Leveling the Playing Field June 24, 2013 _______________________________________________________________________ Well that was a crazy week.

And Im not talking about my brothers wedding this weekend. Lets put it this way if markets were as benign as they were a month ago, we wouldnt be having this newsletter right now. Following the FOMCs statement on Wednesday, rates spiked higher, particularly on the long end of the curve. The 10yr Treasury ended the week at 2.51% and is poised to move higher. One trader we spoke with said Were in no mans land right now. When you break 2.40%, 2.85% is the next level and that would fill in the gap from July 2011. The Fed has markets hooked on QE and we are experiencing the unavoidable pain associated with the withdrawal of this accommodation. The Fed is trying to handle this withdrawal as delicately as possible to avoid significant tightening in financial conditions. Too bad the Fed is about as delicate as a temper tantrum of my five year old. Based on last weeks wild ride, it is clear the Fed has much to learn about the definition of delicate. With interest rates at 0%, the Fed has no choice but to remain behind the tightening curve. Bernanke said last month, A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. This is also why the Fed continues to reiterate its commitment of a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. Despite the Feds best efforts, stocks tanked. Paradoxically, bonds tanked as well (rates higher). Investors got spooked, but rather than the traditional flight to safety that would drive rates down, no one wants to be left holding the Treasury bag when the Fed stops playing the role of artificial buyer. Traders are paid to be in front of the Fed and thats why weve been expecting a jump in rates several months ahead of the actual tapering, but this was even earlier than we expected. It doesnt help that during an interview last week President Obama emphasized Bernankes tenure is up in January. Simultaneously, the voting members of the FOMC appear to be rebelling against the lame duck chairman. With Bernanke set to skip Jackson Hole this summer, its quite possible that he is gently fading into the background and allowing his likely replacement Janet Yellen move to the forefront and begin to set policy tone over the second half of 2014. This, too, makes markets jittery. According to our favorite economist Julia Coronado, This is a Committee that wants out of QE in a way that is almost unrelated to the data. In the past the Fed would have reacted

to falling inflation and inflation expectations with additional QE. Now they seem to be intent on reducing the pace of easing despite mixed indications of progress on their mandates. This sends a very clear signal to investorsyour days of subsidized risk premia are numbered. Any sensible investor will respond by reallocating their portfolio, and this seems to be underway. Bernanke provided more clarity around the timing of the withdrawal. After noting the improving labor market, he described the parameters for tapering: if gains in the labor market continue and incoming data are broadly consistent with a pick-up in growth, then the Fed will moderate the monthly pace of purchases later this year. If data continue to reflect strengthening growth the Fed would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear at which point the FOMC would project a substantial improvement in the labor market outlook with the unemployment rate in the vicinity of 7 percent, with solid economic growth supporting further job gains. Tapering should last between six and nine months. Markets appreciate transparency, but Bernanke seems to be sending mixed signals. On the one hand, he noted that the recent increase in rates reflects more optimism, I think, about the recovery. Too bad the Feds own economic forecasts call for lower growth. Bernanke must be aware of this contradictory message on some level as he continually made analogies to cars and aircraft carriers, even adding he hoped markets would be able to follow what were saying. Here is the bottom line any signal of tapering will lead to tightening financial conditions. Reducing QE suggests the start of a bear market for interest rates. Treasury holders respond by selling now before the Fed gets out of the Treasury buying business. Take a look at the calendar below and note the numerous Fed speeches. Markets will be closely watching for clarification of last weeks message. We suspect the violent swing upward in rates will lead to some backpedaling on tapering.

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Economic Calendar
Economic Data Day Monday Time 8:30AM 10:30AM Tuesday 8:30AM 8:30AM 9:00AM 9:00AM 10:00AM 10:00AM 10:00AM Wednesday 7:00AM 8:30AM 8:30AM Thursday 8:30AM 8:30AM 8:30AM 8:30AM 10:00AM 11:00AM Friday 9:45AM 9:55AM Report Chicago Fed National Activity Index Dallas Fed Manufacturing Index Durable Goods Orders Durables ex Transportation Case-Shiller 20-city Index House Price Index (MoM) Richmond Fed Manufacturing Index Consumer Confidence New Home Sales (MoM) MBA Mortgage Applications GDP (QoQ) Personal Consumption Initial Jobless Claims Continuing Claims Personal Income Personal Spending Pending Home Sales (MoM) Kansas City Fed Manufacturing Activity Chicago Purchasing Manager U. of Michigan Confidence 2.4% 3.5% 345k 2959k 0.2% 0.3% 1.0% 4 55.0 82.9 Forecast -0.15 -0.5 3.0% 0.0% 10.60% 1.1% 1 75.0 1.3% Previous -0.53 -10.5 3.3% 1.3% 10.87% 1.3% -2 76.2 2.3% -3.3% 2.4% 3.4% 354k 2951k 0.0% -0.2% 0.3% 2 58.7 82.7

Speeches and Events Day Monday Tuesday Time 1:00PM 2:30AM 10:00AM Wednesday Thursday 10:00AM 10:00AM 10:30AM 12:30PM Friday 8:00AM 9:15AM 12:00PM 3:30PM Fed's Fisher speaks Fed's Clark speaks on Bank Regulations Fed's Vermilyea testifies on Student Loans Fed's Fisher, Lacker testify on Financial Regulation in House Fed's Dudley speaks on Labor Market Fed's Powell speaks on Monetary Policy Fed's Lockhart speaks on the Economy Fed's Stein speaks on Monetary Policy Fed's Lacker speaks on Economic Outlook Fed's Pianalto speaks on Monetary Policy Fed's Williams speaks on Monetary Policy Washington, DC New York, NY Washington, DC Marietta, GA New York, NY West Virginia Wheeling, WV Sonoma, CA Report Place London Paris

Treasury Auctions Day Tuesday Wednesday Thursday Time 1:00PM 1:00PM 1:00PM 2-year Treasury 5-year Treasury 7-year Treasury Report Size $35B $35B $29B