It's official: the glass is (almost) always half empty for the Fed

Well, the Fed minutes were generally just as dovish as you might have expected given Yellen's press conference and her subsequent speech last week.  Macro Man had to laugh at the one bit where the committee

"agreed that their ongoing assessments of the data and the implications for the outlook, rather than calendar dates, would determine the timing and pace of future adjustments to the stance of monetary policy.

Just a couple of sentences later,

"several expressed the view that a cautious approach to raising rates would be prudent or noted their concern that raising the target range as soon as April would signal a sense of urgency they did not think appropriate."  

Funny, Macro Man could not find "April" listed amongst the data releases on FRED, though strangely enough he did find it on his calendar.  Anyhow, so much for "every meeting being live", assuming the passage above quotes Yellen and her coterie of doves.

Macro Man has never paid much attention to the "balance of risk" tables in the minutes, but after yesterday's release he went back and tabulated the FOMC's balance of risk estimates since they were first released in 2011.   The calculation method is simple:  respondents suggesting risks to the upside less respondents suggesting risks to the downside equals net balance of risk.  The results, meanwhile, were remarkable if not totally surprising:   The FOMC is an institution for whom the glass is always half empty, the sun is always in shadow, and the postman never rings once, let alone twice.

The pessimism is perhaps most understandable when it comes to GDP forecasting, as growth outcomes have generally undershot the Fed's forecasts as the FOMC has slowly come to grips with the decline in trend growth.  (The median estimate for long-run GDP growth has fallen from 2.65% in 2011 to 2.0% now.)  Still, even though growth has generally undershot the Fed's forecasts, it's still notable that not once over the past five years has the FOMC ever thought GDP risks were not tilted to the downside.

The data on unemployment is even more remarkable.   Anyone who's followed the labour market and the Fed's forecasts for the past five years knows that a) the unemployment rate has fallen sharply in more or less a straight line, and b) the Fed has persistently underestimated the degree of the decline in the unemployment rate.   Yes, there have been mitigating circumstances via the decline in participation, but the Fed's forecasting track record has nevertheless been execrable, comfortably under-performing a simple linear extrapolation ever since the SEP forecasts have been published.  This makes it all the more remarkable, therefore, that not only have the Fed's unemployment rate forecasts been too high, but they've almost always thought that the risks to those forecasts have been tilted to the upside!  In fact, in the three years from June 2011 to June 2014, there were only two instances in which even a single member of the FOMC thought that the unemployment rate risks might be tilted to the downside.


Finally, we come to the core inflation risks, which these days are probably the most important.  It's easy to forget that a few years ago the core PCE deflator actually printed above 2%, though of course at that point the Fed didn't give a hoot because there was too much slack in the labour market.  Back in the early days of the SEP, however, the committee did deem the risks as tilted to the upside for inflation.  From mid-2012 onwards, however, the risks were justfiably deemed to the downside as core PCE inflation undershot both the committee's forecasts and its 2% inflation target.  Since the middle of last year, however, something remarkable has happened.   Not only has core PCE turned higher, printing at a level above the FOMC's implicit 1 year forecast for the first time in nearly four years, but the committee's assessment of the risks to their forecasts have also turned the most bearish ever.  Despite the recent upside surprises to core inflation prints, not a single FOMC member has deemed the risks as tilted to the upside in the last two forecast rounds.

An obvious catalyst for this apparent wedge between the performance of inflation and the Fed's assessment of risks is of course overseas developments.   This was clearly highlighted in both the minutes and in Yellen's recent communications; as Macro Man observed last week. the Fed has joined large swathes of American manufacturers in outsourcing its mandate to China.

An interesting question is how long will the wedge between the Fed's pessimism and data suggesting mandate-consistent conditions endure before the Fed is forced to capitulate in its view?  To be sure, recent trade data will have done little to assuage the Fed's concerns, but if employment and inflation data continue to hold up, will the Fed blink at some juncture?

If it endures long enough, then yes.   Back in the good old days (cough, cough) one might have expected the bond market wolves to pounce on any perceived policy error by selling bonds and steepening the curve.  Alas, the feral bond market vigilantes have been hunted to the brink of extinction, replaced by docile lapdogs who salivate whenever the white-coated Fed PhDs ring the bell for another course of easy money.  

And ring the bell they will, if the last few weeks is any indication.  Macro Man had a play with his Taylor Rule model and has come up with a set-up that has mapped the Fed's reaction function pretty well.  It certainly seems as if Yellen has opted for the "optimal control" policy framework after all, as recent communication clearly suggests a Fed content to remain lower for longer, even if it means raising more aggressively should inflation surprise to the upside.  (Ed.'s note: isn't that what it's been doing?)

In any event, by changing the pre-crisis settings to allow for a lower natural interest rate (1.5% from 2.0%), a much lower NAIRU (4.5% from 5.5%), and a higher inflation target (2.5% from 2.0%), we can see the QE period, the taper, and then eventually (and gradually) an argument for a slight rate rise...which is where we are now.

Should the Fed's median forecasts for growth and inflation eventuate, it would argue for another 1-2 rate hikes by the end of this year....exactly what the power brokers are looking for (and what the market is pricing.)

In a way, Macro Man feels like the scales have fallen from his eyes, and considers himself a fool for not looking into this balance of risk stuff earlier.  Yes, we know the Fed is a risk manager and yes, we know that many of them are academics wedded to imperfect models.     But until performing this analysis he wasn't quite sensitive enough to the committee's willingness and ability to suspend reality to always focus on the downside of life.

Henceforth, Macro Man has a plan to get himself into the Fed's mindset that he can recommend to any readers who struggle to appreciate how downbeat the FOMC can be:

1) Take your worldview
2) Imagine that you've been transported to a run-down corner of central Detroit
3) It's February
4) The wind is howling, the sky is black, and a bone-chilling sleet is driving down
5) You are standing chest high in raw sewage
6) And you've just dropped your car keys

Good luck!
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58 comments

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Anonymous
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April 7, 2016 at 7:26 AM ×

If you have young kids and have seen Pixar's "Inside Out", the Fed reminds me of Sadness.

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Anonymous
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April 7, 2016 at 7:51 AM ×

If you have seen "Pulp Fiction", the Fed reminds me of the Gimp.

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Polemic
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April 7, 2016 at 7:58 AM ×

If you have seen "Hitchhikers Guide To the Galaxy", the Fed reminds me of Marvin

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Whammer
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April 7, 2016 at 7:58 AM ×

Let's just go with Eeyore, we all know him......

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amplitudeinthehouse
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April 7, 2016 at 8:39 AM ×

'Yes, we know the Fed is a risk manager and yes, we know that many of them are academics wedded to imperfect models.'


That's a good one, Macro Man. How do you go from being wedded to a superior economic model to a an imperfect model absent a monetary rout in the market. Please explain. Beyond belief.

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Sucker
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April 7, 2016 at 9:10 AM ×

More akin to Janet doing a 'Linda Lovelace on US equities.... Tissue please.

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Anonymous
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April 7, 2016 at 9:31 AM ×

Pattern:
EU session - EUR gets sold
US session - USD gets sold
wonder if any of these central bank f*ckwits have ever heard of "zero sum game"?

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Anonymous
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April 7, 2016 at 9:35 AM ×

EZ equities trying to extend rally on back of the US equities rally yesterday. Feel sorry for Nico, half his gains on Eurostoxx have been given back courtesy of ECB talking up the market.

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Anonymous
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April 7, 2016 at 9:54 AM ×

if you have seen "the usual suspects", the fed reminds me of keyser soze

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Anonymous
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April 7, 2016 at 10:11 AM ×

Yellen & Co will apply Okun's high pressure economics till PCE is white hot!
Better deal with the inflationary devil you know than with the deflationary spectre...

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Hotairmail
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April 7, 2016 at 10:23 AM ×

They are economists...the "dismal profession", the future is always sh*t.

I don't understand why, because weather girls are usually so bright and bubbly despite the uncertainty inherent in their pronouncements.

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Hotairmail
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April 7, 2016 at 10:27 AM ×

"The popular belief is that Carlyle started using the phrase in response to the "dismal" prediction of 19th-century reverend and scholar Thomas Malthus, who forecasted that the rate of growth in the food supply as compared to the rate of the growth in population would result in mass starvation."

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Cityhunter
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April 7, 2016 at 10:33 AM ×

@Anon 9:35am,

EU is in deep shit

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Anonymous
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April 7, 2016 at 12:12 PM ×

I think it's good to see some conclusions that identify that the Fed are populated by human beings with all their foibles. The least of which is they can be seriously effected psychologically and that can and does result in bias laden policy. Or I could have just said they have not got a f...g clue like most of us.

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Anonymous
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April 7, 2016 at 12:13 PM ×

Mind you being so well paid for not having 'clue' is a great gig to pull.

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Tim Schulace
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April 7, 2016 at 12:13 PM ×

Structured a knock-in put on $/yen at 107.5 when the pair was around 113. Didn't think I'd be so close to knock in less than six weeks. Puts are laddered (if activated) at 120, 125, and 130. Have to believe BOJ goes full retard at some point here.

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Sucker
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April 7, 2016 at 12:21 PM ×

@Cityhunter

Sure is! Pass the Dutchie to the left-hand side... Go back and vote again! Embarrassing outcome, but predictably in referendum. Roll on UK referendum.

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April 7, 2016 at 12:42 PM ×

Yup - the extent to which Yellen/Fed drove the dollar lower is stunning.

The Yellen Put is more valuable than ever...

Valuing the Yellen Put

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Booger
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April 7, 2016 at 12:45 PM ×

Tim Duy on Dovish minutes:

"The winter turmoil made the asymmetric risks all-too-real. They need to allow the economy to run hot to justify sufficient rate hikes to drive a wedge between policy and the zero bound. They need to make a choice: Risk inflation, or risk returning to the zero bound? They are coming around to seeing the former as a less costly risk as the latter.

This begs the question of how quick they will be to react to inflation that overshoots 2%. I don't think they will react too quickly - they will need to tolerate some overshooting to avoid cutting the recovery off at the knees. It will still be about the balance of risks until interest rates are much higher.

Finally, the pretty much decided they wouldn't have enough data to hike rates in April...

Not clear that they will in June either. First quarter growth numbers are looking weak, so they may want a clear picture of the second quarter before acting. That speaks to July or September.

Bottom Line: The Fed is on hold until they are sufficiently confident they can make a liftoff stick. The bar is higher now given the focus on asymmetric risks. They won't want to take June off the table just yet, so expect them to say that it is still too early to rule it out. April, however, is set to be a yawner..."

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Macro Man
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April 7, 2016 at 12:57 PM ×

I mean really, that's absurd. We can't leave the zero bound (0.37% is close enough) so that the economy can be strong enough that we don't risk going to the zero bound?

Reminds me somehow of the joke about the guy who always runs red lights, saying "My brother always does it" then slams on the brakes at a green. When asked why, he says "my brother might be coming the other way".

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Hotairmail
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April 7, 2016 at 1:03 PM ×

I believe Yellen has always had the view that she wants to see some inflation, primarily wage inflation to put some of the money back in the pockets of those who lost out in the GFC due to falling real wages.

This is actually very clever. When you look at the paucity of thinking from our own Bank, in particular Merv, he always held by the view that all inflation, including outsized commodity shocks was to be "looked through", except for wage inflation that could "embed" inflation into the system. Hence why his most keenly awaited report was the "inflation expectations" report. I don't think he ever conceived that the natural corollary of that policy was to make people steadily poorer. The Bank over the years impoverishing people and pressing down on demand in the economy. Ideally, wages (and profits) need to be backed up by productivity improvements, but often the drive for productivity gains is provided by cost calculations.

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Macro Man
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April 7, 2016 at 1:12 PM ×

I could argue the opposite. Merv impoverished Londoners by permitting a monetary regime that enable property prices to soar out of the price range of most residents other than foreign kleptocrats, domestic nobility, and trustafarian winners of the genetic crap shoot.

Also, given the stagnation of real incomes in the US and the rise in income inequality, it's not clear that the Fed model has been superior to the BOE's. Ultimately, much of the responsibility should go to the fiscal authorities, who allowed brass plate shell companies to buy up 3/4 of London and US corporations to go running to whichever foreign whore showed a bit of skirt revealing lower tax rates or a cheaper manufacturing base.

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Hotairmail
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April 7, 2016 at 1:18 PM ×

e.g.

http://qz.com/247113/janet-yellen-is-a-more-revolutionary-fed-leader-than-bernanke-ever-was/

So you know what is coming.

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Hotairmail
admin
April 7, 2016 at 1:37 PM ×

Last post. Sorry - just seen your reply MM. In Merv's case, he contributed in ways you have suggested. I would strongly argue that loose money has benefited the rich ever since the lifting of capital controls as their assets have risen and as they are also the most leveraged, they benefit from low financing costs.

Merv finally contributed by actually crashing the £ amidst a commodity shock. These losses were never made up - but he didn't care. He was watching for incipient embedded wage inflation. Yellen is clearly hoping that any wage inflation will outrun price inflation and make ordinary people richer. I don't hold by that personally in the long run.

We actually need an interest rate for capitalism to work its magic and for fiscal and taxation policy to redistribute demand. Another way will be to QE at the same time as rates are gradually raised (or at the very least staggered over time) so that more of the money supply is non interest bearing.

My own personal definition of a Depression is one where you have to hold Bank rate below 5% (i.e. ditch capitalism itself) to hold things together. Of course, you can have GDP growth of the 'straw fire' kind with extraordinary policy for long periods as we have seen. But monetary policy alone doesn't seem it will cure the underlying problems by becoming self-reinforcing and needing to be controlled. In fact this is a period very reminiscent of the 1930's when every time the Fed thought they were through the Depression, it would come back as soon as policy was strengthened a tad. On that occasion, pricing power had to be restored by the destruction of capacity by WW2 and huge deficit spending and later, very high taxes.

Anyway, all of that is much of a muchness. We are here not to cure the ills of the world but wonder what will happen next. And I think Yellen's thinking is crystal clear in the link I posted above.

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washedup
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April 7, 2016 at 1:47 PM ×

Hotairmail/MM - yellow can wax eloquent all she wants over wage inequality, but how much control does she have over it anyway? All she can do is encourage more malinvestment and hope that somehow the spoils of that accrue not to corporations staffed with tax geniuses but working folk - good luck with that.

I will point out that capitalism can work in mysterious ways regardless - it could be argued that the oil boom started out as a classic boom led over investment is now finally creating returns to consumers. The technologies behind Facebook and twitter may aid some productivity growth, but also aid the rise of Trumps and Le Pens who threaten to go all out nativist, which pulls in the other direction.

The bottom-line here is that Yellen is well intentioned, completely unoriginal, thoroughly focused on saving her own hide, and most importantly, notwithstanding her sway over ST trading mentality, completely powerless over any material time horizon. She is no revolutionary.

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Booger
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April 7, 2016 at 1:50 PM ×

MM: quite true, it is ridiculous. But it is also the consensus, that we are strong enough to leave zero or 0.25%. And yet we don't and we're still here. The consensus here could be wrong as it was with letting Bear Stearns go. Maybe things would go completely down the clapper if they hiked again. That certainly seems to be what they are indicating.

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Error404
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April 7, 2016 at 1:54 PM ×

Fascinating analysis - tks.

An unelected Politburo is applying a dystopian worldview and flawed mainstream economic theory to the output from flawed models fuelled by flawed statistics. A voodoo priest rattling chicken bones would be just as useful as this bunch of charlatans, who really seem to believe our hyper-complex, increasingly interlinked economies can be tweaked as though they were a machine. Lucky for them that the widespread but false belief in their theories, models, competence, and omnipotence is the only safety-net beneath our fragile, overleveraged economic and financial systems. Too many people have a vested interest in keeping their eyes (and mouths) firmly closed. For now.

Rant over...back to the tables....

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Anonymous
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April 7, 2016 at 2:02 PM ×

Don't worry. With incomes still in decline YoY, low paying jobs fueling the uptick in participation rates, a 25 year low in home ownership, increasing rents & healthcare, Yellen should grow some balls and raise rates a few times. The poor & low income here are screwed anyways, may as well take the rest of us out with them.

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Macro Man
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April 7, 2016 at 2:06 PM ×

@hotairmail The problem with Yellen's focus on wages is that it's pretty unclear that she can do a damn thing about them, other than around the edges. I touched on this soon after my comeback a couple of years ago:

The globalization of wages

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Anonymous
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April 7, 2016 at 2:07 PM ×

It does not matter what the Fed is yapping about, as long as it grabs your attention. Snake oil salesman had that figured out centuries ago.

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Anonymous
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April 7, 2016 at 2:10 PM ×

How come Yellen has not mentioned this...

43% of all college loans now delinquent . That's almost $400bln in dead loans the taxpayer gets stuck with .

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Anonymous
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April 7, 2016 at 2:24 PM ×

DB just 40+ cents away from the lowest since it started trading in USA in 1999

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Leftback
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April 7, 2016 at 2:34 PM ×

EURJPY is down a cool 2%. Tell me that isn't risk aversion rearing its ugly head....?

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Eddie
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April 7, 2016 at 2:38 PM ×

"The mistake that most market observers make is to think that if the Fed is talking about normalizing rates, then we must be moving towards normalized markets, i.e. non-policy-driven markets. That’s not it. To steal a line from the Esurance commercials, that’s not how any of this works. So long as we’re paying attention to the Missionary’s act of communication, whether that’s a Mario Draghi press conference or a Mayhem Guy TV commercial, then behaviorally-focused advertising — aka the Common Knowledge Game — works."

http://www.salientpartners.com/epsilon-theory/my-passion-is-puppetry/

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Leftback
admin
April 7, 2016 at 2:55 PM ×

It seems as though we are on a one way ticket to USDJPY 105. Only Kuroda stands in the way of a large risk-off move into JPY. Although many expect him to go Full Retard, one wonders whether that is possible when he is clearly already at the asylum.

When FX markets become drunk and disorderly, volatility in equities is usually not far behind. Take a look at AUDJPY and tell me that more weakness in commodities and EMs isn't on the way. It only takes a few buyers or shorts to cover for Bucky to get a grip here, and that spells trouble for commodity tourists.

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Leftback
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April 7, 2016 at 2:57 PM ×

Just to reinforce the point, HGK6 broke sharply below support at the 50-day MA this morning.
Dr Copper is sending a message.

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Anonymous
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April 7, 2016 at 3:00 PM ×

@Error 404, good rant, thanks.

Rossmorguy

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Anonymous
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April 7, 2016 at 3:29 PM ×

Putting out the narrative...the bailouts just keep getting bigger and bigger with no end in sight

Reuters: Italy is considering setting up a state-backed fund that would help troubled lenders by buying up bad loans and plug capital shortfalls, three sources close to the matter said, as the government looks for ways to shore up its ailing banks.

The governor of the Bank of Italy, the economy minister and the chief executives of UniCredit, Intesa Sanpaolo and UBI discussed the idea at the prime minister's office on Tuesday, the sources said.

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Macro Man
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April 7, 2016 at 3:38 PM ×

Yeah, a couple of months ago that was just going to be backstopping pvt sector investors who bought turds from the banks. Remind me again why i would want to own BTPs yielding 1.28%?

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Eddie
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April 7, 2016 at 3:42 PM ×

Italy is considering setting up a state-backed fund that would help troubled lenders by buying up bad loans

The usual caveat applies: these loans must be sold at arm's length prices which means those banks hopefully have enough loan loss reserves in the first place... especially if the fund is majority owned by private investors.

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Leftback
admin
April 7, 2016 at 3:48 PM ×

Bank earnings are always going to be an important factor in whether investors can make any money. With NIRP in many countries, yield curve inversion in Japan, and an essentially flat curve in Germany, it is hard to see how many of those institutions can make money in the medium term future. That's one of the things the DB share price is telling us today, and there are lessons there for the rest of the economy and the equity markets. Recession now seems likely for Germany and Japan.

In 2008 (and no, we are not expecting a repeat, in part b/c of all the CB interventions), there was a precipitous fall in commodity prices that began before the general world-wide move out of risky assets into USD and JPY. Disorderly moves in FX were a frequent feature of that transition. We can expect highly leveraged vehicles to suffer the most if carry trades unwind quickly.

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Anonymous
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April 7, 2016 at 4:43 PM ×

Is the copper move really indicative of general risk ? There has been stories coming out of china on their stockpiling of copper so moves could be driven by that ?

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Nico G
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April 7, 2016 at 5:23 PM ×

spoos critical - there is nothing until 1995/2000 if we break 2037

EUrope new lows etc etc

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jbtfd
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April 7, 2016 at 5:54 PM ×

Haven't we basically just undone yesterday's gains? This isn't a real fall... I want to see carnage in commodities, Japan bankrupted by the BOJ, and hundreds of points wiped off the spoos in seconds.

Then, maybe then, we'll get a buy-able dip.

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CV
admin
April 7, 2016 at 5:54 PM ×

"Italy is considering setting up a state-backed fund that would help troubled lenders by buying up bad loans"

Not allowed under the new rules as far as I know, but they will probably bend the rules.

As for the BTPs, yes agree. But the CA surplus makes it a difficult short right now, coupled of course with ECB purchases. Better to have a look at Spain, much more upside given the risk to growth and the political situation this year. Plus, their external finances are much more precarious.

Heck, I would be long BTPs, short Spanish paper here.

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April 7, 2016 at 5:54 PM ×

Nico or whoever wants to answer,

What does that mean? if we break 2037 there is nothing until 1995/2000? what why?

Genuinely curious.

Thanks

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Leftback
admin
April 7, 2016 at 6:21 PM ×

JBTFD, be careful what you wish for. Once currency pairs start to move at a 2% clip overnight, things get interesting. Watch AUDJPY and EURJPY overnight. At some point everything Europe will be dumped and a sharp USD short covering rally will begin.

The current game of Whack-A-Mole by central bankers, each jawboning their currency lower in turn is unsustainable.

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washedup
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April 7, 2016 at 7:38 PM ×

"@jbtfd - I want to see carnage in commodities, Japan bankrupted by the BOJ, and hundreds of points wiped off the spoos in seconds.

Then, maybe then, we'll get a buy-able dip."

Japan bankrupted and hundreds of points spoo crash in seconds, thats ur ask before you step in? oh no problem - I'm sure the probability of that is north of never.
Let it be noted jbtfd will henceforth be known as jbTfd - must have been quite a different tone at the most recent buyers anonymous meeting.

Nico - I do see some reasonable support 2015-2025 FWIW.

Left - any thoughts on tonights central banker dove off? Will they exchange clothes on stage, complete each other's sentences, braid one another's hair? Anyone??

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Anonymous
admin
April 7, 2016 at 7:47 PM ×

Most of us wish central bankers would just shove off, never mind Dove Off....

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jbtfd
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April 7, 2016 at 8:02 PM ×

washedup - Don't take me too literally, I'm just bored senseless waiting for spoos to re-trace ;)

LB - Fully agree with you regarding the CB proverbial "race to the bottom". Am having fun watching Yen though...

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Anonymous
admin
April 7, 2016 at 8:29 PM ×

Well, got to say that I did not expect the equities went down This fast, without any clear risk event. Is Yen qualified as one? So far I still believe that sp500 will rebound once earning week begins.

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Anonymous
admin
April 7, 2016 at 8:48 PM ×

anon 8:29 Don;t worry, the PPT are buying equities as we speak...

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Anonymous
admin
April 7, 2016 at 9:11 PM ×

There we are, PPT have pushed S&P500 back up to the key 2037 level that Nico mentioned above. Events like this give you a real-time view of market manipulation in progress.

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Macro Man
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April 7, 2016 at 9:23 PM ×

Well, either that or VWAP algos tend to push the price back towards the VWAP at the close. Your story sounds more realistic though, particularly if they trade through a boiler room brokerage on Jupiter.

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jbtfd
admin
April 7, 2016 at 9:46 PM ×

Anyone watching Treasuries? Yields heading back to Feb lows. My dip is coming (i hope).

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Anonymous
admin
April 7, 2016 at 9:48 PM ×

JP Morgan cuts US Q1 GDP estimate to 0.7%. They forecast 2.0% only a month ago.

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Anonymous
admin
April 7, 2016 at 10:57 PM ×

Nice 3rd chart mm. Sometime after the September meeting where they passed I read Yellen 06/06/12 and the lightbulb went off, similar to what you describe here. Was good for one meeting, I knew what data data-dependent meant - 4 handle unemployments... It was a crappy model (yep adrem/error404) but at least we had a model.

Now though. Seems like the board has turned away from Yellen's baby. Too much criticism. Central bankers, oil-patchers, Larry, Stiglitz. Too much for them. Data dependence now is what? Euro inflation, japan gdp, china exports, oil price, no idea. I know what it isnt though - cpi/pce. Dont look now!

Fed is all about avoidance of criticism, that's it. They dont set policy, they enact policy the market wants.

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Polemic
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April 8, 2016 at 4:38 AM ×

Re Japan, usdjpy and Nikkei...

Tada kusodippu o kaimasu

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