the script for the coming episode, just cleared from e-mail tray [note by tj: annaly does hold much cmo, and would wobble as and when fed off-loads cmo even as annaly would benefit from steepening yield curve]
From: M
Sent: Wed, April 20, 2011 3:14:36 PM
Subject: Re: simple summary
Thanks guys.
Given those comments, I'll continue to hold both my gold and my Annaly, and increase more when the panic selloff ensues after a 25 basis point hike in Fed rates, as it promises to be the "last chance" to play the game at a reasonable entry level.
M
On Wed, Apr 20, 2011 at 1:15 PM, J wrote:
super summary by G.
though offers no practical way out, because there is no way out.
below see my e-mail exchange with one-time manager of (1.5 bil) considerable-moolah, but i do so without authority and so remove name. his track record is good with me, and his take also has merit this time.
From: PC
Sent: Wed, April 20, 2011 8:51:41 AM
Subject: Re: Strategy
Then the curve stays just where it is --and we make money the same way as the banks --borrow short term money and invest it in longer term assets.
1) buy UST and then repo them out: wen will be scared
2) Buy PFN and let them do the work
3) buy equities of all good banks -- jp morgan type not BofA type
4) S&L's
On Apr 19, 2011, at 5:46 PM, Jay wrote:
what if #1 is the truth but #2 is the popular spin that all believe in?
From: PC
Sent: Wed, April 20, 2011 8:43:22 AM
Subject: Strategy
GUYS,
As noted in yesterday's meeting- I believe it is critical to understand the fixed income situation and thereby derive expected equity, commodity, fx outcomes.
To that end, please read this long article twice! Seriously ...
hussman.net
This gives a very good understanding of what choices the Fed has given itself and several yardsticks we can follow and measure.
Barring an exogenous shock: four potential outcomes
1) bad economy ? Fed starts QE3 ? 1-4 bp 3 month Tbill yields ? stable to no inflation
2) okay economy ? no QE3 ? any market driven rise in short term rates has to be scrubbed essentially by huge sell off of balance sheet or else ? big rise in inflation
3) heating up economy ? no QE3 ? Fed raises rates by 25 bp ? has to be scrubbed by a sell off of over $600 billion in USTmort (since front loaded effect) ? every rise of 25 bps in later stages would still require a sell off of over $125 billion in UST/mort? so Fed keeps raising rates and selling securiites to reduce monetary base.
4) okay or heating up economy ? no QE3 ? Mkt or Fed raises rates by as little as 25 bp in short end? no FED sell off of securities ? would lead to a 40% rise in CPI
Important note: as FED raises rates it wipes out its capital and since it is currently levered 50 to 1 that is a problem. It will have to live off the spread just like other banks so it too will need a steep curve to survive.
So I doubt that #1 or #4 will happen? so # 2or #3 means that the FED can only raise rates by a very small amount (max 25-50bps this whole round) because they cannot afford to either wipe out their capital nor can they dump $ 1.4 trillion of govt debt (out of a total $ 2.5 trillion monetary base currently) back on the market in short order to stifle the inflation effect.
So probably they will raise rates 25 bp and sell back too little debt ? raising inflation quickly.
Quite oddly: raising rates without sterlizing the effect by quickly selling down the balance sheet will lead to high inflation. If they don't raise rates at all, then you can be sure they will be trying to carefully sell off alot of UST to reduce their balance sheet and get out of this precarious situation. This will have a negative effect on bond prices and I expect the curve to steepen alot. So long rates up alot and short rates stay very close to here.
Conclusion:
1) tips and gold now;
2) find a curve steepening trade to put on --expect the intermediate and long end to back up alot
3)invest in nly and cim only on the expected pullback due to either the first rate hike or the Feds need to sell UST and CMO's back into the market (careful here it could hit mortgage prices hard)
4) what else : perhaps high yielding reits such as PDM after the backup in mort prices and any short end rates
5) your other ideas gentlemen?
From: C
Sent: Wed, April 20, 2011 1:00:28 PM
Subject: simple summary
Here is a good summary comment of where we are I am sending with permission. Simple and to the point.
From: G
Sent: Wednesday, April 20, 2011 10:19 AM
Dear all
… this little remark calls for an answer, which will probably surprise no one
My points have been, by order of importance
- the dollar is the reserve currency of the world. The dollar has two prices, interest rates and exchange rate. All the prices in the world derives directly or indirectly from these two prices. If they are manipulated, it means that they are false prices. If they are false prices, all prices in the world are false, and nowhere is it more visible that in the asset markets where it leads to a massive over performance of zero duration assets (gold, silver, French wines, art...etc) vs long duration assets. Any economic system but capitalism first needs a system of free prices We are NOT there anymore
Abnormally low rates prevent the destruction part in the creative destruction process by maintaining alive a considerable number of zombie companies
This leads unavoidably to a massive mis allocation of the factors of production (land, labor ,capital), the only winners being government spending and zero duration assets
This mis allocation of capital leads to lower growth, higher unemployment structurally and to bear markets
Put it simply,capitalism cannot work without free prices any more than without a proper cost of capital. The sooner we can return to a normal cost of capital the better
The only reason to maintain rates at zero is if banks are bankrupt. If 3 years after the problem, they are still bankrupt. let's nationalize them.
Having an abnormally low cost of capital might be necessary in a recession cum banking panic, a little bit like the state of emergency when there are uncontrollable riots in the streets. But the Fed looks more and more like the Assad government maintaining the state of emergency for the last forty years
So while raising rates may not create growth, maintaining them at zero will certainly create a disaster ans is in the process of doing so, as in the 70's or in Japan for the last 20 years.
My quarrel against Keynesian policies as understood to day has always been the same. I do not understand how by ruining the saver ( negative real rates, euthanasia of the rentier), by allowing the size of government to go through the roof ("creating" demand) and by following a policy of beggar thy neighbor in the exchange rate market, thus making the local consumer poorer (the 3 pillars of a good Keynesian policy), you create any growth at all. But it probably does just show my lack of sophistication
G
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