Claims Rule Everything Around Me C.R.E.A.M.

Last week Bloomberg’s Michael McKee was interviewing one of my favorite economists, Neil Dutta of Renaissance Macro, and asked him whether he thought initial jobless claim deserved such a wide following or if it might be an overrated indicator. I was pleased to hear Dutta confirm its importance.

If anything this data point is underrated. It is hard data so it is not reliant on estimates (excepting rare examples like California last year when a state fails to correctly collect it). It is released with a six day lag so it’s about as close as one can get to real time. It is subject to an extremely low level of revisions. However, unlike numbers like NFP, durable goods, retail sales, or industrial production it rarely results in market volatility upon its release.

The lack of an upward trend in claims is why I stuck by my guns over the recent data weakness being an entirely weather related phenomenon. My charts below are a testament as to why it is unquestionably the best indicator of the domestic economy.

Let’s start with a comparison to another labor metric: Claims 4WMA (white) vs. Unemployment (orage).

One more labor metric: Claims 4WMA inverted (white) vs. NFP (orange) with recessions shaded red. Claims offers a far less noisy data set.

Overall economic growth: Claims 4WMA inverted (green) vs. GDP growth year over year (blue).

Soft manufacturing data: Claims 4WMA inverted (red) vs. US PMI (blue)

Hard manufacturing data: 4WMA inverted (orange) vs. US auto assemblies (white) with recessions shaded in red.

Sentiment data: Claims 4WMA inverted (green) vs. Consumer Confidence (white)

And the ultimate sentiment indicator: Claims inverted (green) vs. SPX (orange)

Fisher on Tapering

Over the past few days we have seen a relatively minor selloff in domestic risk assets. A 4% swing peak to trough in equities is not exactly earth shattering, but the onset complacency and lack of volatility in the past year amplified at least the vocal reaction to the move. This coupled with a few mixed economic signals has some under the impression that the Fed might alter its tapering path for QE.

With inflation currently picking up, unemployment significantly below Fed projections, and GDP growth significantly above them, I think the easier case is for more tapering not less. These projections are already so cautiously off the mark that the January unemployment rate is likely to breach the 2014 year end central tendency. That’s an estimate made last month.

Projections which will need to be need to be drastically altered in hawkish directions below.

This situation reminded me of a quote by Dallas Fed President Richard Fisher from his remarks on January 14th. Though clearly the most hawkish member of the Fed, he is a voting member this year, and I found this insight important especially as to why their focus on long term real economic trends is of a great deal more importance than noisy short term market reactions.

“Were a stock market correction to ensue while I have the vote, I would not flinch from supporting continued reductions in the size of our asset purchases, as long as the real economy is growing, cyclical unemployment is declining and demand-driven deflation remains a small tail risk, I would vote for continued reductions in our asset purchases, with an eye toward eliminating them entirely at the earliest practicable date.”

I am confident that as long as the dual mandates of inflation and unemployment are moving in the right direction this, extremely competent, Fed will continue along the path of policy normalization.

Full disclosure I’m a short duration all over town.

Richard Koo on Tapering

In a note this week Nomura Research Institute’s famed chief economist Richard Koo laid out his case for the Fed to start tapering as soon as possible. Most of it focused on liquidity, recent labor market improvement, benign inflation, and the current pace of economic growth through his ever insightful balance sheet recession lens. Most of these factors have been debated to their fullest extent by every research team in finance, and with industrial production and CPI as the only significant data points left before the FOMC meeting, there is little to change any views from that angle.

What stuck out to me was his “personal standpoint” argument. This is especially worth noting because he recently met with both Bernanke and Yellen to discuss monetary policy and presented his case for normalizing policy. As an aside the aforementioned presentation, which I was lucky enough to see later in the month, included one of my favorite chart’s of the year.

Since I did not see any of the usual suspects write up his most recent note I have shared the relevant section directly below.

(A)n objective view of the situation suggests that now—when forward guidance is still in effect and inflation is subdued—is the time to act in order to prevent a premature rise in interest rates under tapering. For that reason, I suspect many FOMC members are arguing that now is the time to make the announcement.

December tapering would benefit both Bernanke and Yellen
A December tapering would also be beneficial from a personal standpoint for both the current Fed chairman and his successor nominee. As the man responsible for launching quantitative easing, Mr. Bernanke would no doubt like to set a course for the normalization of monetary policy before his term expires.

I suspect he began talking about tapering in May because he wanted to at least put things in motion before his term expired at the end of January. Then, even if the US economy fell into a quantitative easing “trap” during the process of normalizing policy, he would be able to avoid the criticism that he had started QE but left the cleanup to his successor.

Decision by Bernanke would make it easier for everyone else
Ms. Yellen, meanwhile, has strong dovish credentials, and if that was the basis for her nomination by the Obama administration, I think it would be difficult for her to announce a tapering immediately after becoming Fed chair.

For the first few months, at least, it would be better for her to spend time preparing everyone psychologically for the next step given her dovish reputation in the markets and the administration. But this would delay the start of tapering and could push the Fed behind the curve, possibly leading to an undesirable rise in long-term rates.

Her job, therefore, would be made much easier if Mr. Bernanke were able to set a new course for the Fed before stepping down.

In short, if a decision has to be made in the near future, it would be easier for all concerned if Mr. Bernanke were to make it before his term expires.

Dutch again: The parameters for policy normalization have been in place for some time now, and I agree that it is both important and would be far easier for Bernanke to make the call.

Negative Ghost Rider, the pattern is full

This post is little more than a victory lap so please feel free to stop reading now.

Something strange happened yesterday. In the morning I was looking through data from the past two debt ceiling clusterfucks trying to think of an ideal way to structure a trade for a potential impasse. Having remembered that the US sovereign CDS curve had some wild fluctuations the last two times I focused on another possible flare up on the front end. This is a rather illiquid little backwater and a truly useless market for anyone actually trying to hedge risk on a treasury portfolio, but it’s a fun spot for doing some punting.

As it stood this morning 1y CDS were at 13bps with a 6bp spread on the bid ask and 5y CDS were at 24bps with a 4bp bid ask spread. Both of these levels were significantly below their (short) historic averages.

Since I can’t trade these in my PA, my desk doesn’t actively take risk in these instruments, and our clients don’t particularly care for small illiquid trades I thought I would share my thoughts on twitter.

I was happy that a number of people thought it was an interesting trade and got a few follow ups on the matter but most people just thought it was a halfway funny joke about Top Gun.

Then at the end of the day I was going through my pricing rundowns and I saw that this happened.

1y CDS had shot up by 45bps since the morning. Upon further examination I noticed that the aforementioned 1-5y spread went from 11bps to an all time record of -28bps. As shown below this is a 5.9 standard deviation event, and if you believe that derivative pricing follows a normal distribution this is something that should be seen once in every 300 million observations.*

And here’s the one day change for the curve.

I am going to run with the assumption that I just happened to have timed this recommendation perfectly, but I will hold out an inkling of hope that just maybe someone who reads my tweets banged this level and moved the market.

*If you think illiquid derivatives follow normal distribution patterns you should stay away from them, as well as any other assets that might prove too complicated for you.

A Few Thoughts on Domestic Inflation

Yesterday a far more talented sell sider than myself @barnejek in a discussion on the relentless rise in US real rates over the past two months sparked this post at BI and it lead to continued discussion on twitter and a few more posts about the recent fall in inflation rates. I took a few issues with it and received many questions so it’s far too much for twitter.

First and foremost the tweet makes no sense because inflation in the US has been stubbornly low for the past two decades, so unless you think it’s going lower from these current depressed, generationally low, levels saying goodbye to inflation is ridiculous. If however, that is your actual opinion please reach out in the comment section I would be thrilled to enter a swap to that effect.

Here are US benchmark real rates and their ramp up since April. I’ve been saying for the past seven months that short 5y TIPS was the best trade on the planet as they had all the overvalued characteristics of USTs but with positive carry. I still like the trade but the recent run up in the inflation expectation component of it looks overdone. As such I find it hard to see inflation going any lower from here.

Here’s the benchmark breakevens where the move has been just as staggering, the two year most notably is off 114bps.

US inflation levels are quite low. PPI leveled off last month but CPI and PCE both surprised to the downside. Luckily, this trend looks to have reversed last month.

Inflation will be supported by the recent climb in wages which were the input most severely impacted by the payroll tax increase. If I had to peg the soft inflation from the spring to one thing, that would be it.

It is important to look at wages coupled with consumer credit which was also continued to expand.

The most stable of the bunch core PCE has a good long term track record with the 5y UST, where the recent rise in yield points to upward pressure.

Last month’s CPI reading looked like a fluke to anyone who follows it.

The reading was inconsistent with the data from PriceStats (formerly the billion prices project) where prices have been rising for weeks.

Case-Shiler showing CPI should face continued pressure from rising home prices and rent equivalents.

Lastly to show just how overdone the move in short term inflation expectations has become here’s crude oil charted against the 2y breakeven. Since it factors so heavily into both consumer and producer inflation it has had a great predictive factor.

That said, my base case if for inflation rates moving significantly closer to the Fed target of 2% over the next 6-9 months.

Three Bearish Charts for Equities

First off let let the record show that equities are by no means my area of expertise, but I thought this was worth sharing and too long for twitter.

This week three of my favorite correlations for US equities in different risk areas ended up significantly disconnected from the levels where the SPX is currently trading. Because of this I decided to enter into a short term risk reversal on Thursday.

Economic risk: SPX has lined up very well initial jobless claims for the past 5+ years but has recently overshot by quite a bit

High quality risk: the BAML Global Financial Stress Index, which attempts to measure stress in areas such as solvency and liquidity, price momentum, and short term volatility. This is the first time it has broken significantly below equities in over two years.

Low quality risk: the Markit CDX North America High Yield Index tracks CDS for 100 non investment grade debt issuers. This has been an extremely tight relationship and was the straw that broke the camel’s back for me.

It might be worth keeping an eye out for a minor correction.

Bassmasters, It’s A Fishing Show

Feel free to chalk this up as an obnoxious victory lap, but I thought this was worth a look. As I pointed out over a year ago Kyle Bass seems to have become victim of the great widow maker macro trade of the century. The exceptional quant team at Nomura, which has produced some of my favorite charts, decided to highlight some problems with the short JGB trade.

The odd thing for a sell side desk is that in the process they chose to flame one of their own clients.

Keep in mind this is based in cash bond investing and not the strategy of rolling derivative short JGBs Hayman has employed, which has produced returns closer to -90% over the past two years.

Moral of the story: macro tourism doesn’t pay.

Is Japan Becoming The US?

Since 2007 I have heard no less than 1000 versions of this question: “Is the US becoming Japan?” Countless pieces of sell side and buy side analysis have been published on the topic, and a few Japanese economists such as Richard Koo who intricately understand the effects of widespread public and private balance sheet deleveraging have gained a cult following.

I have been a huge advocate of Koo over the past few years as the Japanese treatment of their economic collapse has proven the best example (thanks to better data than the Great Depression etc.) for modern economists to examine deleveraging. However due to a reasonable level of monetary easing and a far more accommodative banking system it seems that the US has been able to enjoy what Ray Dalio and the team at Bridgewater have deemed a “beautiful deleveraging” where enough printing has occurred to balance the deflationary forces of debt reduction and austerity in a manner in which there is positive growth, a falling debt/income ratio and nominal GDP growth above nominal interest rates.

Nevertheless people continue to return to the Japanese crisis for answers on an asset basis, because it is the most recent true crisis in a developed market from which to learn. Over time, surely enough, assets have moved outside of the boundaries prescribed by this analog. First it was currency flows, then equities, then widespread economic growth measured by GDP and GDI disconnected entirely from the Japan thesis. One outlier remained, rates have stayed stubbornly low and this is where I end up yelling at people.

The thing with rates is when one is comparing JGBs to USTs everyone who doesn’t understand real rates or long term trends, does it backwards. The current bull market in USTs started almost ten years before the similar one in JGBs.

Yesterday an equity focused hedge fund PM from the emerging market nation know as Florida brought this chart to my attention.

The obvious problem is that it is comparing a midmarket shift to that of a pre peak market, Japanese yields in their era of a liquid global market topped out in 1990. I will cut him some slack though because he understands companies in ways I find confusing.

The bull market in USTs started in 1981 and from a much higher point in nominal yields. It has continued up to this day. I personally think it is carving out a bottom right now but that’s a stance that has made many far more competent stewards of capital before me look foolish. What is interesting though Is that few seem to ask, the question is the “Japan becoming the US?” JGBs lagged 9 years against UST from a year before their peak look staggeringly similar. (Note this analog ends with 10y USTs hitting a bottom at 353 bps in June 2003)

Over this time period it looks like Japanese rates became US rates and note the other way around. As seen below real rates in Japan (red) have been significantly higher each of the past five years in the US (blues).

If the long term trend in the US means anything JGBs have another decade at least to put in a bottom on yields. The question people should be asking is “Is Japan Becoming the US?”


(lagged 108 months extended to present day)

Under the Bridge

Felix Salmon decided to respond to my criticism of his inaccurate post by calling me a troll and characterizing me as one of Wall Street’s “many overconfident frat boys with overstuffed paychecks”

Here is a tip: If you are going to take issue with someone’s lack of civility it helps to avoid sweeping generalizations and calling them a boy. Your crowning achievement is writing a blog chief, get over yourself.

Now let’s run down the rebuttal, which he titled “How Pimco works” even though both articles make it abundantly clear this is an area in which he has no expertise. Felix doesn’t know how much Bill Gross was paid last year, how his pay is administered, or how it is determined. I have no idea what Bill Gross made last year, that’s why I don’t write blog posts about his pay package. Yet he proclaims “Is there a formula governing Gross’s remuneration, based on some combination of Pimco revenues, Pimco profits, and the performance of the funds he manages? I’m sure there is.” That’s conjecture backed up by nothing at all. I will gladly bet Felix that Bill Gross’s pay is not established by some black box formula. Saying that he is sure of it is misleading his readers for no reason but vanity.

Next on the example set by Gross “If they would risk getting fired after turning in such dismal performance, then it would be downright hypocritical — and bad for the cohesion of the senior management team — were Gross to accept a $200 million paycheck in such a bad year” this sentence gets to the crux of his misunderstanding. Unless you’re at a leveraged shop you don’t get paid on performance. You get paid for asset gathering. Nobody gets fired when their funds are getting massive inflows. PIMCO and Gross in particular had a great year, but for some reason the opposite ends up in the article. Also Felix has zero insight into the inner workings of the firm’s management team so judging effects of hypothetical events or their cohesion is laughable.

The next paragraph gets some things right. There is without question a move toward fee compression in the asset management space. The pools of capital that allocate to PIMCO should be diligent in their attempts to maximize management skill and minimize fees paid for that skill. I didn’t argue to the contrary on this matter, but saying that every client should worry about how much the CEO of their service provider made last year is ridiculous. You would run out of time in the day if that was the case just trying to keep track of how much your barber made, or whenever you went to Starbucks for a coffee you’d need to worry about Howard Schultz’s pay package.

Felix then goes on to argue about whether the 200 million figure was probable. I have no idea. I never claimed that’s what he made. I simply quoted his article which had that figure which was presented by another reporter. He doesn’t know either.

On to El-Erian, Felix then goes rambling quoting me in three word blurbs. If you read the original article is still clear he mischaracterized how Harvard and HMC’s portfolios are constructed. The reason that “Mohamed was having a heart attack” was that his hand was forced in investing a liquidity sensitive portfolio in an illiquid fashion. Of course he should have worried about this; it was a terrible position to be placed in with his mandate. I was there and dealing with him from the opposite side at the time on this very issue I can assure you he was. However, my only problem was with Felix’s assertion that he “was having a hard enough time on the liquidity-management front when he was in the office every day” because he didn’t have a hard time. He did it exceptionally well; there is no evidence to the contrary.

It goes on, after he asked this very question as an open ended mystery a day earlier “How did Blackrock grow so big? In large part by buying a lot of index funds” No, it didn’t buy funds. It bought an asset manager, the largest one on earth. Those things are not the same.

Then just tossed out there as fact “And also, in part, by being a public company.” No evidence whatsoever to support this. Of the top 15 asset managers in the world only Blackrock is public. The other 14 are insurance companies, subsidiaries of banks, or private firms. So the concept that one might need to go public just to compete with Blackrock is founded on nothing.

Both posts make it quite clear that there were broad misrepresentations of how asset managers operate especially the one in question. So if telling someone they are wrong and having a number of people that we both respect, including those that actually work in this field, agree with me is “trolling” then I guess I’ll keep it up.