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Leveling The Playing Field February 15, 2016: FOMC - An Orderly Retreat
Leveling The Playing Field February 15, 2016: FOMC - An Orderly Retreat
And perhaps this turmoil will settle in the coming months and a full blown collapse will be
avoided. The Fed cant afford to say now, All hikes are off because of the lead time for reengaging hikes is so long (18 months leading up to December). If the Fed says no hikes, it really
means no hikes until the end of 2017. She cant make long term decisions like that based on
short term disruptions (if thats what this ends up being).
Yellen et al continue to talk about being open to a hike. But we will need to see an extended
period of calm before they can hike. What part of the global situation suggests that is right
around the corner?
The Fed is on hold for now, probably until at least the summer. And they need a lot of things to
break their way for that to happen.
Here is where things get really tricky. Most economic forecasts called for a slowing economy at
the end of this year even before this recent mess. Toss in a presidential election with polarizing
candidates and business could really slow down. In other words, the longer the Fed waits to
hike, the harder it becomes.
But..Yellen is like Colonel Jessep on his Code Red ordershe wants to hike. And she
wants to tell us she is hiking again. I think shes pissed she has 4.9% unemployment and cant
hike again. I think she wants to say she made a command decision about hiking in December
and thats the end of it.
(Imitating Jessup): She eats breakfast 300 yards away from 400 politicians that think they are
smarter than her. And nobody is going to tell her how to run her Fed, least of all the Ivy league
bureaucrats with no economic experience and a state schooler in Charlotte.
So yes, I think the Fed has a bias towards hiking, but cant hike in the face of global panic. And
if they can squeeze just one more hike in, Yellen can say we got off 0% and then pause. And I
would bet money a hike in that environment would come with some sort of assurances that there
isnt another hike for an extended period of time. We got to 0.75% and we are staying her until
at least the end of 2017.
We believe March is off the table, but April or June could potentially bring another hike if
markets settle down and domestic data comes in reasonably strong.
The next FOMC is March 15/16 and will bring an updated Summary of Economic Projections
(SEP aka blue dots) forecast for the economy and Fed Funds. As part of the orderly retreat, we
suspect the blue dots will show a slower pace of hikes. They will still be overly optimistic, but
the Fed needs to gradually back down expectations.
Retreat in an orderly fashion is still a retreat, no matter how you dress it up.
China Devalue Currency if China pursues further devaluation, it will exert short term, upward
pressure on USTs. But as you can see below, the dreaded Selling out of China! following the
August 11th announcement never materially impacted our rates materially.
Notice how the line goes screaming lower at the end of that graph? That was when the Fed
hiked in December.
Good call.
Steepness
With the front end up 0.25% following the December rate hike, the steepness between LIBOR
and 10yr swaps is at a three year low. In other words, the premium to go from floating to fixed
is low right now. Heres a graph showing we are back to 2013 levels.
.
Alternatively, a sustained move higher will likely require an extended period of calmness before
markets can start factoring in fundamentals again. Would you want to be the trader betting on a
sell-off in this type of environment? Better to sit on the sideline and now ruin your entire 2016
P&L budget because of one bad run.
Should I Swap to Fixed?
The premium to convert to fixed for 10 years is about 1.17%, which is basically four rate hikes.
That feels highly unlikely in the next 24 months. But I cant say four hikes over the next ten
years wont happen.
A lot of this newsletter has been spent on trader mentality, but it is important to highlight the
difference between a trader and a borrower. The single biggest difference is time horizon.
A borrowers time horizon is frequently 5-10 years until they sell or refinance. A trader, even
when buying or selling 10yr rates, can reverse their position within two seconds. They arent
committed to holding that hedge for the next ten years - they simply sell the other side and move
back into a neutral position. Hey, I was wrong. Time to change my position.
Borrowers, however, are living with these decisions for perhaps the next decade. While we talk
about trader mentality and the short term impact it has on rate movements, be sure to carefully
consider yourselves as hedgers, not traders. You cant reverse your decision in two seconds
when new information becomes available.
Thats why we encourage you to diversify your rate risk. Find a mix of fix/float that works for
your business and risk tolerance.
Jonathan Stewart is sitting next to me on the plane while I write this. Thankfully hes been
asleep the whole time because he may not enjoy my thoughts on the Panthers.
Or 10yr rates for that matter.
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