I'm late on this but it's worth thinking about. Post Bernanke-bashing at the Ira Sohn conference, JBL came out with one of the best pieces I've read in a while. What he essentially does is draw a contrast between two counter-parties with a common 'party' - the fund guys.
Of course, you know the backdrop to the London whale:
a) For while, he was more famous than Moby
b) He still ain't a patch on the real whale i.e: Moby Ben
So while the big funds may have finally sighed in relief as their counterparty could no longer continue (because naturally JP was seeing far too much red ink already), that logic doesn't apply to the Fed. And the way to go about this is to think along a more general line of thought and keep it simple.
If the treasury yield is reflected by the path of expected short term rates, inflationary expectations and the term premium, and the Fed shows no concrete signs of future QE moves then it's not entirely unreasonable to see why its easy to get attracted to the 'widowmaker'.
As JBL states, back in the late 90's toward the end of the Clintonia surpluses, the treasury bond traded between 5% and 7% while after the turn of the century, in a relatively much weaker economy, it hovered around the 4-5% mark. Hence the questions such as why was there a low-yield peak and why/when does it return to the 'fundamental'.
Cue Big Ben, printer of deposits, mass purchaser-in-chief of treasuries thus acting as chief culprit in pushing prices up well beyond 'fundamentals'. But here's where reason takes a short step out the window.
Rather than easing off, the buying persisted and fund managers made a very wrong comparison between the little whale and the big whale. While the little one was severely constrained due to obvious reasons, the big one should have been constrained by goals of financial stability and price stability. And just as the little one was answerable to Ina Drew and eventually Dimon, so should the big one have been....waitaminit...
Moby Ben answers to no one, and any dissent that he faces at the FOMC is not even worth writing home about relative to the broader consensus. While the CDX IG9 had a fundamental (the payouts of the bankruptcies times the probability of occurrence), the little whale could not alter the fundamental through his bets and positions.
And the key here is a healthy economy. Because in a healthy economy, the treasury has a fundamental. In a healthy economy, pricing power is partially determined by workers and the Fed's mandate is keeping inflation in check. Is this a healthy economy? No pricing power. Downward nominal wage rigidity. Unlimited market appetite for zero interest cash. Far from it.
Moreover, the Fed is not a profit-making enterprise. It's balance sheet stands at seeming odds with its goals. Unwinding positions and incurring portfolio losses is something the Fed will gladly take if it returns the economy to a steady and healthy state.
Now sure, it's logical to expect a rise in rates and you'd be well-off if you were a very patient investor. Use a crude Taylor rule (for example, the Mankiw rule) with an indicator of about 9.5 and you'll end up plotting an S-shaped curve picking up somewhere in the latter half of 2014.
And if you're screaming inflation and hyperinflation from every rooftop like a lot of people have over the past few years, then you might do well to read about the dog that never barked.
I don't know why exactly it's called the widowmaker but the real widowmaker is a coronary artery that is fatal if blocked.
The analogy seems dubious but still, shorting the bonds:
1) of a sovereign nation that
2) issues debt in not just a currency it controls
3) but a currency that acts as the global reserve currency
4) in a depressed economy
5) is foolish
Of course, you know the backdrop to the London whale:
a) For while, he was more famous than Moby
b) He still ain't a patch on the real whale i.e: Moby Ben
So while the big funds may have finally sighed in relief as their counterparty could no longer continue (because naturally JP was seeing far too much red ink already), that logic doesn't apply to the Fed. And the way to go about this is to think along a more general line of thought and keep it simple.
If the treasury yield is reflected by the path of expected short term rates, inflationary expectations and the term premium, and the Fed shows no concrete signs of future QE moves then it's not entirely unreasonable to see why its easy to get attracted to the 'widowmaker'.
As JBL states, back in the late 90's toward the end of the Clintonia surpluses, the treasury bond traded between 5% and 7% while after the turn of the century, in a relatively much weaker economy, it hovered around the 4-5% mark. Hence the questions such as why was there a low-yield peak and why/when does it return to the 'fundamental'.
Cue Big Ben, printer of deposits, mass purchaser-in-chief of treasuries thus acting as chief culprit in pushing prices up well beyond 'fundamentals'. But here's where reason takes a short step out the window.
Rather than easing off, the buying persisted and fund managers made a very wrong comparison between the little whale and the big whale. While the little one was severely constrained due to obvious reasons, the big one should have been constrained by goals of financial stability and price stability. And just as the little one was answerable to Ina Drew and eventually Dimon, so should the big one have been....waitaminit...
Moby Ben answers to no one, and any dissent that he faces at the FOMC is not even worth writing home about relative to the broader consensus. While the CDX IG9 had a fundamental (the payouts of the bankruptcies times the probability of occurrence), the little whale could not alter the fundamental through his bets and positions.
And the key here is a healthy economy. Because in a healthy economy, the treasury has a fundamental. In a healthy economy, pricing power is partially determined by workers and the Fed's mandate is keeping inflation in check. Is this a healthy economy? No pricing power. Downward nominal wage rigidity. Unlimited market appetite for zero interest cash. Far from it.
Moreover, the Fed is not a profit-making enterprise. It's balance sheet stands at seeming odds with its goals. Unwinding positions and incurring portfolio losses is something the Fed will gladly take if it returns the economy to a steady and healthy state.
Now sure, it's logical to expect a rise in rates and you'd be well-off if you were a very patient investor. Use a crude Taylor rule (for example, the Mankiw rule) with an indicator of about 9.5 and you'll end up plotting an S-shaped curve picking up somewhere in the latter half of 2014.
And if you're screaming inflation and hyperinflation from every rooftop like a lot of people have over the past few years, then you might do well to read about the dog that never barked.
I don't know why exactly it's called the widowmaker but the real widowmaker is a coronary artery that is fatal if blocked.
The analogy seems dubious but still, shorting the bonds:
1) of a sovereign nation that
2) issues debt in not just a currency it controls
3) but a currency that acts as the global reserve currency
4) in a depressed economy
5) is foolish
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