Leveling the Playing Field

February 4, 2016
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Bernie is turning up the heat on Hillary. Cruz and Trump are knocking each other around while
Marco sneaks up behind them. Predominantly white America is criticizing Cam Newton for his
dab without a hint of irony (Joe Namath, Jeremy Shockey, basically the entire Patriots
offense). Random thought of the day: if Cams significant other was found to have received
large shipments of HGH right around the time he was trying to come back from major neck
surgery, would the negative campaigning have died as quickly as it did for Peyton
But the negative campaigning is creeping into markets as well. Japan announced negative
interest rates and canceled a subsequent 10yr government auction for fear it would price at a
negative coupon. Several central banks within the ECB have been experimenting with negative
interest rates for18 months. The ECB itself last month pushed its deposit rate further into
negative territory and committed to QE through at least March 2017.
But thats waaaaaaaaaaaaaaaaaaaaay over there. The Eurozone was all the rage for catastrophe
chatter in 2011 but it never dragged the US economy into recession. We are resilient! We play
real football! Well build a wall around our borders and get China to pay for it! Were Merica!
And then a few interesting things happened this week.
Firstly, the Fed quietly added a prolonged negative interest rate environment to its stress test of
banks. This has bad news written all over it. The Fed politely explained that this scenario does
not represent a forecast of the Federal Reserve, but thats like me checking for airfares to NYC
and then claiming I have no intention of going there. Theres a reason bank stock ETFs are
down 16% in the last month.
On Monday, Fed Vice Chairman Stanley Fischer admitted he was surprised at the success of
negative interest rates in countries like Switzerland, Sweden, and Denmark. Its working more
than I can say I expected in 2012Everybody is looking at how this works.
And then from the Department of Piling on, NY Fed President Dudley said yesterday, "One thing
I think we can say with more confidence is that financial conditions are considerably tighter than
they were at the time of the December meeting. He continued, "So if those financial conditions
were to remain in place by the time we get to the March meeting, we would have to take that into
consideration in terms of that monetary policy decision.
Prior to the January FOMC meeting, we suggested that the Fed was not ready to admit it erred by
hiking in December, if for no other reason than it doesnt like to react to market volatility and
change long term expectations as a result of short term jitters.
But Dudleys statement suggests something deeper, particularly when coupled with the threat of
negative interest rates.

A March hike at this point is off the table. That is in line with what we expected, but look at how
much the odds of additional hikes have been reduced. There is no time in the next twelve
months that has a probability greater than 50% of another hike.
Just like we felt the December spike in rate hike expectations was too dramatic, yesterdays
market reaction also feels overdone. If the current market is based more on jitters rather than a
true deterioration of fundamentals, the Fed can likely still hike at some point later in 2016. But
four hikes seems outrageously high and the Feds own Blue Dot forecast released next month
will likely reveal a slower path of hikes (and will still be too optimistic).

So Why Didnt Rates Move?

If you werent sitting in front of a trading screen yesterday, you could be forgiven for asking why
rates didnt move much yesterday. 10yr swaps started in the mid 1.70%s and ended the day in
at basically the same level. But look what happened between 9-10am they dropped from
1.77% to 1.66% in just a few minutes. Not quite flash-crash worthy, but dramatic nonetheless.

The real plunge began at 10am when the ISM Non-Manufacturing data was released (basically a
reading on the service industry). While it still suggested expansion in the service sector, it
missed consensus forecasts badly and was the lowest reading in two years.
This type of reading alone wouldnt normally translate into a 10bp plunge in yields, but one of
the last remaining components of the bullish narrative is how the service sector will help prop up
the US economy (gig economy and whatnot). Take that away and couple it with a Fed official
potentially conceding error and you have a dramatic movement.

I of course turned to TBTIHEK for his thoughts:

Markets have lost faith in the ability of the Central Banks to positively affect the economy
anymore (neg rates dont work), the only channel left was in generating animal spirits, higher
asset prices, etc. Without that angle their ability to cushion a blow is basically zero. So markets
forced to find a clearing level, which I believe will be lower than here.

Bottom Line
We see very little reasons for rates to rise materially in the near-term outside the typical trader
profit taking.
As we noted in our December 11, 2015 newsletter, the 10T actually dropped 0.70% in the six
months following the first rate hike of the last tightening cycle.
Since December 16, the 10T is down 0.45%. Even a state schooler like me can see weve got
room to go lower here and precedent.
Add in a jittery market searching for a clearing prices assets, negative interest rate chatter, and a
backpedaling FOMC and things could get interestingtomorrows job reports just got a lot more
important (if thats possible).

Super Bowl Prediction

Part of the reason this newsletter is going out today is because who wants to write a newsletter
on Super Bowl Sunday? And who wants to read one on the morning after? Plus, I live in
Charlotte we are going to be on lock down Monday for the parade.
The line opened at Panthers -3.5 and has since moved to -5.5. That is still free money. The
Panthers should be favored by 30 points. Take the Panthers all day and wish Peyton well as he
limps off into the sunset to help his wife with her HGH problem.

PS - Cams greatest offense this year isnt his TD celebrations, the dancing or the dab. Its him
suggesting weve never seen someone like him play QB like this.
Eagles fans from the late 80s and early 90s could point to a certain QB that kicked a 91 yard
punt (a punt!) from his own endzone. The fourth longest punt in NFL history. Made by a QB.
Randall W Cunningham.
Or the electrifying (albeit distasteful) Michael Vick from five years ago. He was voted to the Pro
Bowl, led the Eagles to the playoffs, and broke fantasy football on one glorious Monday night
when he threw for three TDs and rushed for two more. In the first half.
Dab on that Cam. You can be great without claiming to be the first. Enjoy your Super Bowl
parade.
(Editors note: I had to find a way to mention the Eagles during Super Bowl week, my
apologies).

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