[Not one of my more inspired posts, but this goes to show you why directional trading is not always the best approach.]

I have a lot of mixed thoughts about rates right now.  The best course of action was to jot them all down, take a step back and evaluate them.

BULLISH THOUGHTS

  • Later Non-Quarterly meetings. “Later this year” does not just mean Dec.  It could mean Nov (and Sept is a remote possibility).  This means that the Nov non-quarterly meeting year is not looking great for a hike, if you are in Dudley’s camp that the Fed takes a little pause while gradually reducing reinvestments.
  • There are also ETFs for Fixed Income. I hear all the time about how auto-invested ETFs are ramping up equities, by buying equities without looking at valuations.  There are ETFs for fixed income as well.  Many individual investors and (robo) investment advisors are probably similarly putting money to work via some percentage allocation system.  Yes – this has nothing to do with the events of the past week, but I recently thought of it, and I didn’t want the “Later Non-Quarterly meetings” bullet above to be lonely.

NEUTRAL THOUGHTS

  • Is the rush to end reinvestments Yellen’s last hurrah? When I saw the minutes, I got a flashback to how Bernanke started tapering QE and then rode off into the sunset.  I’m wondering if Yellen is thinking something similar… “I have less than a year left – it sure would be nice if I could get us to the point where we’ve removed some more accommodation and reduced some balance sheet.”  I’m not saying this is her primary motivation… just that when you only have less than a year to live, you may (subconsciously) start thinking about the things on your bucket list.  Otherwise, what’s the rush?
  • Equity valuations. I am not going to claim to be any kind of expert on equity valuation (although I did take a class with Damodoran).  It seems to me that a lot of the standard valuation metrics don’t apply in the current environment.  The FOMC mentioned “standard valuation measures” in their minutes.  Let’s take a simple measure like the P/E ratio.  Think about how much the numerator should be elevated on repatriation and buybacks, and how much the denominator should be elevated because of things like tax cuts, lower regulations, favorable investment regulations, fiscal stimulus, etc.  The current P/E ratio is not as high as it seems, when you factor in the above.  I’m not saying stocks are cheap, but I’m not sure they are *that* expensive.  Other factors for higher equities include the current low interest rate and low volatility environment (since some look at volatility adjusted returns).  You can’t use a simple valuation metric without looking at what else is going on in the world.
  • Payrolls could have been the gorilla’s play (I suppose it could also be the French elections).  You generally don’t do something that aggressive without an exit plan or “out” (a poker term for a back-up plan).  A former economist at JPM used to be really great at looking for discrepancies in the seasonal adjustments, so there are people out there who have good insight into how the data could come out – especially after something like a winter storm.  The morning rally was instilled over several weeks, and caused the markets to join in on a morning rally they may have otherwise had no interest in.  Pavlov would have been proud.  We saw a fixed income surge post-the missile attack, and post-payrolls.  But at the end of the day, we couldn’t hold the rally.  Does this mean the gorilla is getting out while trying to get everyone else to buy?  If they are going to set up a morning buying pattern, we may see them getting out further if the morning buying is met with heavier-than-normal selling.
  • [Op-Ed] If I was a gorilla, I think I go for a strategic retreat around 10 bps lower (the next support). While they did set up a regular morning rally dynamic to eventually take advantage of, I see no point in trying to defend the current support level, for the bearish reasons mentioned below.  This assumes there isn’t a true fundamental underlying reason for the rally (“something else”).  If I was truly bullish and could move the markets, I probably sell the snot out of fixed income overnight to get all the technical guys chasing and the other bulls stopping out, and then load back up on longs at much better levels.  It’s free money if I was supremely bullish and I thought the rest of the market was not.  I would really only keep the markets supported overnight if I wanted the trained followers to start piling in in the morning, so I could sell into them.  That’s what I would do, but I am not the gorilla (don’t ask Mrs. CA though).  I think we could get some interesting price action next week, so let’s see what happens.

BEARISH THOUGHTS

  • We can’t rally on missile attacks nor a 100K miss on payrolls. This sure makes it unattractive to be bullish.  What exactly are bulls hoping for?  Some carry and roll on a flat curve with no other principal upside?  That’s a pretty crappy trade when carry is the only thing going for it.
  • Does tapering reinvestments mean a pause? Dudley seems to think so, but this is far from a done deal.  I could see the argument for a 1-meeting pause if they were going to just stop reinvestments cold.  But the FOMC seems inclined to do this gradually.  So there is no reason the FOMC couldn’t do both (hike and gradually taper reinvestments).  Other central banks have changed rates and adjusted QE in the same meeting, no?  In fact, there was an economist at a large bank on BloombergTV calling for a Nov tapering.  While I think a Dec hike should be discounted, it’s anywhere from being a sure thing that the Fed skips Dec.
  • Dudley said his comments on March 31 that caused a rally were “misconstrued.” He only sees a “little pause” in his view.  Of course if the FOMC disagrees, they may not pause at all.  And if the economy looks great, he may change his mind.
  • Rate cap estimates. I was watching a prominent analyst’s take on where they thought long rates should be and it went something like this… 1% real growth (a la GDPNow for Q1) plus 1% inflation (presuming yoy oil price gains go away) means that long run rates are capped at 2%.  <crickets>  <more crickets>  Except real GDP has been running 2.11% the past three years and core inflation has been around 1.55% the past three years.  I think GDPNow is understated this quarter from being overstated last quarter (from that one-time trade surge the previous quarter).  Nowcast is calling for a 2.8% Q1.  Using the “correct” more realistic historical numbers, we get a cap of 3.66%.  Saying that long rates are capped at 3.66% is not very sexy (or informative).  So unless you think we go into recession, I fail to see how that 2% back of the envelope estimate makes any sense.
  • In another possible “misconstrue”, I think some people may have done the “rate cap” estimate incorrectly off of what Dudley said last week. He had implied only seeing 4 to 6 more hikes to get to “neutral.”  That would mean about a 2.16% rate (= 0.91 [current FF rate] + 1.25 [five hikes]).  To a bull, considering it may take a looong time for the Fed to hike that many times (especially with a reinvestment-related pause), tens at 2.34% or 30s at 2.99% could look like free money if rates are only going to 2.16%.  Except there are several measures of “neutral,” based on the time horizon you are looking at.  There is (1) the neutral rate NOW (the current neutral rate to get the economy balanced), (2) the neutral rate X months/years from now, and (3) the long term neutral rate.  I suspect there are some who construed Dudley’s “neutral” estimate to be the long run neutral.  But this would not be correct, since there is no such dot on the last dots from the March meeting.  Dudley is smarter than to say something that is inconsistent with his dot.  I would have to assume the 2.5% longer run dot was Kashkari’s, and then the next lowest dots are five people at 2.75.  Dudley is most likely one of those dots.  So “dovish” Dudley most likely thinks we eventually end the hiking cycle at 2.75%, not 2.16%!  I think his 4-6 hike estimate was most likely a current estimate of neutral.[1]  So this is why the Fed is stressing “gradual” to maintain accommodation – they need 4-6 hikes to get to neutral NOW but only see 2-3 more hikes this year.  I suppose you could argue that there is no reason to think the long term neutral should be much different than the current neutral.  Oh, except we have this “stimulus in the pipeline” coming, that even Dudley said posed upside risks…
  • Trump is appearing more “presidential.” It’s been a while since my wife (#1 Trump hater) went off the deep end on Trump.  And I am starting to think he might end up being okay.  I especially like how he is talking to various business and other leaders to get more facts.  The missile strike, delegating to Ryan on healthcare, demoting Bannon, very constructive and friendly talks with leaders of other countries… it all adds up.  I’m not saying he’s Reagan, but the journey of 1,000 miles begins with one step.
  • I think something will get done on healthcare. It’s currently such a terrible system.  My premiums have doubled since it went into effect, several major carriers have left my state and I think my current carrier (the last major one left) is about to leave soon.  I am certain the Freedom Caucus is getting tons of calls from irate constituents.  So if part of the fixed income rally was lower potential stimulus from failed healthcare, I’m not sure healthcare reform (and the associated savings) are out.

Hmm… That’s 2 bullish bullets (one real bullet and a pity bullet) and 7 bearish bullets.  I seem to be leaning heavily in one direction.  Increasingly, I seem to be finding myself thinking that we will be rangebound in the zig zag until we get more definitive stimulus.  We are at the top of the range.  In the meantime, if we can’t stay rallied on missile attacks and a sub-100 payroll, and the near term hikes refuse to be taken out noticeably, what am I afraid of?

[1] The more remote possibility is that 4-6 hikes is a forward-looking running neutral estimate about 2 years from now (when the Fed will have hiked 4-6 times).