Thoughts/Response to Bill Gross Piece


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Well stated and agreed!!!

A few highlights(mine), below:

On Thu, Jan 7, 2010 at 8:57 AM, Lando, Joseph wrote:

In a bit of a surprising philosophical shift, Bill Gross came out yesterday strongly bearish and firmly in the camp of the deficit hawks: Link . My reaction:

1. Any major tightening of financial conditions due to a spike in rates right now, particularly back-end rates, would just be met with more QE anyway. That much was certainly clear in the Fed Minutes yesterday.

2. Given a battle between the fundamental input of deflation and the technical factor of supply, deflation will win hands down. And though many seem to disagree, the data and the Fed and our own economists still think risks are tilted the other way. This input is making the 100-200bp difference in 10yr yields. Supply issues make the ‘1-2 standard deviations rich/cheap’ (speaking in Sudoku terms) differences of 20-30bps. Which wins?

3. I actually think the technicals are the other way. New supply of private label AAA securities is down 1T MORE than Treasury supply is UP. De-levering is, BY DEFINTION, a reduction in the overall supply of investible term fixed income assets. Here’s a picture from a couple months ago from our Global Markets group.

4. The yield curve is offering more yield enhancement than EITHER vol OR credit spread to the investment community. Not to mention Treasuries are 0% weighted (AND state/local tax-advantaged). Where do you think banks will turn to generate NIM? At some point, they will change their behavior. Look at CURVE vs both VOL and CREDIT regression below. Perhaps most notably…


5. The deficit hawk premise is flawed to begin with. Government buys a bridge, bridgebuilder buys a coat, coatmaker deposits or saves the money…it’s a closed loop in which deficit spending CREATES the precise funding for the deficit itself. All that moves around is DURATION as the need for 10yr savings or 30yr savings is swapped around vs the demand for say, overnight savings (like T-bills or banks reserves). Deficits in the US (unlike a Muni or a EU power or a Corporation) don’t have a problem funding. The ‘problem’ is if the Treasury wants to issue 30yr paper and people only really want 5yr paper. Actually, the market sells off when the sum of all borrowers’ duration is longer than the sum of all the lender’s preferences/liabilities. Not when there is a mismatch in AMOUNT. The AMOUNT is the same! Which takes us to…

6. Japan.

7. I also respectfully but strongly disagree with Gross’ interpretation of QE. The Fed has actually been swapping the bank and fixed-income universe OUT of their term treasuries and mortgages and into cash. By definition they have actually been crowding OUT overall NIM in the universe. And generating revenue for the Treasury. It’s actually an investor tax not a bailout. When they step away, those (and by parity zero-sum principles they are there) who were swapped out of their investments and into cash will swap back into term duration. Asset transfers themselves are zero sum. Additionally, in getting mortgage rates down, the Fed has been TEMPERING the pace of de-levering by ensuring mortgage refi’s can continue. They ‘made happen’ many of the mortgages that they bought. It’s a very self-regulating supply universe. If they slow down, there are just plain fewer mortgages being originated for people to buy, and the pace of overall deleveraging picks back up, and well…it’s not bearish, for sure.

8. Actually I hope 10s go to 4.25 because that just means there will be more to make in the big rally that I think starts in 6 weeks or so when the data turns back from fiscal stimulus withdrawal, and the Treasury’s ‘extension of average maturity’ program – what is TRULY the cause of the steepening of the yield curve – tapers off. For now, am only tactical in the back-end.

But that’s why we all have a market and life, as ever, will remain interesting in fixed income this year.





UE Rate->FF Rate”>


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8 Responses

    1. Zanon, Yes I think so. It looks to me he is positing that mainstream misunderstanding of of QE is causing many (PIMCO, et al) to sell longer term Treasuries at the same time Treasury has decided to issue more longer dated maturities as a new policy (Treasury data confirms that they are issuing larger amounts of bonds in 1Q FY 2010). Thus pushing up longer term rates and perhaps setting up a great buying opportunity if the 10-yr yield goes up to 4.25.

      I”m not sure what he means by: “in 6 weeks or so when the data turns back from fiscal stimulus withdrawal” though? Which fiscal stimulus is being withdrawn in 6 weeks? I generally agree that YoY fiscal is not looking nearly as robust as last year, but am not aware of a specific “withdrawal” of stimulus. Resp,

      Reply

  3. Makes sense.

    Interesting distinction between amount mismatch (zero) versus duration mismatch (non-zero)

    I’d be curious to see more analysis on the dollar sensitivities of the duration mismatch in question – the core position involved is roughly $ 1 trillion (excess reserves). We’re talking $ 2.5 billion paid annually on reserves versus what – $ 50 billion or so on risk assets or less on long treasuries counterfactual? How big a deal is this in a $ 10 trillion plus income economy?

    Also shouldn’t overlook that the Fed has been crowding out risk along with NIM.

    But it could be a big deal for the banks. I agree banks should start to buy more treasuries at some point, provided they can secure accrual accounting treatment. That could happen with or without Fed balance sheet shrinkage. Contrary to popular fictional reports, banks really haven’t bought many yet.

    Reply

  5. Why I like the prospect of an interest rate hike:

    1. MBS and ABS combined make up the bulk of debt in this country

    These assets are for the most part locked in for 30 years at current low interest rates. If the Fed hikes rates these MBS and ABS loans locked at a lower rate will go up in value. This helps the banks sell them in the future or make money holding them and writing mortgages at higher rates. The financial sector should see positive earnings as they either sell the assets or make loans to customers at higher rates. This recovery in financial stock prices is happening now as money is moving out of technology and into financial stocks in expectation of the January Fed Meeting.

    2. Retirees specifically the baby boom generation have the majority of the nations private wealth. They are at a point in life where investing in stocks is not as advantageous because they are more worried about capital preservation than speculation. Many baby boomers and retires have stock portfolios and the majority of them still holding stocks are waiting for a return to normal price levels. Otherwise they are in cash on the sidelines getting low rates. What they really need is higher interest rates to provide them with income to live on as they retire. The extra money they get from higher CD rates will go into bank accounts and the market.

    3. An interest rate hike likely means a stronger or at least flat USD. This allows the federal government to pursue additional stimulus options. Personally I am in favor of a modest minimum wage hike during the time that they raise rates. It is also becoming clear that nationalized health care is not going to happen. This should help the USD stay strong. Australia has one of the highest minimum wages of any country in the world and the housing market is strong and the unemployment rate is around 5.5%. Forcing Multi-National Corporations that operate within the US to provide employees a fair living wage will all but guarantee a rebound in consumer spending. Not sure how the government can implement this as each state sets its own minimum wage.

    The bottom line is a rate hike gets more money in more peoples pockets.

    Reply

  6. higher rates make fixed income go down in market value.

    agreed higher rates generally benefit savers.

    the fed does not want a stronger dollar, at least for now.
    it wants more exports and less consumption, as per congressional testimony by the chairman

    the fed understands the interest rate/income channel but continues to believe that higher rates slow things down.

    Reply

  7. Can you provide more detailed descriptions of the content in the two scatter plots found in “Thoughts/Response to Bill Gross Piece.” Thank you.

    Reply

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