Global Macro Commentary

Tangled Up In Blue
Thursday, March 05, 2015

Guy Haselmann
(212) 225-6686
Director, Capital Markets Strategy
John Zawada
Director, US Rate Sales

FED
LastFriday,IattendedtheUniversityofChicagosannualUSMonetaryPolicyForum.Several(imprecise)headlines
hitthetapesthatdayfromstatementsmadebyFOMCmembersinattendance.Afterafewpresentationsand
personalconversationswithFOMCmembers,Ibecameevenmoreconvincedthatthewordpatientwillbe
removedatnextweeksmeetingandthatthefirsthike(since2006)willoccurinJune.
StanFischerstoletheshowwithanoutstandingpresentationandconciseanswerstopointedquestions.Oneofhis
mainmessageswasthatforwardguidancewouldsoonbegoingaway.Hequestionedtherationaleofconstraining
theFedsflexibilitythroughsometypeofcalendarbasedfuturepromise.Hefurtheraddedthatafterliftoffthere
wasnoreasontotelegrapheachmeeting;but,noneedtosurprisemarketseither.HesaidthattheFedwill
maintainitscredibilitybydoingthethingsthatwesaywewilldo(e.g.,aJuneliftoff?).
ItishardtoimagineafterlisteningtoFischerthatpatientwillremainintheMarchstatement.Eventhosewho
expectliftofftobedelayeduntil2016wouldprobablycometothesameconclusion,becausetothem,removing
patientstilldoesnotensureorguaranteeaJunehike.
TherearethosewhobelievetheFedwillnothikeratesatallin2015,becauseinflationistoolowandfalling.Yet,
duringFischersdiscussionaboutfuturepolicy,hesaidthatinorderfortheFedtothinkaboutliftoff,theFOMC
needstobeconfidentthatinflationwillmovetowardsits2%targetin2to3years.HethenaddedthattheFedis
confidentthatitwill,sonowisthetimefortheFedtobethinkingaboutliftoff.
TheintentofthefirstpanelofthedaywastodiscussthisyearsacademicpaperaboutTheEquilibriumRealFed
FundsRate.Theconclusionofthepaper,withoutgettingintothedetails,suggestedthatFedratehikesinthis
cycleshouldbelaterandsteeper.DudleyandMesterwereonthepanel.Ratherthanjustagreeingwiththe
conclusionsofthepapertojustifythepathoftheirpolicystanceitwassurprisingthatMesteractuallyargued
thatlaterhasalreadyarrived.Inotherwords,sheagreedthatwhenyouhittheZLB(zerolowerbound)thatyou
havetomakeupforitontheothersidebydelayingthefirsthike.ShesaidthattheFedhasdonethisalready.
MesteremphasizedthatFedmodelscannotmeasurecostsoffinancialinstability,andsucharguesforanearlier
hike.Sheaddedthatcontinuingtodelayhikeshasseriousimplicationsforfinancialstability,andatsomepoint
uncertaintyaversioncarriesmoreweight.Inthisregard,shestatedthattheFedFundsrateshouldhavebeen
liftedalready.
ECB
ManydetailsoftheECBsQEprogramwereannouncedtoday;alistofparticularsthatistoolongandcomplextolist
here.Yet,allmaynotbewhatitseems.Whilemarketsaretryingtopriceinandprepareforthe60billionper
monthprogramuntilatleastSeptember2016,Ibelievethereisareasonablechancethattheprogramendswellin
advanceofthisdate.
Onceagain,Draghiwasmasterful.Hispressconferencedeliveredareasonablyupbeatmessageaboutthe
considerableprogressthatisalreadybeingobserved.Hespecificallycitedandemphasizedsuchfactorsasoil,the
weakerEurocurrency,andpriormonetarypolicyactions.Infact,hewassoupbeatattimesthatacasualobserver
mighthavewonderedwhythisprogramwasnecessarytobeginwith.Heevenconfessedthatthedropininflation
waslargelyduetoweakerenergyprices;somethingexpectedtoreverseinearlyin2016.
Draghicalledthisthefinalplan.Maybehefeltthatonemoreshotofadrenalinewasnecessarytohelpsustainhis
progress,andtobuytimewhilethenecessarystructuralreformdetails(thatheoutlined)canbehashedout.In
ordertopreventmarketsfromtestinghisresolve,theECBunleashedwhathasappearedtobeashockandawe
program.Flauntingthearsenalcanbeeffective,butitispossiblethatitwillnotbeusedinitsentirety,as
announced.TheECBmightmakeearlyprogressonitstarget,orrunintooperationalproblemsduetounwilling
sellers,orduetobondyieldsthathavegottentoonegative.
ECBQEwillcauseanevengreatershortageofhighqualitygovernmentbonds.Moreover,thosewhosellbondsto
theECBwillhavereinvestmentrisk;somethingthatdoesnotreceiveenoughattention.Itwillfurtherincrease
pressureoninvestorstotakeextrarisk.Asassetpricescontinuetorise,theglobalfinancialsystemisbecoming
evermorefragile.Moreinvestorsareclimbingoutsideoftheirusualcomfortzone,takinghigherrisksthanthey
areusedto.
Onafinalpoint,riskstofinancialassetscannolongerbeassessed,becausethemechanismstodiscountcashflows
arebroken.Iftheriskfreeratelocksaninvestorintoaguaranteedloss(orzeroreturn),thenhowcanitberisk
free.Whenthisrateisdistorted,anyattempttopriceanyassetwillbemiscalculatedandincorrectlypriced.
AscentralBankshaveracedeachothertothebottom,littleislefttopowerriskassetsforward(intomoreextreme
mispricings).Thelastmarginalspeculatorisalreadyin.Atthispoint,newlyacquiredcashandloweryieldsare
likelyonlytospurgreaterlevelsofsavingsandhoardingofcash.TheMinskyMomenthasfinallyarrived.
Allwarfareisbasedondeception.SunTzu