Thrown for a curve

The sport of baseball is unusual in the extent to which a player's contribution to a particular game, season, and career can be measured through statistics. As such, there is a thriving industry of baseball analysts who evaluate the true worth of present, historical, and indeed prospective baseball players on the basis of their statistical records.

Among this community, one of the more celebrated players of the past forty years in Bert Blyleven, pictured left. Mr. Blyleven was not the best pitcher of the past forty years, but he is one of the most under-appreciated by mainstream analysts and casual fans. Part of the rationale for this is that many of the teams he played for were mediocre, and it's difficult for a pitcher to assemble a winning record with no run support. Then there's the nature of his pitching; Blyleven was a curveball specialist. While he notched up plenty of strikeouts with his wicked "deuce", he also gave up a prodigious number of home runs when his curves were a bit too straight. The treatment of Mr. Blyleven, whose Hall of Fame case is a cause celebre amongst baseball's analytical community, suggests that perhaps curveballs are structurally under appreciated by the mainstream baseball community.

Regardless, the curveballs thrown up recently by the fixed income market have not been appreciated by the financial community. The carnage in short-end yield curves has been messy and bordering on the epic. Rate hikes are now priced in by year-end in each of the G4, according to OIS curves; the price action in LIBOR-based products, such as December short sterling (pictured below) has been gruesome.

So what's going on here? Have markets finally woken up to the secular inflation threat that Macro Man's been banging on about for a year and a half? Perhaps; US 5y/5y breakevens have widened quite sharply over the last couple of weeks.
But even Mervyn King, the uber-hawk, has suggested that there's not a heck of a lot that the BOE can do about inflation in the short term, and indeed that the Bank shouldn't be trying to get inflation back to target in the short run. So if inflation is a legitimate worry, and central banks are constrained from tightening by the economic cycle and credit crunch, surely that's a screaming sign that yield curves should be steepening?

Nope. Yield curves everywhere have flattened, confounding economic analysis and, oh by the way, generating a gazillion dollars worth of losses.
Such a curve ball is hardly unprecedented. If way enter the "way-back" machine and have a look at the last aggressive Fed easing cycle, what do we find? A horrible squeeze higher in 2 year yields in the months following 9/11, with the trough-to-peak rise totalling nearly 150 bps.
Ultimately, of course, 2 year yields traded very substantially lower. It just goes to show that when the market starts throwing curve balls, discipline is important. Far better to wait for the market to hang one of its curveballs and knock it out of the park than to strike out like one of the 3,701 guys that Bert Blyleven dismissed in his career.
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jdc
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May 23, 2008 at 11:56 AM ×

It's not much of a target if you don't feel you ought to be trying to meet it, really, is it?

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Macro Man
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May 23, 2008 at 12:49 PM ×

I think it's mroe the point that their target is on a 2 year horizon, and because of the 'headline' nature of the current miss, they are basically powerless to drive inflation back to target within 1 year.

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jdc
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May 23, 2008 at 1:15 PM ×

This is true, but if my target is permanently two years in the future, I can always claim I'm going to meet it - leaving me totally unaccountable for at least two years, and probably longer.

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Macro Man
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May 23, 2008 at 1:23 PM ×

I would argue that inflation is only an appropriate target during periods of mean-reverting headline. Over a longer term, I prefer nominal GDP targets, as noted a few days ago.

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t
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May 23, 2008 at 5:03 PM ×

I would be curious to see any relationship between the steepening/flattening of the yield curve and changes in the oil price.

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Mr. Prop
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May 23, 2008 at 8:30 PM ×

Higher oil is a flattener as long as central banks are viewed as credible. Why? Because curves discount a central bank response by pricing in real yields forwards above neutral on the expectation that this slows growth and allows the CB to meet the inflation target. Now you may want to argue that we are on the cusp of questioning that credibility, but what is built up over 15yrs is not easy to destroy. My suggestion for anyone who wants to bet that this credibility is at risk is to position for 5y5y breakevens to widen. Indeed, recent evidence suggests the assymetry of running that position against a curve flattener. Of course hindsight is always 20-20...Conversely, I believe if oil collapses, real rate risk premium rises on future higher growth expectations - The trade may be now, sell 5y5y breaks, put on steepener, and hedge it with an oil call

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D
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May 23, 2008 at 11:59 PM ×

It's hard to shape expectations after you've lost the trust of the market. Banksters have their nuts in a vice because it's price inflation, not monetary inflation. There's a distinction to be made.

It's also why I see precious metals being the likely bubble to follow the next dump. Hot money chases alpha, right?

We like:

1) Liquidity
2) Leverage
3) Volatility

I will be reviewing PM market prices/charts over the next three months for a bottom (lower) and the beginnings of a multi-month bull trend. Not a guaranteed trade I will make, but something I am watching.

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D
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May 24, 2008 at 12:08 AM ×

A funny anecdote -

I have a friend with a freight and chemical tote sales company. He has been getting cold-called by commodity brokers for the past few months. He said a recent guy told him he only needs to put in $4,300 (miNY margin + vig) to make money on oil going to $500. We could go much higher in a blow-off, but we are definitely closer to the end of this.

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JAM
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May 24, 2008 at 3:54 AM ×

Good posts lately MM

Interesting you mention Bert Blyleven, he does color on the Twins telecasts here in my home state of Minnesota, thought you may get a kick out of this Clip.
Warning strong lanquage here. CHECK IT OUT. LOL
http://www.afunnystuff.com/videos/Funny-videos/Bert-blyleven-screwing-up-on-live-tv.html

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D
admin
May 24, 2008 at 6:06 AM ×

jam -

Hello friend...I was born in Robbinsdale. The family business is in Minneapolis, but I am in Chicago these days. I spend a fair amount of time in MN over the summer on the lake.

I miss watching Kirby.

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Macro Man
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May 24, 2008 at 10:08 AM ×

Jam, I remember hearing about that when it happened. Rather amusing. I used a picture of Blyleven in a rather fetching 70's Pirates uniform because I lived there as a kid when BB helped pitch the Bucs to their last Series title in '79.

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May 24, 2008 at 6:05 PM ×

Main point being: 'You gotta have balls to play in the market'. Now may be the time to start monitoring not only curvature, but market symmetry? Check your portfolio often, after bathing.

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wcw
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May 24, 2008 at 7:17 PM ×

Off-topic, but there's a great Blyleven anecdote at http://baseballanalysts.com/archives/2008/01/the_yellow_hamm.php

"But then the new guy threw something I had never seen before. It was gorgeous, and it was terrible, and I wasn't sure I had seen it correctly."

It's short and worth a read for fans of Blyleven's pitching. His announcing.. well, not so much for me. I'm a Jon Miller man there.

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Macro Man
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May 25, 2008 at 10:46 AM ×

Thanks, wcw. It was a nice story. While I, too, enjoy Jon Miller, for my money there's Vin Scully....and then there's everyone else.

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