Leveling the Playing Field

April 20, 2015

______________________________________________________________________________
Turns out that moving a family of seven, a volleyball tournament in Atlanta, a dance competition
in Spartanburg, 5 baseball games and a week-long spring break isnt conducive to writing a
newsletter. Also, I was sick following Dukes win and couldnt bring myself out of my funk.
Fortunately for me, the market cooperated with my crazy schedule, trading within a tight range
over that time period. At our last publication, the 10yr was at 1.93%. On Friday, it closed
1.90%. The peak to trough has only been 15bps wide (1.84% - 1.99%). It has been a sedate
market. BNP published an article on Thursday that discussed how rare this kind of low volatility
is over a 21 day period since the Taper Tantrum in April 2013:
There were nine occasions where the trailing 21-day peak-to-trough closing range was below
20bp. The first five instances were short-lived, as the tantrum rumbled on. However, once yields
peaked after the taper tantrum, these episodes were longer-lasting (twice between two and three
months). It seems that while these bouts of super-low monthly realized volatility are rare, when
they happen, they can persist for a few weeks to a few months. So there is scope for extended
range trade that cannot be dismissed as a short-term phenomenon.

In other words, this sort of low volatility, tight range could persist for several more weeks or
even months. Every time yields test key levels (like 1.84% on the 10T), there is enough
resistance to push rates back to the middle of the range.
If (and that is a big IF) rates break out in the next week, it is more likely to be to the downside.
Soft data over the past week has spooked equities (which is tough to do), delayed the first rate
hike (market is still behind the curve here), Eurozone yields are nearly 0% (only Greece and
Portugal have higher 10yr yields) and Greek debt negotiations look dire. Lastly, the Fed is about
to embark on another round of buybacks that will probably keep a lid on yields depending on
which part of the curve they buy on. If the 10yr can break through 1.84%/1.86%, the next stop is
1.70% and a likely testing of the year lows of 1.64%. But again, we will need some sort of
shakeup to break the status quo.
The most volatility, relatively speaking, is likely in the 5yr part of the curve. The front end is
controlled completely by FOMC expectations, while the long end doesnt react quite as
dramatically to every minor Fed-hint. The belly of the curve, however, is far enough out that the
Fed cant control it directly through monetary policy but also feels the effects of a shift in FF
expectations.

Fed Funds
We havent had a traditional newsletter since the disappointing jobs report that delayed hike
expectations until the end of this year or the beginning of 2016. We still believe July/September
to be the most likely first hike, largely in part to the fact that the Fed isnt hiking to control
inflation its hiking to get away from 0% interest rates. Even though the market disagrees, one
disappointing job report wont dramatically change the Feds plans.
Alternatively, a weak job report means that another weak report in May could be the start of a
trend. That could delay a Fed hike because it implies an underlying weak economy. And that is
why the market is reacting the way it is it is trying to front run.
We are holding the line and think the market is taking on an increasingly dangerous position
against a hike. While the market is trying to predict the liftoff, we are trying to predict when the
market will finally wake up and admit a hike is imminent.
Fed Funds futures are back near the bottom, essentially predicting ZIRP Indefinite. There is an
FOMC meeting on April 28th and 29th and Yellen will probably tread lightly. But she may also
use it as an opportunity to close the gap between the Feds own plans and market expectations.
Remember that Taper Tantrum two years ago and the painful correction? We think the resulting
correction around the Fed tightening cycle could be painful as well. It probably wont be as
dramatic as a 1.00% spike in 10yr yields in four weeks, but it will be messy nonetheless. The
first rate change in nearly seven years is going to be a big deal.

Greece
No good news recently out of Greece, where most EU officials are painting a fairly bleak picture.
The next EU meeting is April 24th and the EU has given Greece an April 20th deadline to present
a detailed list of economic and fiscal reforms to be discussed at that meeting.
The Greek government appears to be losing leverage, as the majority of Greeks are opposed to
leaving the euro. While a deal for April 24th appears to be unlikely, most observers are pointing
to the May 11th EU meeting as the most likely timetable for a deal to be struck. Greece has a
relatively small interest payment to the IMF due on May 1 and a larger loan redemption on May
12th, so a deal is likely needed to avoid default.
As with all political conflicts, this will likely go to the 11 th hour as Tsipras tries to appease the
far left without completely walking away from the EU. If a deal really is several weeks away,
its tough to see US yields jumping dramatically with a black swan event hanging over our
heads.

This Week
Pretty quiet week ahead, which means news out of Greece will likely dominate headlines. Any
news is unlikely to be positive at this point, probably keeping a lid on US rates. The Fed will go
quiet ahead next weeks FOMC meeting, so we expect more range-bound rate movements with
low volatility.

Economic Data
Day

Time

Monday

8:30AM

Chicago Fed Nat Activity Index

Wednesday

Thursday

Friday

Report

Forecast

Previous

0.10

-0.11

7:00AM

MBA Mortgage Applications

-2.30%

10:00AM

Existing Home Sales

5.03M

4.88M

8:30AM

Initial Jobless Claims

289K

294K

8:30AM

Continuing Claims

2268K

11:00AM

Kansas City Fed Manf. Activity

-4

8:30AM

Durable Goods Orders

0.60%

-1.40%

8:30AM

Durables Ex Transportation

0.20%

-0.40%

Speeches and Events

Day

Time

Report

Place

Monday

8:40AM

Fed's Dudley Speaks on Economy and Policy

New York

Time

Report

Size

Treasury Auctions
Day
None

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