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Tuesday, 17 October 2017

Peters on Fed taper shock

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It wasn’t really supposed to happen like that…

Anthony Peters

Anthony Peters, SwissInvest strategist

… I defy pretty much anybody and everybody to claim that they had had a strong feeling that the FOMC was going to opt to maintain QE3 in its current format. However, to what end keeping the current level of monthly asset purchases at US$85bn escapes me.

You don’t wean a junkie off heroin by giving away fixes.

One would have thought that as the markets were fully set up for the first proper move in the tightening cycle, the FOMC would have taken the free gift but it was not to be. This largely unexpected decision should really be scaring the living daylights out of markets if it means that the Fed is not convinced that the recent pick-up in overall economic activity and consumer confidence is sustainable. I spent a long time arguing that I feared it to be something of a flash in the pan, a dead cat bounce, but I also felt that I was a lone voice in the desert.

Evidently, the FOMC has been studying history, not least that of the behaviour of the Bank of Japan in the mid 1990s when it, as was subsequently suspected, began to tighten too early. I seem to recall that the BoJ was believed to have moved early in the hope that its actions would send a signal that recovery was in good order and that consumers might take that as an encouraging sign. In the event, the Japanese people did not fall for the ploy, the recovery was strangled in its bed and the lost decade ensued.

I could of course be entirely wrong and past Japanese experience never entered into the discussion around the table yesterday but I would be very surprised if Chairman Bernanke didn’t have that risk spooking around somewhere in the back of his mind.

Alas, the decision was taken, bonds rallied sharply, equities rallied sharply, emerging markets rallied sharply and €/$, which was trading as recently as September 5th at €1.3120 is to be found this morning at a lowly €1.3540. So is the Fed erring on the side of caution or is it playing recklessly loose with future inflation?

Outcomes

There is no question that the aggressive backing up of long term rates will have been very much in the FOMC members’ field of vision as the 30 year treasury is the benchmark for pricing domestic mortgage loans. Its yield peaked in late August at 3.92% and was looking as though it was off to the races.

This would very much not have been on the Fed’s list of desirable outcomes and so I guess we must conclude that the decision not to “taper” is largely, if not entirely exclusively, driven by the behaviour of the long end of the yield curve. Anyone who suggests – and there will be those who do – that the FOMC had an eye on Brazil and India and their currency travails when weighing up the policy option should be stood up against a wall and shot.

I wrote in a piece on the G20 meeting a couple of weeks ago that no politician had ever been elected or a central banker appointed in order to help the economy of another country. Although the Case Shiller index is still rallying nicely, the recent housing stars had begun to flatten from an annualised 1,005,000 units in March of this year to the current level of 891,000 which is a long, long way from the peak in activity when the index hit 2,273,000 units in January 2006.

So there we all are, looking sheepish, as we contemplate our short duration positions. Much of that will have been covered by a core long in equities so not all is lost but the broadly held long US$ holdings will now also be hurting a bit. At least we know that we’re in good company. I had recommended fading the rally we’d seen over the week-end and one chum of mine, a strategist at a decent Tier II address, who had heartily agreed with me at the time dropped me a line early this morning which simply read “Surely we’re supposed to fade this rally..?” I guess my reply has to be that the Fed has significantly moved the goal posts and I first have to work out where they have put them and why.

Verizon veritas

Meanwhile, the Verizon complex continues to tighten. In my last weekly article for the print copy of the IFR, I questioned the pricing and the subsequent cost to Verizon’s shareholders. At the time, the issue had tightened, pretty much across the complex, by around 35 basis points.

Most of the world, my editor included, seemed to disagree with me on the basis that some unusual generosity was needed in order to get the enormous deal away.

Last night I received the following from a New York broker/dealer:

*** Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!Risk on!!!

- - - - - - - - - - - - - - - - - Issue Spread- - - - - - -Tight - - - - Close

VZ  7YR 147/141        10x10 (215)                 +140          150-145

VZ 10YR 172/169       10x10 (225)                 +157          169/166

VZ 20YR 183/180       10X10 (250)                 +176          183/180

VZ 30YR 202/199       10X10 (265)                 +197          202/200 “

 

I rest my case. 

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