(More) Silence Would Be Golden

By: Michael Ashton | Tue, Jul 12, 2011
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Most of the New York trading day on Tuesday was sedate, if you could overlook the fact that equity futures had a 25-point range overnight. Futures made almost a full round-trip, with the September S&P futures dropping as low as 1295.30 (from the 1318.60 close on Monday) before rebounding to a loss of only 2-3 points by the time traders walked in States-side. The IMF's new chief was the provocateur; Mme LaGarde said testily that the institution "is not just a cash machine" and that the Fund and EU are not ready to discuss the details of the next Greek bailout. Recall that the recent Greek vote was to release a small tranche of the last bailout, so that the country could make it the few weeks until the next bailout was prepared. If there is no next bailout (and probably even if there is), a default is a certainty. Remarkably, this still comes as a surprise to some investors, who took it hard.

But other investors stepped up to provide the needed liquidity to those who were anxious to exit, and stock and sovereign bond markets rallied at the expense of the dollar (which had been soaring in the middle of the night) and Treasuries. By the morning, a quiet cease-fire seemed to have settled over the market, and T-Note futures chopped in a 12-tick range while the S&P meandered between 1316 and 1323. Commodities, which had started the day somewhat weak, rallied to finish +1.2%, led by Grains.

Equity bulls thought they saw a chance to force short-covering when the FOMC minutes were released. Bloomberg had two headlines to make sure that everyone knew that the Fed hadn't "ruled out" QE3 and that "Fed Officials [are] Divided on Further Stimulus If Economic Outlook Remains Weak."

That's technically true; there are a couple of Fed officials who would continue to beat a dead horse for the sheer enjoyment of it. And look, I'd be the first person to point out the stupidity it would show if they did rule anything completely out ("One Hundred Percent" confidence is just as bad in reverse!). But the hard majority of the Committee has been very clear about how they feel about that issue, and moreover there is no sign that monetary policy since the crisis has done anything except support interbank liquidity and sown the seeds of potential inflation. I wrote yesterday about the fact that elements within the Fed still are searching for "what went wrong," but most of them at least know that something went wrong with very many zeroes attached.

There will be no QE3 unless banks start to shudder again like in QE1 - but mere economic weakness is not going to trigger more large-scale asset purchases (LSAP). Frankly, I think the next lever to be pulled would be a lowering of the reserve requirement, and that could be done without more LSAP.

But if the only way you get more QE is with a lot of economic weakness, I am not sure why I'd want to pile into stocks, which are certainly not priced for economic weakness...as the overnight performance helped illustrate.

After spiking on the release of the Fed minutes, in a feeble attempt to run the shorts, stocks rolled back over and ended the day on the lows albeit with a mere -0.4% loss. The problem is that the people selling overnight were probably not setting shorts, but rather getting out of longs.

Late in the day, Moody's downgraded Ireland to junk and kept her on negative credit watch. This shouldn't really be news, but it seems worth pointing out and it did snuff out a weak attempt to hold the market unchanged on the day.


Now, one interesting thing did come out of the FOMC minutes. Some might argue there were two, as the Fed laid out a detailed but very flexible road map about how a future normalization of monetary policy would be carried out. I suppose it is useful to know that the Committee isn't even going to try to sell any of their bonds until they've already begun to raise interest rates, and that sometime thereafter they'd begin selling assets very slowly over a three-to-five-year period, but frankly all of that has a big ol' asterisk by it: "*that is, if we feel like it and circumstances permit and the next Chairman doesn't have a different idea." We'll see how that pans out.

However, I was surprised and a little impressed that the Fed issued guidelines on public statements by Fed officials, and formally instituted a "blackout" period that for many years existed informally until Greenspan broke it one year and no one paid much attention thereafter. The blackout period is a period from Tuesday the week before an FOMC meeting until Thursday the week after the meeting; during that time Fed officials may not offer their views on monetary policy or economic conditions. The Fed said the guidelines on public statements are aimed at making the central bank "more transparent," but that's a red herring. Limiting speech can't possibly give more information. The new policy is meant to get the policymakers back in the ranks, and marching more in-step. That's not more-transparent. It may be clearer, in the sense that (as was the case in the Greenspan Fed) dissenting opinions will get less airtime so that it will be more obvious where the consensus lies, but it is indubitably more opaque.

Long-time readers will know that I applaud any move to make the Fed more opaque, even though it will seem as if this policy results in the Fed giving clearer signals. What will happen is that shifts in the Fed's view will happen out-of-sight and appear suddenly, and so we won't get a sense for the evolution of the argument and whether one side is gaining momentum until it actually happens. And frankly, that's where familial arguments should happen - behind closed doors.

Since the Chairman of the Fed right now is ridiculously over-confident, the policy is probably also aimed at making himself look better and at consolidating his hold over policymaking - and if true, that's definitely a bad thing. But it isn't clear that good ideas necessarily triumph with this guy, so I doubt that changes much.

Speaking of Bernanke, he will appear tomorrow to deliver the semi-annual Monetary Policy Report to the Congress. Day one is House testimony. The headlines will hit at around 10:00, but I wouldn't expect many surprises from his prepared remarks. However, given what has happened to the economy since his last testimony, despite QE2, I would expect some tart questioning in the Q&A period and I look forward to that.

Stocks are vulnerable and I believe will shortly test at least the overnight lows from last night. The 10y Treasury at 2.88% is likely to run to new highs (low yields) on the year as well, and as I wrote yesterday TIPS, as crazy as it is for the 10y real yield to be at 0.52%, are going to be trading well as long as Italy trades poorly. In my view, commodity indices remain the place to be.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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