Leveling the Playing Field

August 24, 2015

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I cant stand Apples autocorrect. One of the more frustrating corrections involves my frequent
cussing. Maybe its Apples way of chastising me, but the F word is commonly corrected to
duck. But what the duck!??! just doesnt carry the same weight.
This past week I was in Boston for meetings, talking Sawx and deflategate and other points of
misery for Boston fans and someone asked if I had taken the famous Duck Tour. I had not, but
had some time to kill before my dinner meeting and so I booked it. I texted my wife to let her
know I was taking the Boston Duck Tour and guess what Apple autocorrected Duck to?
Yep.
That made for an interesting conversation. Thanks Apple.
What the Duck is Going on in Rates?
-

US equities had their worst week in four years.

Global equities had their worst week since May 2012
Chinese equities closed at five month lows
Chinese manufacturing data lowest reading in over six years
Golds best week in 2015
Crude oils longest losing streak in 29 years
Greek Prime Minister Tsipras resigned

Any surprise that there was a flight to safety all week? The 5yr Treasury closed the week down
17bps, the biggest one week drop two years. Approximately 1.43%-ish has been the
longstanding floor and although we tested it, we did not breach it. But if we do, it brings the
next stop into play 1.25%. The belly of the curve could go another 10bps+, particularly with
another VIX spike to help exaggerate movements. Meanwhile, the 10T tried to break through
2.00% unsuccessfully, but it isnt uncommon for a key level to hold the first time it is tested. I
have a wager with a colleague that the 10T will have a 1-handle at some point before month end
and after Fridays move, I like my odds even more.
From one trader on Friday: Looking at the 10yr yield weekly changes (4wma), we are currently
right in the peak of one of two classic stereotypical UST seasonal high points of the year. We
perhaps have another week or two of that sweet spot to go, in seasonal terms, until things settle
until the next UST high point in November (again, perhaps when hedge funds tend to square for
the year and when in recent years the market has tended to be at its most bearish about the
prospects for the following year).

Look at the market reaction following the FOMC minutes release on Wednesday. The market is
screaming at the Fed, DONT HIKE RATES!!! But Bullard on Friday reiterated that the Fed
is more sanguine than the market on the global outlook, which is about as reassuring as Tom
Brady telling me he didnt know anything about deflating game balls.

Can the FOMC soothe markets? Or is this the beginning of a painful adjustment?

Just last week we cautioned that the VIX was far too low and markets had grown complacent,
citing an interesting BofA report that showed the last time the VIX was this low was
immediately prior to the crash in 2008. Guess what happened this week?
The VIX got smoked, enduring the single biggest weekly spike ever and stocks got crushed.
High VIX readings are not usually correlated with strong economic conditions, so this is
definitely worrisome.

Rate Hike
The Fed is saying all the right things in an attempt to keep September in play, but I think that is
just to manage expectations. I still believe, however, that October is in play and if jobs data
shows strength, they may proceed with a hike. If nothing else, Yellen wants some flexibility to
cut interest rates if she needs to, so getting off the zero-bound range is still important.
Everyone we speak with feels like their business would be just fine if LIBOR climbed to 0.50%0.75%, so why not hike and couple it with a very clear message that this will not be a lengthy
tightening cycle?
The market wont seize up because of just one hike, but the fear of multiple hikes. If Yellen
eases concerns about LIBOR moving to 2.00%+, markets can take that risk off the table and plan
accordingly.
Perhaps the Fed hikes once or twice and couples the moves with a statement a la 2012, saying
something to the effect of we do not anticipate economic conditions warranting a hike above
1.00% until at least mid-2017 or some variation thereof.
The bottom line is that the Fed wants to exit ZIRP, while the market is concerned about the
outlier risk of a dramatic tightening cycle. A scenario like the one described above would keep
both sides relatively happy and keep market disruptions to a minimum.

Economic Data
Day
Tuesday

Wednesday

Thursday

Friday

Time

Report

Forecast

Previous

9:00 AM

S&P/Case-Shiller US HPI MoM

0.40%

10:00 AM

New Home Sales

510K

482K

10:00 AM

Consumer Confidence Index

93.3

90.9

10:00 AM

Richmond Fed Manufact. Index

10

13

7:00 AM

MBA Mortgage Applications

3.60%

8:30 AM

Durable Goods Orders

-0.40%

3.40%

8:30 AM

GDP Annualized QoQ

3.20%

2.30%

8:30 AM

Personal Consumption

3.10%

2.90%

8:30 AM

Initial Jobless Claims

275K

277K

8:30 AM

Continuing Claims

2250K

2254K

11:00 AM

Kansas City Fed Manf. Activity

-4

-7

8:30 AM

Personal Income

0.40%

0.40%

8:30 AM

Personal Spending

0.40%

0.20%

8:30 AM

PCE Core MoM

0.10%

0.10%

10:00 AM

U. of Mich. Sentiment

93.1

92.9

Speeches and Events

Day

Time

Tuesday

3:55 PM

Wednesday

10:00 AM

Thursday
Friday

10:25 PM

Report

Place

Fed's Lockhart Speaks to Public Pension Funding Forum

Dudley Answers Questions At Press Briefing on Local Economy
Kansas City Fed Hosts Symposium

Jackson Hole

BOE's Mark Carney Speaks

Jackson Hole

Treasury Auctions
Day

Time

Report

Size

Tuesday

1:00PM

2-Year Note Auction

$26B

Wednesday

1:00PM

5-Year Note Auction

$35B

Thursday

1:00PM

7-Year Note Auction

$29B

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