It Don't Mean A Thing.....?!?!?!?!

Friday, February 19, 2010

Well, well, well. Yesterday's fixed-income polls proved to be very well-timed indeed; Macro Man cannot help but wonder whether we would once again see 55% of the respondents vote for "no FF hike this year" if the same question were put to them again this morning. Somehow, he thinks not.

The Fed has tried very hard to downplay the significance of last night's discount rate hike. Ex-ante, the minutes of the January FOMC meeting noted that a discount rate hike did not carry on specific implications for monetary policy. In real time, the accompanying statement said the same thing. And ex-post, Messrs. Bullard and Lockhart also downplayed the policy implications of the move.

This is all well and good, of course, but from Macro Man's perch to suggest that the move is utterly devoid of meaning is patent nonsense. First, and most prosaically, if the move had absolutely no meaning then there would be no point in doing it. Even if it was just intended to phase into an ECB-style "corridor" mechanism for Federal Reserve lending and deposit facilities, the widening of the spread between funds and the penalty borrowing rate will have some impact.

After all, it's notas if the Fed discount window is like the ECB marginal lending facility- used for a couple of days around MRO maturities, and then lapsing into disuse. Discount window borrowing, while well off the peaks of the crisis, is still pretty considerable- nearly $90 billion last week. That little 25bp hike has just added nearly $220 million to the annualized borrowing costs of those institutions paying a visit to the discount window.

Finally, it's worth recalling that the Fed's initial policy gambit in the entire crisis was a discount rate cut on August 17. They also cut the discount rate on Sunday, March 16, during "Bear Stearns weekend" before trimming both the disco rate and the Fed funds rate two days later. So it's perhaps a bit disingenuous to suggest that raising the discount has no meaning when they certainly intended it to have meaning when they were cutting it! Moreover, there's nothing to suggest that "extremely accommodative" policy necessarily means FF at 0 - 0.25%. After all, consensus calls for a steady stream of positive growth quarters this calendar year; if that forecast is realzied (and yes, it's a big if), one could credibly argue that rates 100 bps higher than current levels would still be "extremely accommodative."

Now, to be clear, Macro Man does not expect a FF hike this year. He does, however, look for reserves to be drained and believes that there's a decent risk that LIBORs tick up as a result (we're already seeing that in the UK, for example.) And so from a market perspective, he has little interest in owning the front end at current levels. If we look at EDZ0 and compare it with ED4 over the past few contract cycles, we can see that it looks pretty rich (though less so than a few weeks ago, in fairness.)

ED6, meanwhile, is in the middle of the pack. Of course, none of those prior contracts traded in to the context of a discount rate hike and possible draining of liquidity. And there was still a bum-clenching decline in the second and third quarters of last year- declines that occurred with much less open interest in ED6 than the current iteration of the contract has.
So while the Fed and much of the sell side are claiming that the discount rate hike "don't mean a thing", given current market pricing Macro Man ain't biting. If the labour market improves and CPI starts registering UK-style upside surprises, would you really be surprised if there was another 40-50bp bum clencher in ED 4-8? In many ways, it would be a surprise if there weren't one. So Macro Man is content to remain on the sidelines for the time being; far better to wade in when the blood is flowing than trying to ford the river at high tide.

Posted by Macro Man at 9:09 AM  


I agree MM, even if it's only symbolic, it's SYMBOLIC. Tightening, draining, whatever you want to call it, it's here, in a tangible way.

My colleague put a positive spin on it, namely it signals a return to normalcy and is therefore a positive, and that probably explains the muted reaction so far. But in a liquidity-driven market I'm not sure I'd be loading up the boat here.

Steve said...
10:22 AM  

Looks like a typical trial balloon which, given the market reaction, should strengthen the hand of the doves on the board.

Anonymous said...
10:22 AM  

it looks like primary credit was only $14bio, not nearly $90bio.


and FARWOLPC Index

But this is only the latest of a series of measures which will aim to tighten liquidity and gradually regain control of the front end, as discussed on this forum this week.

A popular trade is +FF -ED, particularly because FF-ED spreads are much narrower than Euribor-EONIA.


Anonymous said...
10:22 AM  

Melki, wouldn't you expect primary credit borrowing at the window to be substaintially less that total borrowing? I mean, surely it's only the unsound institutions (secondary credits) that need window access to obtain liquidity? I believe M. Whitney has made the same point- she thinks this move is quite negative for the smaller banks.

Macro Man said...
10:36 AM  

lets see how commodities react next week when the Chinese are back, my guess is not well

price action in HSI today was pretty telling I think

Rossco said...
10:36 AM  

Rossco, would have to agree. This week is silly season in China so we really have no idea how things are going to look on the SHFE and similar. Additionally, some folks might try to fade the equities down move if these futures start trading next month.

Nemo Incognito said...
10:57 AM  

hi macro - i would indeed, its just that the $90bio figure includes credit to AIG ($25bio) and TALF ($47bio), as well as the $14bio to which the dearer rate now applies.

so not so much disagreeing with the general thrust of the argument, as pondering what the immediate significance of this particular move will be.


Anonymous said...
10:58 AM  

non-commercial eurodollar longs are 2.58 to every one short as of the latest cftc data AND that is with a net gain of 170k new shorts over the last three weeks (the chosen ones). your description of potential friendly data/upward infation readings plays in with the trade of most pain in the front end -- namely lower. one would think nearly every rally will be a sell for the next bit.

Anonymous said...
12:03 PM  

The question I can't get out of my mind is, why yesterday? That is a puzzle, and an interesting one, I think. Why, for example, the eve of option expiration?

Steve said...
12:57 PM  

Dear Macro Man, I am surprised by your data and chart
the total funds concerned by the discount window now is rather 15 b USD
you should take the FARWOLPC index series in your bloomberg as discount rate pertains to primary credit only
am I wrong here ?

Anonymous said...
1:18 PM  

Ah yes, the August 17 surprise rate cut--on a Thursday night after someone had purchased a suspiciously large number of deep out-of-the-money S&P index calls that afternoon--maybe they were trying to help out the same guy on the short side of the trade this time? When I check the open interest numbers this morning I'll post if I see anything interesting. . . .

I mean, I don't want to be mistrustful or paranoid, but why do these things on Thursday night before options expiration? Surely someone at the Fed must be aware of the calendar. . .

But What do I Know? said...
1:35 PM  

But What, one analyst claims the Fed is "friendlier" the week of option expiryin terms of its day to day operations. It seems logical they know the calendar.

Anonymous said...
1:44 PM  

I think Bernanke and the doves did this to throw the hawks a bone. Either it is meaningless, or, if it really has a tightening effect, it is a mistake.

Core CPI just came in -.1 for January and y/y inflation has probably already peaked. Check out the metal inventories and oil stocks in the U.S., gasoline demand is DOWN from last year.

I predict this is not a sign of things to come, but may be disruptive enough to quiet those on the Fed hankering for early tightening.

BTW, this is the first piece I've read that actually quantified how much borrowing at the discount rate was actually going on, thanks.

Bob_in_MA said...
1:47 PM  

Nonsense...US equities will recover yesterday's after hour losses and push above yesterday's highs.

No need to make a thunderstorm in a cup of water.

Anonymous said...
1:51 PM  

I was one of 55% who thought there would be no FF change, but historically there is a high correlation between the two that cannot be ignored. That's to say, a discount rate hike almost always leads to FF hike within a few months.

In addition, after a dicount rate hike (coming after an easing cycle) within 6 months the yield curve flattens 40bp on average over the last 75 years. So, the historically steep yield curve could is looking a bit extended now.

Anonymous said...
2:04 PM  

This short-end "signaling" is irrelevant. The real question is what happens to the long end, and what Treasury long bond buyers "want". TYX is breaking out of a decades-long downtrend, and it happens to be at the neckline of a horrific inverse H&S. The bond market is what matters.

So do bond buyers want tightening, so NGDP can be held in check and the curve flattened?

Or do they want loosening, which means the ZIRP carry trade subsidy remains, and so that the Fed returns with more long-end QE?

Answer me the above questions, and I'll tell you which way bonds, stocks and gold will head. Maybe today we'll get the answer to the "tightening" one -- if the long bond heads down with equities, we'll know.

My answer: the long-end wants loosening, because its fear is not too much near-term NGDP growth, but sovereign risk.

David Pearson said...
2:30 PM  

Melki and MacroStudent are correct - the Discount Window borrowings are closer to $14bn and the correct Bloomberg time series is FARWOLPC Index . See the Primary Credit line item on Table 1 of the H.4.1 Release here:

- mojakus

Anonymous said...
2:49 PM  

David to my reckoning the bond market is why the Fed raised the rate, which also dovetails with the timing, ie they were worried about it. Bonds have gotten clocked and although the spread to mortgages is extremely low (about .40% according to my data, down from 1% last October) it's only a matter of time before they begin to rise.

Steve said...
2:55 PM  

The timing of the move was rather interesting, coming the evening before options expiration. Perhaps a reminder to the banks that they are trading with the Fed's dime, after all.

leftback said...
3:10 PM  
leftback said...
3:17 PM  

January Producer Prices:

The 12 month change in crude goods is + 25.2%; the 12 month change in intermediate goods is +4.6%, and the 12 month change in finished goods is +4.6%. A few months ago (Oct), the 12 month change in crude goods was -14.1%. In November, it rose to +4.7%. In December, it rose to +12.3%.

jill said...
3:25 PM  


The long end is unch, so I don't think the Fed's move had much impact. I agree, though, that the Fed is trying to help out next week's auctions with the Greek bond on deck. But I honestly don't think they get it: its likely they think the bond market is worried about growth-induced inflation, because the Fed looks at the world through an output-gap prism. I think they would be very surprised if yields rose on lower growth expectations, which is what happens in every other sovereign risk-driven bond market.

Bottom line, IMO the long-end needs some love, and it will behave badly if the Fed doesn't show it (more QE).

David Pearson said...
3:56 PM  

Everybody has it backwards. Raising the discount rate is significant, keeping the target rate low is meaningless.

der Tillman said...
4:19 PM  

"The 12 month change in crude goods is + 25.2%"

This is all pretty much to be expected, no, given where $wtic and $gaso were trading last February? Now that crude is stuck in a range and with USD rising or at least stable, inflation seems likely to moderate. The y/y PPI numbers are probably going to peak soon if they have not already done so.

Typical options expiration trading today. SPY 111 has already been tagged, I'm sure there is some interest in tagging 112 as well before the dollar rally resumes. Monday will be a very different picture from the usual Magic Monday, IMO.

leftback said...
4:52 PM  

It may prove difficult to resist wagering on the open-air shell games the Fed periodically orchestrates. After all, the "signal" was clear, more rate hikes sooner.

However the Fed is out to trick the market, especially around sensitive dates. If you always take them at face value you're bound to regret it.

There is no credible avenue for the Fed to shrink the its balance sheet. Nor the ECB, in fact they could conceivably expand further and venture into QE in an emergency situation.

Ouzo Man said...
4:55 PM  

Re: S&P index options--nothing stands out too much. 15,000 increase in the 1100 put open interest.

But then again, those are only what we can see. . .

But What do I Know? said...
6:07 PM  

I agree LB, feels like the genie is still in the bottle. If you look at the week following option expiration going back 18 months or so, yes most expiration weeks are positive (and not surprisingly given we have been in a bull market for 11 months) but more reliably, the following week is a reversal, Magic Monday notwithstanding. This holds if expiration week is negative, too.

Steve said...
7:40 PM  

Agree David, not much improvement in the long end although it is the only part of the curve that is better on the day. But the classic addage is that an alert Fed is good for the long end, so even though it didn't work all that well (yet), especially given the timing I think that's what they were up to. Ben must have been pre-approved to go and could have been holding it in his pocket.

Steve said...
7:44 PM  

It Don't Mean a Thing if You Ain't Got That Swing...

Silly Thing

leftback said...
8:08 PM  

Haha is that your Tiger joke.

Nic said...
9:53 PM  

In the past whenever the Discount Rate changed it was always regarded as a very concrete and significant change in the Fed's posture. Whether Fed Funds was like to follow shortly afterwards, or after a long pause, was always an open question but participants thereafter followed with an eagle eye the flow of data in the weeks and months that followed the Discount Rate move. There is absolutely no question that the attitude of Fed watchers changed fundamentally in the wake of a Discount Rate change, whatever gloss Fed governors might try to put on their action.

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8:23 AM  

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