be expected to happen once or twice in a trading lifetime - according to the most popular VaR-based risk models. We’ve seen 10 of those this month in Treasuries. What we should have learned from the GFC has been all but forgotten. What the market had considered to be impossibilities (or at least highly unlikely...) is quickly becoming the norm.

5 Things Every Trader Needs to Know About Rates

From what’s priced in to curve inversion to term premium. Here are the 5 things every trader needs to know about the rates market…

Updated 11:41am EST

Tidal Forces & Financial Markets

There's a pattern & predictability to tides that make them easy to forecast. But, on very long timescales, that doesn't mean they are constant by any measure. At a celestial level, the amount of force produced depends on the mass of the objects involved, the distance, the eccentricity of the orbits, and the radius of the bodies - for starters. The push & pull that's observed in financial markets is analogous: different assets exhibit similar ebb & flow as correlations oscillate. Trough to crest to trough to crest...

Odds of another 100bps or more this year? 1 in 5.

I mentioned this morning that the options market was beginning to make some pretty exceptional progress on the way to pricing in 50bps+ at the September meeting. What's even more significant, in my mind, is what the market has done to the odds of additional easing in 2019. We're now 1 in 5 odds that the Fed delivers an additional 100bps by year-end.

Drug Addiction & the Stock-Bond Feedback Loop

Over the past month, the bond market has seesawed between paroxysmal rallies & emetic sell-offs. In between, however, an overall placid composure has taken hold: arguably due less to complacence & more to trauma as investors prepare for the next bout of volatility. While there's little disagreement about the role that policymakers have played, what's fascinating is the degree to which so much of the recovery in risk assets is due solely to the promise of more imminent easing, as opposed to any improving fundamental picture. It's an addiction - and the time for intervention is long gone.

Let's be clear on one thing: the equity market has only managed meaningful recoveries when the odds of Fed easing are on the rise. Not the other way around. 

Yes, We are Pricing Odds of an Emergency Cut

At its most extreme this morning, I'd estimate the mkt was pricing in almost 10% probability of a 25bp cut by the Fed tomorrow. How do I figure? It's based on FFQ9 (August Fed Funds futures).

WARNING: This will involve some basic math.

Cut Odds Rising

As it stands this morning, options market-implied odds of the Fed cutting by at least another 125bps by year-end are about 1 in 4.

Since Wednesday’s close, the odds of the Fed cutting by at least another 75bps by year-end have roughly doubled. As it stands this morning, the Eurodollar options-implied odds (fitted to the FF curve & fwd FRA/OIS spreads) of a) the Fed only cutting once more by 25bps in September or, b) the Fed cutting rates by at least another 75bps are about equal.

Market-implied odds using the Eurodollar options surface, fitted Fed Funds curve & fwd FRA/OIS spreads.

From the Vasty Deep

GLENDOWER: I can call spirits from the vasty deep.
HOTSPUR: Why, so can I, or so can any man - but will they come…?

Such has been the dilemma faced by the central banking community, increasingly so: policy officials have the same apparent ability as Shakespeare’s Glendower (based on one Owain Glyndŵr, the last native Welshman to hold the title of “Prince of Wales”), yet the characteristic response from markets has been just as capricious as Hotspur’s retort suggests: just because you say it's easing doesn't necessarily make it so...

Fiat policy is successful not by virtue of the exhortation, but by manifestation of that which has been prescribed. It’s one thing to say you’re easing, quite another to convince markets of it.

Owen Glyndŵr of Wales, Fiat Policy Pioneer

The difference, perhaps, is that while the character in Henry IV seems to have genuinely “believ’d the magic wonders which he sang”, central bankers should be more acutely aware of the wide gulf between saying & doing. Indeed, the pragmatic response has been to join edict with act to the point that we now have policy prescription written in no uncertain terms (“yield curve control”). 

On the threshold now of the first rate cut by the Federal Reserve since 2008, this question has to be even more vexing for those about to do the cutting. At this point, is a 25bp cut alone enough to “ease”? The simple answer is no.