Monday, February 15, 2010

Shift Work

Man, it seems like finance has been reduced to shift work these days, doesn't it? After being snowed in for a few days in greater NY last week, Macro Man finally made in front of his screens today....only to find much of Asia, the US, and even those pesky Greeks off for public holidays today.

Your author's sequesterment in a hotel room with little accompaniment (he only packed enough for an overnight trip) offered him a new perspective on the spending habits of the fabled American consumer, as he watched a few hours of television. Perhaps it hasn't really changed that much since Macro Man was resident in the US, but man oh man: at every (frequent) commercial break, the viewer was exhorted to spend his cash on a dizzying array of items that could be best described as "crap." Perhaps a four-piece "diamond" jewelry set from JC Penney for $49.99 really does say "I love you"....though if Macro Man were to present Mrs. M with such a gift, he suspects an altogether different message would be conveyed.

Equally jarring were the drug ads; given the ongoing debate about health care reform, Macro Man wonders how much of the prohibitive cost of prescription drugs goes to feed the pharmaceutical firms' advertising budgets. (Sure, he knows it's not large, but the contrast to the rest of the world, where drug advertising is not permitted, nevertheless jars the senses.) In any event, having watched more American advertising over the past few days than he had over the past decade or so, it really struck your author where America's relative manufacturing advantage lies. While US business isn't that great at manufacturing goods, they are second to none at manufacturing demand.

Anyhow, normal service has resumed today, albeit in the context of reduced participation. Another day, another sovereign-y debt worry, with rumours swirling about Dubai World debt holders receiving a "#1 all over" haircut on their holdings. While it seemed last night that this would submarine markets today, Macro Man has been surprised by the relative lethargy displayed on his screens.

One development that bears watching is the trend at the short end of the curve. While your author remains firmly planted in the "Fed doesn't hike in 2010" camp, Bernanke's comments on the discount rate have muddied the waters a bit. Moreover, it is curious to observe that sterling LIBOR has begun ticking higher again after the BOE did nowt this month.

At some point, playing the short end is going to get very, very tricky, for the simple reason that LIBORs are, for all intents and purposes, a complete fiction, a political construct. How much three month money do you think is being lent in the dollar market at 0.25%? Macro Man's guess is that the answer rhymes with "zero." Ditto sterling.

So if LIBORs don't really reflect underlying supply and demand conditions, how can you tell when they are going to move, and how far they will go? Will supply and demand return as a driver first? Will we need to see reserves drained to effect that transition? What, if any, impact will a discount rate hike have, both literally and as a signalling mechanism?

These are the questions that Macro Man is trying to wrap his head around. In the meantime, looking at 2y yields provides a handy guidepost to the relative richness/cheapness of short ends. To be sure, they are impacted buy things like the sovereign wobbles at the periphery, but still; they give a decent flavour for where the risks lie.

And to Macro Man's reading, the risks lie skewed to somewhat higher short-end yields, particularly if and as the Greek situation fades from prominence. Such a shift need not be seismic, nor indeed particularly painful. Still, if Macro Man were long the front end (which, alas, he is not), he'd be inclined to book some profits relatively soon.


Matt Johnson said...

the discount story is a red herring. the fed thinks they'll have a better link between the deposit rate and fed funds if they raise the penality for being caught short fed funds. but the system is 99% excess reserves and 1% primary credit just now, so it'll have only the most marginal impact.

teh fed's still got the problem of way too much in teh way of reserves, and no certainly that they can drain them sufficiently to make effective fed funds equal to target.

the discount rate was +100bps over fed funds for 2003, and effective fed funds hit 100bps pretty much all the time. there is about 1tn more reserves now, so i expect it'll sag sub 25bps even if the discount rate is +100bps.

i'm bearish inflation, so i'm inclined to think that short ends remain safe for carry trades.

this is esp the case in the EU. wages are very rigid, and so many weak nations have uncompetitive prices, i can see 20% unemployment in greece, spain, portugal, and ireland. this will last for a long time- and create strong system wide deflationary pressures. Europe has a dead set deflation problem.

The US is not much better, with abnormal price increases making up the bulk of high CPI (trimmed mean & median measures are ~1%y/y). US core CPI is likely to trend down to sub 1% over teh next year. that's uncomfortably low.

if i'm right about this, there's every chance the fed will buy more bonds.

Matt Johnson said...


page 16 in particular

Matt Johnson said...

i just posted something on it for general benefit.

Anonymous said...

hi matt, you are right of course but that's not all the fed are doing.

in particular paying interest on reserves at 25bp (or 50, or 1%)should see the very short dates moves closer to that level (i don't think the agencies qualify for this, so presumably overnight money would be somewhere close to but below whatever they pay).

plus there's the term deposits, plus the long-term reverse repos. plenty of ammo for removing excess reserves and regaining control of interest rates.

this is all very nerdy but the upshot is the same as always: if you think the economy is strong enough that the fed will be move to hike, pay short rates and especially the 2 year. or the flattener if you don't like paying carry and you've got deep pockets...


Matt Johnson said...

for sure, the fed is setting up to do all these things. but they cannot yet do most of them. read the frbny paper - the specific problem the higer discount rate spread seeks to temper is that effective fed funds will lag IOR due to excess reserves.

when the time comes, the fed will use all these tool to try and tie up the caseh - but the GSEs don't have deposit accounts, so they give o/n funds at whatever rate clears the market. balance sheet has a cost, so eff will be sub IOR until you stop the GSEs from lending 400bn o/n every night.

flatteners also carry badly, as the paid short leg rolls down so fast. if you're bearish rates i reckon something like are 1y1y v. 2y1y steepeners or some such are best.

markets tend to put the hikes way out first of all, and keep the short end anchored which tends to widen the 1y gaps.

Anonymous said...

I'll lay you 20% unemployment in Ireland

Anonymous said...

thanks for that matt

But What do I Know? said...

Your observations on commercials are interesting, MM. I always wonder if people will become desensitized to "selling with sex" at some point, especially as they age, but it doesn't seem to happen. . .

But I like your "manufacturing demand" concept--turn on QVC the next time you are in that situation and you'll see it in all its glory.

Anonymous said...

rhymes with zero?
Manhattan w/o the fam? Enjoy.
Ta, JL

Anonymous said...

I always wonder if people will become desensitized to "selling with sex" at some point,....

So you think there's a chance people won't look at a vid of a good looking male or female because they see too many of them?

Yea, right and it's freezing in hell.

Bob said...

MM - in all your advertisement watching, did you happen to catch the actual sales figures at JC Penny?

After living from BBC land, you are forgiven for not understanding: in the US, fewer and fewer people are watching network TV.

The price of those advertisements keeps falling (because they don't have the viewers), but the TV networks haven't trimmed much overhead. In more than a few cases, mergers between networks (eg NBC and Universal) has resulted in a combined network with at least double the number of suits that of an internally grown network of the same size

With lower revenue prices, lower quality programming (overall, each network has a few good shows) but higher fixed costs, the networks are finding themselves in much the same situation as GM. They must sell more lower quality commercials to pay for a bloated headcount.

Jeffrey D. Benson said...

Isn't there greater concern that all of the lending rates are completely manufactured by the US government? Or, were you referring to the manufacturing of demand via financial not advertising channels? After all, the federal reserve has purchased $1.7 Trillion of treasury and agency bonds. What happens when the program expires on March 31st along with the housing incentive tax credit? I don't see any other option but another wave down in housing prices. I also don't see a revival of private credit demand. The US government has supplanted the entire private credit market for the past year. I wonder what life will be like without the life support?

Bob said...

MM - your observations on drug advertisements are xenophobic, bordering on completely misinformed.

If you follow the pharmaceutical industry at all -- you know that 99% of global drug research (at the moment) happens in the US. The few drug companies that still exist in Europe do 100% of their research in the USA.

While there are LOTS of inefficiencies in the US medical system, one unfortunate element that goofs in Canada and Europe don't want to admit is that the US consumer pays for 100% of drug development costs -- effectively subsidizing the rest of the world

If Canada and the UK actually paid their fair share of drug costs (instead of getting a free ride off the US consumer), their drug costs would be easily double or triple what they are now.

When you have a vibrant R&D culture, LOTS of new ideas come forth. Some of them are good, many are bad -- all of them make commercials.

Europe's pharmaceutical R&D culture is so institutionalized, homogenized and resource constrained that it essentially does not exist.

Just as censorship (however well intended) will stifle good writing, Europe's controls on drug development have pretty much forced Europe out of pharmaceutical research. CEOs of European drug companies have publicly stated as much

Europeans really need to think more carefully what you wish for -- if the US shifts to a government controlled health system, some inefficiencies will be reduced -- but also a lot of cross border subsidies

James said...

I realize that the world is always changing, but the interventions from the governments around the world is messing things up like crazy.

Jeff is right, what is going to happen when they stop? I bet everything goes haywire, but if they start up again everyone will know that his system is insolvent on a massive scale. How people begin to act after that is anyones guess.

The only way GDP grows is through massive and perpetual borrowing. The US GDP is 40 percent than in was at the beginning of the decade, but debt more than doubled. How is that real growth?

Macro Man said...

Bob, what on God's green earth does that have to do with the desirability of advertising those drugs on television?

Anonymous said...

I am sensing some sexual tension between Bob and MacroMan.

Me thinks they both protest too much

Anonymous said...

"that the US consumer pays for 100% of drug development costs -- effectively subsidizing the rest of the world"

Given the effect the US has had on global health I'd rephrase "subsidising" and call it repaying the rest of the world!

Anonymous said...

Not that most of the US needs further convincing, but we now have irrefutable evidence that banks must be prohibited from prop trading:

Henry Paulson is opposed to the idea

The man really needs to repay all the money he plundered from the US Treasury, or else else he should just shut up

If he wants to voice any more opinions of how his cronies can steal more money from taxpayers, his illegal activities need to be investigated and he needs to be in prison

If anyone outside Goldman Sachs had ordered AIG to lie to the SEC -- they would be convicted and banned from the industry for life.

Paulson should be too

Gary said...

Over the weekend, new polls of the German populace show 80% of Germans are opposed to a Greek bailout

All the political parties in Merkel's coalition (including her own) have publicly stated opposition to a bailout.

Former ECB chief Otmar Issing said that a Greek bailout would "deal a major blow to Euro credibility"

And further details have emerged on how Greece essentially committed accounting fraud, with a lot of help from Goldman Sachs, when it first joined the Euro -- which is lawyer speak for saying that Greece never lawfully joined the Euro, so obviously it can be ejected

About the only support for a Greek bailout comes from out-of-touch academics, prop desks with big Greek debt positions, and EU politicians interested in keeping the facade of the EU alive. In short, support comes from losing traders talking their own book.

A super-majority of those that will actually have to pay the costs of a bailout are opposed

James said...

"gary on the kick drum come come gary on the kick drum"

Anonymous said...

Are you kidding me? I don't know how my life would be without my "Slap Chop" and "Shamwow".

Anonymous said...

MM: Perhaps a four-piece "diamond" jewelry set from JC Penney for $49.99 really does say "I love you"....though if Macro Man were to present Mrs. M with such a gift, he suspects an altogether different message would be conveyed.

For some, its the thought that counts.

For overpaid yuppies, its the cost of the gift that counts

Its easy to spend a few thousand at Harry Winston's when the money comes "free" from taxpayers and not your own hard work

Anonymous said...

Top selling drugs in the world:
1) Lipitor by Pfizer
2) Plavix by Bristol Meyer
3) Nexium by Astra Zeneca
4) Seretide by Glaxo
5) Zocor by Merck
6) Norvasc by Pfizer
7) Zyprexa by Eli Lilly
8) Risperdal by J&J
9) Prevacid by Abbot Labs
10) Effexor by Wyeth

How many of these drugs are made by US companies? Enough said...hat tip to Bob

Anonymous said...

I'm the happiest dad on earth when my 4 & 8 year old daughters give me a card with a $1 gift from the Dollar Store. Best gift was a miniature plastic throphy that read "Best Dad in the World" which probably cost $1 or $2. In my book it is the thought that counts...but MM has a point...Americans are fixated on "crap". I wonder how much money I would make if I stuffed a whole bunch of cans with party favors and placed a label on the can that read "Crap". I bet you that I could make a fortune selling those in the US.

Anonymous said...

US consumers do buy a lot of crap, but we also buy a lot of high quality goods as well

Speaking as someone more culinary inclined (my wife and I love to eat out, but don't really care about jewelry) -- British cuisine leaves quite a bit to be desired

The top restaurants in London serve French, Indian, German, Irish, Thai -- pretty much anything other than "home cooking". British people may not like crappy jewelry, but they certainly eat crap :)

Cultural jabs aside, not everyone wants to spend thousands of dollars / pounds / other wampum on some sparkly carbon atoms in a lattice structure.

Most humans need to eat, and you are what you eat

Gary said...

I have to agree with Jeff Benson -- at least the first part of what he said.

Short term interest rates, whether government debt or LIBOR variants, are political fiction.

I don't know a single company that is able to borrow at LIBOR. Banks publish whatever made up figure -- but at the end of the day, its nothing but a number that expresses how much yield curve "carry" the banks are extorting.

Banks can borrow at politically set rates, but real economy entities can't get loans at even 2x LIBOR -- not even if they have better credit ratings than the banks.

Banks have no balance sheet. They no longer have staff trained in loan evaluation -- only loan securitization. Since the securitization market is dead, and the bank has no balance sheet available (they are insolvent, especially if Geithner claims otherwise).

Betting LIBOR is more silly than betting at a craps table. At a craps table, you know your odds. LIBOR is a bet on politics and how long banks can keep up the illusion that it is all just a short term credit crunch (not insolvency).

That's a suckers bet -- you will "make" 1% for a couple years, then you will lose 15%

Anonymous said...

British cooking lessons:

1. Take a large slab of beef covered in fat, and boil it in a huge cauldron for three days

2. After three days, a special emissary of the Queen will arrive and sample the beef, checking for taste, colour and texture. If it has any of those things, it goes back in the cauldron to boil another three days

3. After boiling to mush, the beef is formed into plastic looking "steaks" which are broiled until they ossify.

4. The ossified beef clumps are presented with overcooked vegatables -- some of which may even be edible

Anonymous said...

Typical US take on British food ... ergo London is Britain and all things culinary may be found there ..the only thing worse than your culinary analysis is your paucity of geographical knowledge ...Obama forget Health care and concentrate on Education ..or should that be Edjucakion.

Anonymous said...

In fairness to the awful London cuisine, it should be mentioned that you can get great lamb dishes in Edinburgh -- oh wait, that is Scotland.

Um, well England does have fish and chips... but if you want real pub food you have to go to Dublin -- oh wait, that's Ireland.

The top restaurant in London is McDonalds, followed by Pizza Hut -- American retribution for years of British tyranny!

Anonymous said...

Honeybuns ... I love you so much I bought you this diamond!

Several hundred South Africans were killed to get this, not counting thousands more killed in various wars England pursued to initially conquer and then suppress the South Africans. And that whole apartheid thing. By gones! The point is I love you so much

And to prove I can spend more than the other guys -- I mean that I love you -- I bought this shiny carbon atom lattice structure!

Look, it sparkles! All the blood of the people killed getting it has been cleaned off

This proves that I got culture -- lotsa culture. I got culture out my ass! I am a regular proper English gentleman, I am!

Anonymous said...

Smells like derivative default in the making. Now that would be nice.

igk said...

Hmm. Funny, LIBOR might be political fiction, but I can borrow several hundred million at LIBOR +. + what? Somewheres between 100 and 200.

If you are willing to politically construct LIBOR at 25bps. Borrowing at 175 still sounds pretty good to me.

Point being, LIBOR is a reference rate, and one widely used at that.

Nic said...

Hardly anyone seems to cook anymore in Britain but I'm not sure I want to be lectured by the people who invented corn dogs, spam and velveeta cheese.

Bob said...

igk -- claiming (without any proof) that you can borrow at LIBOR+150 is absolutely meaningless.

You aren't saying a word about the credit status of whatever entity is supposedly getting LIBOR+150 ... so your comment has no context. If you are a credit worthy counterparty, the spread should not be anything close to 150bp.

If this entity of yours is low credit -- than your spread is extra meaningless. Its widely known that banks are "refinancing" garbage loans into FNMA/FHLMC's problem. If this is your case, then you didn't pay LIBOR+150, you got a political loan at whatever rate Geithner needed to quote to avoid the appearance that he is bailing out banks still.

Second, the banks are giving a few token loans at LIBOR + huge spread -- just to keep the populist politicians at bay.

Saying one entity supposedly got a loan (if true) is meaningless. What about the other 99 that were denied (at any interest rate)?

Banks have no balance sheets to work with -- not even the banks are disputing that. You got lucky (supposedly) and got the token loan? Whoopeee

Still doesn't make LIBOR anything more than political fiction

Anonymous said...

@nic Hardly anyone seems to cook anymore in Britain but I'm not sure I want to be lectured by the people who invented corn dogs, spam and velveeta cheese.

Its entirely possible that these foods were invented in Britain, but were so overcooked that someone mistook them for concrete

オテモヤン said...


Anonymous said...


Watch out for those pesky Swiss.

Anonymous said...

regardless of which country's cuisine is edible / not ... the fact is MM should not be attacking his birth country based on his experience watching hotel TV while being stuck in a snow storm

A "proper English gentleman" doesn't act like an Ugly American and demand that the country he is visiting re-arrange everything to the guests liking.

Why don't the stupid French in Paris speak American like everyone else? ... because its Paris

Why don't New Yorkers watch the BBC like "English" citizens? ... because its New York

Madonna is now living in her English estate with her fake British accent -- makes her appear ridiculous.

MM doesn't sound any better

Bob said...

@Anon 2:12

That article does not say where any of the research is being / was done.

The big Swiss pharmas do all their research in the USA, even if they have their headquarters in Switzerland. Europe made R&D impossible years ago.

The unfortunate truth is that the US is starting to emulate Europe under the guise of controlling cost -- the drug companies are doing less research and more litigating

Europe's tactics control costs in the short run (look what low R&D spending did for GM in the 1960s versus a decade or two later). But long run, Europe's bureaucracy (and soon the US's bureaucracy) stifled all innovation.

Not exactly something for Europe to be proud of