Leveling the Playing Field

December 14, 2015

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For the last seven years, readers of this newsletter have heard the phrase TBTIHEK, my
intentionally clunky reference to The Best Trader I Have Ever Known. This is the guy I go to
find out what is really happening in the markets because by the time we read it in the WSJ its
too late.
I met TBTIHEK in one of my first days at The Bank That Shall Not Be Named. As part of
hazing ritual, I was sent over to the head of the swap desk to ask some absurd and HR-unfriendly
question like why are your swap spreads tighter than everyone elses? I was pointed to a
young guy that I was certain was my age and was probably a fellow analyst definitely not old
enough to be the head of our swap trading desk. So I approached him, figuring the most harm
that would come of it would be that he would sympathize with my plight and clue me in on how
to get out of this hazing ritual. I walked up and asked my stupid question.
Unfortunately, that young gentlemen was, in fact, the head of the swap desk. Fortunately, he
was very nice albeit incredibly confused by my question. He didnt scream at me or break his
phone on the desk because my interruption had cost him money. He just said something to the
effect of Hey bud, I think youve been had. I noticed a Redskins helmet on his desk and asked
if he was a fan. The Redskins are the most poorly run organization in the NFL, but yes, theyre
my favorite team. (I may have added some flair to his response). I told him I was an Eagles fan.
And thats when he started to scream at me. And that was my introduction to Jon Farrin,
TBTIHEK.
In my estimation, Jon is one of those guys that was born to trade and is fortunate enough to
found his way to a trading floor. He could probably be doing a million other things, but nothing
would make maximum usefulness of his skills the way trading does. Everyone at the bank
(especially management) knew he was too good to be running the desk for a Charlotte bank, but
family life kept him anchored there.
For the first few years, I only referenced him by this acronym because he was still running the
trading desk of one of the biggest banks in the world and had to remain anonymous. Even when
he was working at perhaps the most prestigious hedge fund in the world, he wanted to remain
silent while still providing me insight.
Hes been one of my biggest sources for market insight over the years and is someone I trust
completely. Unlike many traders, however, he is a genuinely good guy (Skins allegiance
notwithstanding).

A little over three years ago, Jon teamed up with David Hathaway to form Sandpiper Asset
Management, an alternative asset management company specializing in macro trading strategies.
David was another one of those guys that was simply too good at his job to be just another cog in
the machine for a bureaucratic bank. He wrote a trading program that makes a lot of out deeply
of the money bets, losing a little bit at a time in exchange for big payoffs (think The Big Short).
This has created a dynamic partnership Jons macro trading gains offset the small monthly
losses from Davids systematic program until the next payoff from an out of the money position.
With compounding returns of more than 15% per year since inception, something is working.
Our real estate clients have enjoyed working with Jon and David because it allows them to
diversify their holdings while retaining liquidity for new projects. And no, we dont get anything
from pumping them up - they are just two of the smartest people Ive ever worked with and I like
connecting my clients with good people.
Given Wednesdays FOMC and the evolving landscape for 2016, we sat down so I could pick
Jons brain about the economy, the Fed, 10yr rates, short term rates, and even the dreadful
Eagles. Heres the Q&A from that discussion.

Q: What surprised you most about 2015?

A: I think the thing that has surprised me the most is how much the markets narrative has
shifted around the ongoing decline in energy prices. I dont recall there being any
euphoria/optimism when all you heard about was peak oil and how could the consumer survive
with crude oil trading north of 100. Now weve received a de facto, massive tax cut and a sector
that represents only 6% of the S&P is causing widespread anxiety about the broader impact. I
think investors were clearly too long energy, as it represented the easiest sector to achieve
significant yield in ones portfolio now that fixed income now longer offers a reasonable yield,
but I dont expect any contagion a la 2008 that you hear about now. While our energy
production has exploded in the past decade, we are still on net, a significant consumer of energy
and thus the drop in prices represents a net positive to the US economy.
Q: How has the Fed done this year? What do you expect out of it in 2016?
A: I think the Fed is in a very difficult spot. Personally I think theyve paid far too much
attention to every tick in asset markets rather than focusing on a sensible monetary policy. The
problem with QE, and asset purchases in general, is that the ostensible goal is to boost
confidence, and asset markets. So how do you begin to unwind that, without upsetting asset
markets at some level? And then when they skip the meeting in September, citing vague
international developments it furthers the feedback loop. Here were are again heading into a
meeting that was supposed to be 100% telegraphed, and theyre faced with an ugly high yield
market and stocks that were down almost 4% last week. Will they be forced to blink? I sure
hope not because it will mean that the markets have fully taken over monetary policy decisions

for the Fed. Were at, or very close to, economists estimate of full employment, and we still
have zero interest rates. Taking into account the long lag within which policy works and the fact
that headline inflation is set to rise sharply over the next 6 months simply due to base effects, and
wage pressures already starting to emerge it makes no sense for them to wait. But again I think
theyve gotten themselves trapped by the market.
Q: Number of Fed Hikes in 2016?
A: I expect by the end of 2016 they will have hiked once a quarter.
Q: Chance of a rate cut within one year? Two years?
A: Expansions dont die of old age, and while much has been made about the length of the
current expansion (which is just now equaling the average length of a post war expansion), I
believe this one will be much longer than the typical expansion because of how slow and gradual
it has been due to the aftereffects of the financial crisis. Importantly, assuming that the Fed gets
started with the normalization process, I dont expect them to have to tighten sharply, but rather
slowly move policy to a neutral stance. So no, I dont expect the Fed to have to ease at any point
over the next 2 years.
Q: So no other accommodative measures, either?
A: No.
Q: What is the impact of ECB policy on US yields?
A: Clearly the ECB and BOJs policies will help to keep a lid on any yield rises here, and I
expect both of those Central Banks to remain exceptionally accommodative.
Q: Chinas impact on US rates?
A: The Chinese devaluation will be enormously important in dictating the speed within which
the Fed normalizes. Importantly, Central Bank reserves have been shrinking over the past 18
months, not only Chinas but oil producing nations as well. This has led to selling of treasuries
which will partly offset the impact of ECB/BOJ.
Q: Impact of global headwinds on US economy? Commodities?
A: I tend to be an optimist, and view the ongoing decimation in the commodity complex as a
massive opportunity for the developed world. Its the natural byproduct of Chinas healthy
attempt to transform their economy into one more driven by domestic consumption. Why would
an advanced country such as ours not take advantage of these incredibly low interest rates and
cheap inputs and rebuild our aging infrastructure? Unfortunately our political system seems to
render anything other than a two-week, stopgap funding bill all but impossible to pass. But I

tend to view the ongoing commodity collapse as predominantly a supply story, and less
instructive on demand.
Q: What worries you about the next two years?
A: My biggest fear is we get drawn into a larger conflict with ISIL/ISIS.
Q: Impact of election in 2016?
A: Zerounless we change our gerrymandering process Im afraid nothing will ever get done of
consequence in Washington.
Q: Inflation?
A: I tend to be a contrarian, so I will venture to say that in two years well be laughing at the idea
that we were concerned with deflation/disinflation, as we are now.
Q: What are people like me spending too much time talking about?
A: The manufacturing data. Clearly US manufacturing is in a cyclical slump, with the stronger
dollar and commodity collapse crushing the industry. But it represents only 9% of US
employment. Meanwhile the broader economy is growing above trend.
Q: T10 high/low/most likely? What causes the 10T to break 3%? Will we ever see 4% again?
A: Demographically, the case for higher yields is tougher going forward than it was in the past.
You have an increasing need for safe, income-producing assets and our potential growth rate has
slowed over the past decade due to demographics as well. Slower potential growth means that
rates dont have to increase as much before they exert a tightening force. So for 10s to trade
significantly higher youd have to see a sharp increase in inflation in the developed world. I
think the most likely level for 10y yields a year from now is 2.65%, with 1.90-2.90 covering the
range for the year.
Q: T2 thoughts?
A: I believe 2y yields will end the year at 1.75%. (Editors note this prediction is particularly
worrisome for cap buyers and ties out with Fridays newsletter about our concerns for 2016).
Q: FF in 2016? FF in 2017? Will 1mL trade about 10bps above this?
A: I expect the Fed to move next week, and then tighten 4 times in 2016, taking the midpoint of
their range to 1.375. Its hard to forecast 2017 from here but if the economy evolves as I expect I
would expect another 100-150bps of hikes in 2017, taking them to/near neutral policy by the end
of 2017.

Q: Cap prices our guys buy lots of 2-4yr caps, maybe 2%-3% strikes. I know this isnt your
specialty, but any thoughts on what cap prices may do in the coming year would be helpful.
A: No strong view, but would opportunistically buy when vol is low. I dont think theres any
expectation that rates will need to move sharply higher, vs the view in 2009, so would think
theyre a relatively inexpensive hedge.
Q: Will negative swap spreads persist?
A: Swaps, as we knew them before the financial crisis, have ceased to exist. I think its best to
view each asset individually at this point. Clearly they will be correlated, but relationships that
tended to exist in the past will no longer, for a multitude of factors. Happy to go into them in
more detail if anyone would like to follow up.
Q: How have you enjoyed working for yourself?
A: I can say that once youve been your own boss, its impossible to imagine working for
someone else ever again. Running your own business is certainly more all-consuming, and the
amount of sleepless nights certainly increase, but the level of engagement and sense of
accomplishment are unparalleled.
Q: What has changed at Sandpiper over the last two years?
A: David and I have been up and running for 3 years now, and while our focus on our
performance and letting our numbers do the talking hasnt changed, we certainly have increased
our institutional exposure over the past 18 months. We recently hired Mike Collins from Wells
to be our head of investor relations, and are more actively telling our story, as we believe we
offer a compelling alternative asset that offers true, uncorrelated returns and a team that focuses
100% on delivering attractive real returns over time. Clearly that story is easier to tell now that
weve been compounding at more than 15% a year since inception versus the early years.
Q: Redskins vs Eagles who is more inept?
A: For probably the first time since the Gibbs 1 years of the early 90s, I have to say the Eagles.
Chip might be a good coach, but hes an abysmal GM.
Q: What is the most memorable phone call you ever received?
A: The one that haunts me, almost daily, is the call I got from my friend, and broker Mike
Finnegan on the morning of 9/11. As you remember on the trading floor we had open lines to all
of our brokers and he was in the Cantor Fitzgerald offices in the North Tower (above where the
first plane hit, and as we learned later completely cut off from any possible exit as the plane
severed the stairs and elevators down). He would periodically come back to the phone to ask
what was happening as in the confusion of that morning no one knew what was happening.

Finally the last time I heard from him, he told me to call his wife and tell her how much he loved
her. It was a haunting, tragic moment.
Q: Wow, that is powerful. Do you miss working on a trading floor at all?
A: YesI miss the comradery and feeling like you were on a team. Having worked at a number
of banks, and the one hedge fund in Connecticut, I have to say the best group of guys were at
Wachovia. I didnt realize at the time because it was my first gig, but it was a special group.
Very little politics, a great competitive and collegial atmosphere, and a ton of fun memories.
Q: Will it bother you when the Eagles win a Super Bowl with RGIII?
A: I think he would be a good fit for you guyshe has to be better than Sam Bradford, right?
Having said that, hes never going to win a SB, unless hes a backup on the Patriots.
Q: Its funny you mention that, heres our discussion on RGIII two years ago:
Q: Is RGIII human?
A: Clearly nothes going to be fully recovered by training camp in a month while the
initial prognostications had him out until November at least. Hes going to be president
one day.
A: (silence)
Q: In your defense, I guess he could still become president

Q: If Vanderbilt and Duke played in a basketball game, who would you root for?
A: HahIm an unabashed Vanderbilt bandwagon fan. Already have my tickets for Houston
this year. So safe to say Id renounce my fake, Duke fandom.
Q: Is living at the beach as hard as it sounds?
A: I have to say after four years, there hasnt been a day that has gone by where I have regretted
the decision to launch Sandpiper or the location that David and I chose to start it in. I encourage
anyone to come visit Atlantic Beach. Its an undiscovered gem with cheap real estate and the
best weather on the planet. 78 and sunny today.
Q: As a home owner in Atlantic Beach, you sound a bit like Bill Gross telling people to buy
bonds
A: The Eagles would be easier to stomach while overlooking the ocean.
Q: Ouch, fair enough.
Jon Farrin is a Managing Partner at Sandpiper Asset Management. For further dialogue on
interest rates or the macro environment, please contact him at jfarrin@sandpiperam.com.


Economic Data
Day

Time

Tuesday

8:30 AM

Wednesday

Thursday

Friday

Report

Forecast

Previous

CPI MoM

0.002

8:30 AM

CPI YoY

0.006

0.002

8:30 AM

CPI Ex Food and Energy YoY

0.02

0.019

7:00 AM

MBA Mortgage Applications

0.012

8:30 AM

Housing Starts MoM

0.066

-0.11

8:30 AM

Building Permits MoM

-0.01

0.041

2:00 PM

FOMC Rate Decision (Upper Bound)

0.005

0.0025

2:00 PM

FOMC Rate Decision (Lower Bound)

0.0025

8:30 AM

Initial Jobless Claims

282K

8:30 AM

Continuing Claims

2243K

10:00 AM

Leading Index

0.001

0.006

11:00 AM

Kansas City Fed Manf. Activity

Speeches and Events

Day

Time

Friday

1:00 PM

Report
Fed's Lacker Gives 2016 Economic Outlook

Place
Charlotte

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