Tenor Madness

Regular readers will know that Macro Man is a bit of a music aficionado. While he sadly possesses no musical ability (other than possibly as a lyricist), he nevertheless finds it useful on occasion to draw on musical analogies to distill market insights.

He often selects the iPod music for his commute on the basis of his mood or the prevailing market environment. Given the stressful conditions of the past few weeks, he's been listening to an exclusive diet of 1950's and 60's post-bop jazz. After all, The Clash and Run-DMC, linked above, are a bit shouty for the current environment. And if he wants to hear someone moan about the miseries of life, he doesn't need the Smiths- he'll just call up one of his brokers.

In any event, Macro Man's been listening to a lot of Sonny Rollins this month. While Saxophone Colussus is his favourite Rollins record, Tenor Madness isn't too far behind. The latter seems particularly apt for the current state of finance, as fixed income and money markets are caught in the throes of a bit of tenor madness.

With the end of the quarter and the three month date about to rollover into the new year, the dash for cash has generated substantial distortions, despite the recent central bank dollar swap announcements. First quote of the day for overnight dollars was 13.5%, and yesterday's ICAP 3 month quote was 4.375%. The last time 3 month LIBOR was that high, Fed funds were 4.25%. The ruptures in the market can be seen in the chart below, which shows the 2-10 US government yield curve and the 2-30 US swap curve. Unsurprisingly, they are normally very highly correlated. However, recent front-end stress have driven a very significant wedge between government and swap curves.
Quarter-end also brings about the usual mechanistic rebalancing flows from pension funds and other long-term real money investors. It appears that such flows are already going through in Europe, helping to generate a vicious intraday bounce in stocks. Well, it's either that or the news of another Benelux bailout or an Irish government bank guarantee.

Or perhaps the market has decided that news which apparently ushered in a new Great Depression last night is actually pretty meaningless this morning. Macro Man and the chap next to him, both of whom are short stocks, have just been left shaking their heads this morning.

With respect to the TARP's failure to pass Congress, Macro Man touched on the political aspect of it last night (at least with respect to his opinion of the politicians involved), and doesn't intend to go there again.

After an evening's thought, however, it struck him that last night's vote was a Fort Sumter-esque shot in a modern class war. Macro Man has long thought the the negative aspects of globalization would eventually manifest themselves; however, he suspected that the primary mechanism would be protectionism. While there's nothing to say that that still won't be the case, he nevertheless views last night's failed vote through the prism of Joe Sixpack desiring to claw back some living standard away from modern plutocrats.

If the rationale for the TARP's failure could be distilled in one chart, it would be the one below, which shows a surge in corporate profits (at the apparent expense of wages) as a share of national income. It is the divergent fortunes of these two series that has fueled Main Street anger and turned "no" voting Congressmen into class warriors.
Of course, laying the blame for the current state of the world exclusively at the foot of Wall Street is badly misplaced. The US savings rate has been steadily declining since long before the invention of CDOs, SIVs, and subprime. It will have to rise, particularly as society ages. A large part of the rationale for government intervention in the current crisis is to ensure that this occurs in a gradual, orderly fashion, rather than abruptly via the wholesale withdrawal of credit throughout the economy.
Last weekend, Macro Man exhumed some laid-back tunes from his university days in a further effort to remain chilled. The lyrics from one song in particular are remarkably pertinent to the current situation, despite having been written forty years ago:

The percentage you're paying is too high priced
While you're living beyond all your means
And the man in the suit has just bought a new car
From the profit he's made on your dreams
But today you just read that the man was shot dead
By a gun that didn't make any noise
But it wasn't the bullet that laid him to rest was
The low spark of high-heeled boys

Month-end flows and poor liquidity have thus far enabled equity markets to defy the Low Spark; however, thanks to tenor madness Macro Man continues to expect the High Heeled Boys to win out in the end.