Since the bottom in stock prices, and the top in bonds, the monetary base has dominated all other exogenous variables on the movements of stock and bond prices.
As the base increases, the stock market advances and the bond market declines. Markets follow Fed action precisely.
Thursday's announcement of a major increase in the base has caused a sell-off in bonds and an increase in stocks, gold, and commodities.
Saturday, July 18, 2009
Saturday, June 06, 2009
Leading Indicators Jump
Leading economic indicators rose sharply in April, the first increase in seven months.
Strengths among its components exceeded the weaknesses for the first time in one and a half years.
Strengthening were the following.
Stock prices,
Interest rate spread,
Consumer expectations,
Initial unemployment claims,
Average workweek, and
Supplier deliveries.
Negative contributions came from these.
Real money supply and
Building permits.
When the real money supply starts to grow, this expansion will be unstoppable.
Look for continued weakness in long bond prices and the dollar.
Strengths among its components exceeded the weaknesses for the first time in one and a half years.
Strengthening were the following.
Stock prices,
Interest rate spread,
Consumer expectations,
Initial unemployment claims,
Average workweek, and
Supplier deliveries.
Negative contributions came from these.
Real money supply and
Building permits.
When the real money supply starts to grow, this expansion will be unstoppable.
Look for continued weakness in long bond prices and the dollar.
Thursday, June 04, 2009
Economists in Denial?
Yesterday I went to lunch with a group of economists to discuss the recent disaster in the credit markets.
Here are the main concerns we discussed.
1. The effect of the Fed's purchase of more that $1 trillion of securities and the inevitable inflation arising from the injection of all that high-powered money.
2. The possible inflation coming unless the Fed can sell those securities promptly and reduce the monetary base.
3. The inability of the Fed to begin to sell the hundreds of billions of dollars while unemployment surges.
4. The effects on the falling value of the dollar for government borrowing. No one will want to own dollar denominated assets in this environment.
5. The effects on long maturity interest rates of Treasury borrowing, Fed selling, prudent risk managers not buying, and the dollar dropping.
In summary, most agreed that the situation is far from normal and will not return to normality until the economy recovers and the Fed can pull all this high-powered money out of the system.
That is a long way off.
Yet, three surprising opinions emerged.
1. The cause of inflation. Someone repeated the old confusion about inflation being caused by too much growth rather than too much money. It is astonishing to me that this debate has any credibility at the senior levels of macro analysis.
2. The effects of inflation on the bond and dollar markets. There was little concern over the disaster the US economy is facing and and underestimation of the time it will take to solve this problem.
3. The failure to place the blame for this disaster where it belongs: on Congress, Fannie and Freddie, the SEC, Greenspan's Tsunami in the Fed Funds market beginning in 2004, and unregulated Credit Default Swaps. This is most troubling for future disasters.
TACTICS FOR PORTFOLIO RISK MANAGERS
Brace yourself for higher long rates, a falling dollar, and continued high unemployment.
Extend the maturity of your liabilities as much as you can. The cost of borrowing farther out the curve - as much as 450 basis points - will deter many portfolio risk managers, but those who do will be favored when the yield curve flattens and rises.
It's time to tell senior management and the board that we're in for heavy weather.
Here are the main concerns we discussed.
1. The effect of the Fed's purchase of more that $1 trillion of securities and the inevitable inflation arising from the injection of all that high-powered money.
2. The possible inflation coming unless the Fed can sell those securities promptly and reduce the monetary base.
3. The inability of the Fed to begin to sell the hundreds of billions of dollars while unemployment surges.
4. The effects on the falling value of the dollar for government borrowing. No one will want to own dollar denominated assets in this environment.
5. The effects on long maturity interest rates of Treasury borrowing, Fed selling, prudent risk managers not buying, and the dollar dropping.
In summary, most agreed that the situation is far from normal and will not return to normality until the economy recovers and the Fed can pull all this high-powered money out of the system.
That is a long way off.
Yet, three surprising opinions emerged.
1. The cause of inflation. Someone repeated the old confusion about inflation being caused by too much growth rather than too much money. It is astonishing to me that this debate has any credibility at the senior levels of macro analysis.
2. The effects of inflation on the bond and dollar markets. There was little concern over the disaster the US economy is facing and and underestimation of the time it will take to solve this problem.
3. The failure to place the blame for this disaster where it belongs: on Congress, Fannie and Freddie, the SEC, Greenspan's Tsunami in the Fed Funds market beginning in 2004, and unregulated Credit Default Swaps. This is most troubling for future disasters.
TACTICS FOR PORTFOLIO RISK MANAGERS
Brace yourself for higher long rates, a falling dollar, and continued high unemployment.
Extend the maturity of your liabilities as much as you can. The cost of borrowing farther out the curve - as much as 450 basis points - will deter many portfolio risk managers, but those who do will be favored when the yield curve flattens and rises.
It's time to tell senior management and the board that we're in for heavy weather.
Saturday, May 16, 2009
The dollar is doomed
There are three things that make the dollar fall.
1. US trade deficits increase
2. US interest rates fall relative to others
3. US inflation higher than others
Of these three, the last - inflation - is dominant, and the current Fed monetary policy ensures rising inflation in the months and years to come, causing the dollar to fall in value relative to countries with better inflation management.
The explosion of the monetary base, as the chart below shows is sure to cause inflation unless that money can be removed from the system quickly.
The dilemma facing the Fed is the effect of removing this new money on interest rates and economic activity. In order to take money out of the system, the Fed has to sell something, and that something is the securities they hold.
In particular, the Fed has to sell $1 trillion in securities, and that will raise interest rates as sure as the sun comes up.
Put this in perspective.
If the Fed sells $40 billion in securities each month, it will take two years to get all that money out of the system.
If the monetary authorities begin this program quickly, economic activity is certain to fall, and that is not in the Fed's plans.
So, until the Treasury stops selling bonds to fund the explosion in Federal expenditures, and the Fed can begin selling to reduce the monetary base, inflation is building and the dollar is doomed.
Here is the relevant currency chart.
The number of dollars it takes to buy the Euro.
Notice that the general trend is up, meaning the Euro central bank is better at controlling inflation than the US Federal Reserve.
Next, notice that the recent collapse in the US economy has reversed that trend.
Finally, notice that the trend is about to resume.
Unless the Federal Reserve can find a way to pull all that new money out of the system without crashing the US economy, the dollar is in for a long fall.
When combined with the flood of US securities coming, this is disaster for financial institutions unable to extend the maturity of their liabilities.
TACTICS
Extend the maturity of your liabilities. Get as far out the curve as senior management and the board will allow you. Make sure of credit quality as you add assets.
Money market arbitrage will power the institution for the years to come, as the spread between bank paper and everything else widens.
STRAGEGY
It's time to get back to work. We've survived the biggest scare since the Great Contraction of 29-33 and we now have profit opportunities not seen in decades.
Warn senior management and the Board that disaster is coming: inflation and rising long rates are certain.
1. US trade deficits increase
2. US interest rates fall relative to others
3. US inflation higher than others
Of these three, the last - inflation - is dominant, and the current Fed monetary policy ensures rising inflation in the months and years to come, causing the dollar to fall in value relative to countries with better inflation management.
The explosion of the monetary base, as the chart below shows is sure to cause inflation unless that money can be removed from the system quickly.
The dilemma facing the Fed is the effect of removing this new money on interest rates and economic activity. In order to take money out of the system, the Fed has to sell something, and that something is the securities they hold.
In particular, the Fed has to sell $1 trillion in securities, and that will raise interest rates as sure as the sun comes up.
Put this in perspective.
If the Fed sells $40 billion in securities each month, it will take two years to get all that money out of the system.
If the monetary authorities begin this program quickly, economic activity is certain to fall, and that is not in the Fed's plans.
So, until the Treasury stops selling bonds to fund the explosion in Federal expenditures, and the Fed can begin selling to reduce the monetary base, inflation is building and the dollar is doomed.
Here is the relevant currency chart.
The number of dollars it takes to buy the Euro.
Notice that the general trend is up, meaning the Euro central bank is better at controlling inflation than the US Federal Reserve.
Next, notice that the recent collapse in the US economy has reversed that trend.
Finally, notice that the trend is about to resume.
Unless the Federal Reserve can find a way to pull all that new money out of the system without crashing the US economy, the dollar is in for a long fall.
When combined with the flood of US securities coming, this is disaster for financial institutions unable to extend the maturity of their liabilities.
TACTICS
Extend the maturity of your liabilities. Get as far out the curve as senior management and the board will allow you. Make sure of credit quality as you add assets.
Money market arbitrage will power the institution for the years to come, as the spread between bank paper and everything else widens.
STRAGEGY
It's time to get back to work. We've survived the biggest scare since the Great Contraction of 29-33 and we now have profit opportunities not seen in decades.
Warn senior management and the Board that disaster is coming: inflation and rising long rates are certain.
Monday, May 04, 2009
Coming Bear Market in Bonds
WHO'S NOT SELLING BONDS?
First, the US Treasury has hundreds of billions of dollars of bonds to sell to fund the trillion dollar deficits Congress is mandating.
Second, the Federal Reserve will be selling the trillions of dollars of securities they have purchased in the recent expansion of the monetary base.
Third, and finally, any investor who owns bonds will be selling to avoid the coming bear market.
Paterson is advising its clients to continue to extend the maturity of liabilities past the 5 year mark, and look at 10 year liabilities, or more.
TACTICS
Continue to shorten the maturity of assets and use money market arbitrage to improve earnings.
Consider borrowing long term deposits.
Use extreme caution on long term lending.
STRATEGY
Warn senior management and the board that a disaster is in the offing.
The flood of money recently added by the Fed will either cause inflation or increases in long term interest rates - or both.
First, the US Treasury has hundreds of billions of dollars of bonds to sell to fund the trillion dollar deficits Congress is mandating.
Second, the Federal Reserve will be selling the trillions of dollars of securities they have purchased in the recent expansion of the monetary base.
Third, and finally, any investor who owns bonds will be selling to avoid the coming bear market.
Paterson is advising its clients to continue to extend the maturity of liabilities past the 5 year mark, and look at 10 year liabilities, or more.
TACTICS
Continue to shorten the maturity of assets and use money market arbitrage to improve earnings.
Consider borrowing long term deposits.
Use extreme caution on long term lending.
STRATEGY
Warn senior management and the board that a disaster is in the offing.
The flood of money recently added by the Fed will either cause inflation or increases in long term interest rates - or both.
Friday, March 27, 2009
Recession is Over
March 2009 the NYSE hit bottom at 4,181.75, levels we will not see again for a long time - if ever.
In the decline from more that 10,000 at the end of 2007, more than half the value of the NYSE has been wiped out, leading to a massive decline in consumption, production, employment, savings, investment, and tax revenues.
The nation and the world will suffer from this debacle for years.
MONEY SUPPLY
Except for a short blunder in early 2009, the Federal reserve has performed magnificently, lending on troubled assets, neutralizing monetary injections when needed, and finally pouring high-powered money into the system when it was justified.
The latest program to add primary reserves to the system leads Paterson to conclude the recession is over. The temporary blunder of allowing the base to fall caused the final spike down in stock prices and convinced the Fed that money easing is the right policy.
CREDIT SPREADS
As Fed policy takes hold, and banks continue lending, credit spreads continue to tighten.
Paterson concludes the worst of the credit crunch is over, and lenders can resume longer-term lending.
TACTICS
Money market arbitrage should continue to take advantage of the wide spreads between bank issued paper and other assets.
Longer term lending can also continue, with careful attention to credit quality.
STRATEGY
The Portfolio Risk Management Team should plan some vacations to get away from the office and the grinding pressure of interest rate and credit risk.
Report success to senior management, and encourage a visit from Paterson to explain why it's time to take a breather.
FINAL NOTE
Thanks to those of you who have sent word of thanks and appreciation.
Paterson will be traveling to your town in the next few months, so please plan to spend some time reliving this debacle and our successful performance.
In the decline from more that 10,000 at the end of 2007, more than half the value of the NYSE has been wiped out, leading to a massive decline in consumption, production, employment, savings, investment, and tax revenues.
The nation and the world will suffer from this debacle for years.
MONEY SUPPLY
Except for a short blunder in early 2009, the Federal reserve has performed magnificently, lending on troubled assets, neutralizing monetary injections when needed, and finally pouring high-powered money into the system when it was justified.
The latest program to add primary reserves to the system leads Paterson to conclude the recession is over. The temporary blunder of allowing the base to fall caused the final spike down in stock prices and convinced the Fed that money easing is the right policy.
CREDIT SPREADS
As Fed policy takes hold, and banks continue lending, credit spreads continue to tighten.
Paterson concludes the worst of the credit crunch is over, and lenders can resume longer-term lending.
TACTICS
Money market arbitrage should continue to take advantage of the wide spreads between bank issued paper and other assets.
Longer term lending can also continue, with careful attention to credit quality.
STRATEGY
The Portfolio Risk Management Team should plan some vacations to get away from the office and the grinding pressure of interest rate and credit risk.
Report success to senior management, and encourage a visit from Paterson to explain why it's time to take a breather.
FINAL NOTE
Thanks to those of you who have sent word of thanks and appreciation.
Paterson will be traveling to your town in the next few months, so please plan to spend some time reliving this debacle and our successful performance.
Friday, January 23, 2009
Credit Spreads at 800 Basis Points
The spread between Baa credits and 10 year US Treasuries reached 800 basis points.
The cost of long-term corporate debt has declined more than 100 BPs, but is still at historic spreads to Treasuries.
MONEY CONTINUES TO GROW
The Fed's policy of adding reserves to the system continued in the past two weeks, and the monetary base is now twice it's value in September of 2008.
Here is the raw data.
Paterson is confident that the Fed's action to support the fixed income markets with massive purchases of securities will shorten the recession by many years.
REAL ESTATE LENDING RESUMES
Even as the economy continues to deteriorate from the collapse in wealth in the stock and property markets, the business of lending is stabilizing.
In California the number of homes sold last month increased nearly 200%.
As this trend continues, the housing market will stabilize.
However, do not expect the trend of the last 20 years to resume. Growth in the value of real estate was caused by the decline in interest rates due to the elimination of inflation. That game is over.
SUMMARY
The Fed's actions to stabilize money growth are succeeding, suggesting a resumption of economic growth in months, not years.
Residential real estate lending - at prudent underwriting standards - is safe again. It is unlikely we will see much more of a sell-off in residential real estate.
Commercial real estate is in much worse shape and should be avoided except for unique situations. The economy has much farther to go to see a bottom.
New lows in stocks. As the magnitude of the disaster grows, there is a significant probability we will see new lows in the stock markets. If this happens, it will probably present a buying opportunity. Look for record volume in shares traded as the signal we've seen the bottom.
However, do not expect a quick rebound. Paterson expects a double or triple bottom in stocks before all selling is done.
TACTICS
Continue money market arbitrage. Paterson is advising clients to take advantage of the double digit yields in high quality short term paper. These assets can be funded profitably with deposits and the book matched nearly to the day.
Do not run a mis-matched book.
Avoid commercial real estate.
Expand prudent residential real estate lending and sell all long-term assets in the secondary market.
Balance sheet lending is extremely risky.
STRATEGY
Make senior management and the Board aware of the successes of the risk management team. Suggest bonuses for continued excellent performance.
Cooperate with regulators to understand their concerns and allay their fears.
The cost of long-term corporate debt has declined more than 100 BPs, but is still at historic spreads to Treasuries.
MONEY CONTINUES TO GROW
The Fed's policy of adding reserves to the system continued in the past two weeks, and the monetary base is now twice it's value in September of 2008.
Here is the raw data.
2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.655
2008-10-22 1174.106
2008-11-05 1265.015
2008-11-19 1506.539
2008-12-03 1502.872
2008-12-17 1689.661
2008-12-31 1728.184
2009-01-14 1773.924
Paterson is confident that the Fed's action to support the fixed income markets with massive purchases of securities will shorten the recession by many years.
REAL ESTATE LENDING RESUMES
Even as the economy continues to deteriorate from the collapse in wealth in the stock and property markets, the business of lending is stabilizing.
In California the number of homes sold last month increased nearly 200%.
As this trend continues, the housing market will stabilize.
However, do not expect the trend of the last 20 years to resume. Growth in the value of real estate was caused by the decline in interest rates due to the elimination of inflation. That game is over.
SUMMARY
The Fed's actions to stabilize money growth are succeeding, suggesting a resumption of economic growth in months, not years.
Residential real estate lending - at prudent underwriting standards - is safe again. It is unlikely we will see much more of a sell-off in residential real estate.
Commercial real estate is in much worse shape and should be avoided except for unique situations. The economy has much farther to go to see a bottom.
New lows in stocks. As the magnitude of the disaster grows, there is a significant probability we will see new lows in the stock markets. If this happens, it will probably present a buying opportunity. Look for record volume in shares traded as the signal we've seen the bottom.
However, do not expect a quick rebound. Paterson expects a double or triple bottom in stocks before all selling is done.
TACTICS
Continue money market arbitrage. Paterson is advising clients to take advantage of the double digit yields in high quality short term paper. These assets can be funded profitably with deposits and the book matched nearly to the day.
Do not run a mis-matched book.
Avoid commercial real estate.
Expand prudent residential real estate lending and sell all long-term assets in the secondary market.
Balance sheet lending is extremely risky.
STRATEGY
Make senior management and the Board aware of the successes of the risk management team. Suggest bonuses for continued excellent performance.
Cooperate with regulators to understand their concerns and allay their fears.
Tuesday, January 06, 2009
Money Explosion Continues
Growth in the monetary base continues.
Since September, 2008 when the monetary base stood at $870 billion, the Fed has added more than $800 billion to the base.
With stimulus like this, the recession will be shortened by years, bringing the return to growth in the next year or two.
OTHER MONEY NUMBERS
MZM which had been stagnant, is now growing.
Here is the raw data.
Here is the rate of growth data.
M2 Growth Signals Economic Recovery
M2 is a leading indicator, signaling both financial and commercial expansion.
The rate of growth in M2 is soaring, approaching 10%
COMMERCIAL AND INDUSTRIAL LOANS
The problem now is to get banks to lend.
Though flush with cash, thanks to Fed actions, Banks are reluctant to lend to Commercial and Industrial companies for two reasons.
One, the uncertainty of every company's balance sheet in this world of Interest Rate and Credit Default swaps. Until this confusion is cleared away, very few financial institutions will take the risk of lending.
Two, economic uncertainty also brings a halt to lending. As economic activity collapses, even good companies might not be able to pay back their loans.
REAL ESTATE LOANS
The surprising fact is real estate loans are holding up well.
INTEREST RATES AND SPREADS
Credit spreads have stopped widening.
Of all the signs that the credit crisis is ending, this is the one most watched by forecasters.
The drop in BAA yields by 100 basis points is a sign that lower quality credits are finding buyers.
SUMMARY, TACTICS, AND STRATEGY
In summary, the Fed's aggressive expansion of the monetary base has shortened a 10 year depression into a 3 year recession.
Though it is not time to invest or lend yet, that time will soon be here.
Tactics
Continue money market arbitrage, extending deposit maturities to 2 years, and adding high-yield assets.
Spreads of 1,000 basis points on AAA quality credits are not uncommon.
Stragegy
Prepare senior management and the board for continued earnings enhancement thanks to the investment department. Focus attention on finding high-yield assets.
Since September, 2008 when the monetary base stood at $870 billion, the Fed has added more than $800 billion to the base.
With stimulus like this, the recession will be shortened by years, bringing the return to growth in the next year or two.
OTHER MONEY NUMBERS
MZM which had been stagnant, is now growing.
Here is the raw data.
Here is the rate of growth data.
M2 Growth Signals Economic Recovery
M2 is a leading indicator, signaling both financial and commercial expansion.
The rate of growth in M2 is soaring, approaching 10%
COMMERCIAL AND INDUSTRIAL LOANS
The problem now is to get banks to lend.
Though flush with cash, thanks to Fed actions, Banks are reluctant to lend to Commercial and Industrial companies for two reasons.
One, the uncertainty of every company's balance sheet in this world of Interest Rate and Credit Default swaps. Until this confusion is cleared away, very few financial institutions will take the risk of lending.
Two, economic uncertainty also brings a halt to lending. As economic activity collapses, even good companies might not be able to pay back their loans.
REAL ESTATE LOANS
The surprising fact is real estate loans are holding up well.
INTEREST RATES AND SPREADS
Credit spreads have stopped widening.
Of all the signs that the credit crisis is ending, this is the one most watched by forecasters.
The drop in BAA yields by 100 basis points is a sign that lower quality credits are finding buyers.
SUMMARY, TACTICS, AND STRATEGY
In summary, the Fed's aggressive expansion of the monetary base has shortened a 10 year depression into a 3 year recession.
Though it is not time to invest or lend yet, that time will soon be here.
Tactics
Continue money market arbitrage, extending deposit maturities to 2 years, and adding high-yield assets.
Spreads of 1,000 basis points on AAA quality credits are not uncommon.
Stragegy
Prepare senior management and the board for continued earnings enhancement thanks to the investment department. Focus attention on finding high-yield assets.
Saturday, December 20, 2008
Base Growth Continues
Monetary Base Doubles in 3 months.
The following table shows the growth in the monetary base since August.
2008-07-16 870.637
2008-07-30 870.659
2008-08-13 870.775
2008-08-27 869.886
2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.662
2008-10-22 1174.141
2008-11-05 1265.079
2008-11-19 1506.630
2008-12-03 1502.996
2008-12-17 1689.771
Since October 2008 the monetary base has doubled, going from $800 to $1600.
Paterson will have more to say about this in future posts.
The following table shows the growth in the monetary base since August.
2008-07-16 870.637
2008-07-30 870.659
2008-08-13 870.775
2008-08-27 869.886
2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.662
2008-10-22 1174.141
2008-11-05 1265.079
2008-11-19 1506.630
2008-12-03 1502.996
2008-12-17 1689.771
Since October 2008 the monetary base has doubled, going from $800 to $1600.
Paterson will have more to say about this in future posts.
Monday, December 01, 2008
Monetary Base Explodes
The explosion in the monetary base is historic.
As the money numbers shown below indicate, money growth is not signalling a continued recession.
However, credit spreads indicate profit opportunities for institutions with portfolio risk skills.
PROFIT OPPORTUNITIES
Recently a Paterson client locked in 22% on AAA rates securities for 9 months, bringing in a profit of nearly $2 million. If your institution is interested in Paterson's Money Market Arbitrage program, please contact us right away. Sellers are looking to clean out their portfolios by the end of the year.
10 Years of Growth in 10 Weeks.
Without this addition to reserves, money would not be growing as fast.
MZM
M2 Growing as Well
Loan Growth Slows
SUMMARY OF FED ACTION
Without the prompt and resolute action by the Board of Governors of the Federal Reserve System, the US and world economies would be collapsing.
With Fed action, the recession will likely last only a few years.
Money growth is a reassuring fact in this convoluted world.
Keep an eye on the monetary base in the months to come. If the Fed stops adding to the base, it's a sign that the markets are healthier.
INTEREST RATES
There is no sign of inflation in the bond market.
For the last 10 years there has been little change in long-term rates and none is expected in the future.
TACTICS
Money market arbitrage has become the most profitable thing for financial institutions.
Continue to fund at the short end of the curve, and match the book with high yeilding paper guaranteed by the Fed.
A billion dollar portfolio of deposits will purchase $100 million in profits in one year on AAA rated paper.
STRATEGY
Brief the board on the profit opportunities in short term paper and obtain authorization to expand the Money Market Arbitrage program.
As the money numbers shown below indicate, money growth is not signalling a continued recession.
However, credit spreads indicate profit opportunities for institutions with portfolio risk skills.
PROFIT OPPORTUNITIES
Recently a Paterson client locked in 22% on AAA rates securities for 9 months, bringing in a profit of nearly $2 million. If your institution is interested in Paterson's Money Market Arbitrage program, please contact us right away. Sellers are looking to clean out their portfolios by the end of the year.
10 Years of Growth in 10 Weeks.
Without this addition to reserves, money would not be growing as fast.
MZM
M2 Growing as Well
Loan Growth Slows
SUMMARY OF FED ACTION
Without the prompt and resolute action by the Board of Governors of the Federal Reserve System, the US and world economies would be collapsing.
With Fed action, the recession will likely last only a few years.
Money growth is a reassuring fact in this convoluted world.
Keep an eye on the monetary base in the months to come. If the Fed stops adding to the base, it's a sign that the markets are healthier.
INTEREST RATES
There is no sign of inflation in the bond market.
For the last 10 years there has been little change in long-term rates and none is expected in the future.
TACTICS
Money market arbitrage has become the most profitable thing for financial institutions.
Continue to fund at the short end of the curve, and match the book with high yeilding paper guaranteed by the Fed.
A billion dollar portfolio of deposits will purchase $100 million in profits in one year on AAA rated paper.
STRATEGY
Brief the board on the profit opportunities in short term paper and obtain authorization to expand the Money Market Arbitrage program.
Sunday, November 16, 2008
Portfolio Risk Management
There is no way to minimize the disaster that has befallen the US and world economies, and no way to repair the damage done by Credit Default Swaps.
In the coming months, it will become clear that the disaster of Greenspan's Tsunami has ruined the lives of three generations of US taxpayers. Current students will find no work when they graduate, their parents have lost half their wealth and can't access much of the remainder; their grandparents retirement will be cold and dark with pensions, health care, and real estate values tumbling.
Greenspan's Tsunami
Like an unexpected wave of disaster, the increase in Fed Funds from 1% to 5.25% caused the flood of defaults in the adjustable loan market, leading to the collapse in Fannie Mae, Freddie Mac, and AIG.
Bad Loans in the Mortgage Industry
Following the decision to relax loan standards in 1999 lenders flooded Fannie and Freddie with low quality paper: borrowers with insufficient downpayment, low income, and poor credit quality. As interest rates rose, these adjustable-rate loans fell into default, and foreclosure sales began.
As the assets behind these loans fell in value, investors in Fannie and Freddie paper looked to the agencies to make good on their promise to guarantee principal and interest. As the magnitude of the disaster became clearer, the markets knew the resources of Fannie and Freddie would not be adequate to make good the losses on mortgage-backed paper.
Credit Default Swaps
Standing behind Fannie and Freddie were sellers of Credit Default Swaps (unregistered insurance), but their capital proved insufficient too, and they failed. AIG and others are now wards of the US Treasury.
The lack of registration of CDSs meant that the risk of default, now spread throughout the system, was unknown and unknowable, leading prudent banks to shun all enterprises not protected by the Federal Reserve. Lending slammed to a halt.
For example, US exports now sit on the piers waiting for a letter of credit from a qualified lender so that the seller will release the goods.
Summary
In the months to come, the credit disaster will grow, and economic activity will collapse. Consumption, production, employment savings, investments, and tax revenues will all decline much more than the markets anticipate.
The stock market has anticipated most of the disaster, but not enough. There is still one more significant decline coming.
TACTICS
Continue money market arbitrage. Take advantage of low deposit costs and pick carefully through the wreckage of the market.
Lend only to solid companies or profitable residential real estate with good spreads.
STRATEGY
Tell the board we are in a long and deep depression and we will not recover soon.
In the coming months, it will become clear that the disaster of Greenspan's Tsunami has ruined the lives of three generations of US taxpayers. Current students will find no work when they graduate, their parents have lost half their wealth and can't access much of the remainder; their grandparents retirement will be cold and dark with pensions, health care, and real estate values tumbling.
Greenspan's Tsunami
Like an unexpected wave of disaster, the increase in Fed Funds from 1% to 5.25% caused the flood of defaults in the adjustable loan market, leading to the collapse in Fannie Mae, Freddie Mac, and AIG.
Bad Loans in the Mortgage Industry
Following the decision to relax loan standards in 1999 lenders flooded Fannie and Freddie with low quality paper: borrowers with insufficient downpayment, low income, and poor credit quality. As interest rates rose, these adjustable-rate loans fell into default, and foreclosure sales began.
As the assets behind these loans fell in value, investors in Fannie and Freddie paper looked to the agencies to make good on their promise to guarantee principal and interest. As the magnitude of the disaster became clearer, the markets knew the resources of Fannie and Freddie would not be adequate to make good the losses on mortgage-backed paper.
Credit Default Swaps
Standing behind Fannie and Freddie were sellers of Credit Default Swaps (unregistered insurance), but their capital proved insufficient too, and they failed. AIG and others are now wards of the US Treasury.
The lack of registration of CDSs meant that the risk of default, now spread throughout the system, was unknown and unknowable, leading prudent banks to shun all enterprises not protected by the Federal Reserve. Lending slammed to a halt.
For example, US exports now sit on the piers waiting for a letter of credit from a qualified lender so that the seller will release the goods.
Summary
In the months to come, the credit disaster will grow, and economic activity will collapse. Consumption, production, employment savings, investments, and tax revenues will all decline much more than the markets anticipate.
The stock market has anticipated most of the disaster, but not enough. There is still one more significant decline coming.
TACTICS
Continue money market arbitrage. Take advantage of low deposit costs and pick carefully through the wreckage of the market.
Lend only to solid companies or profitable residential real estate with good spreads.
STRATEGY
Tell the board we are in a long and deep depression and we will not recover soon.
Apology
For the past three months Paterson has been busy working with existing and new clients to avoid the disaster in the credit markets.
My apologies to students, casual readers, and potential clients for the absence of this weblog.
Paterson is back, explaining the situation and suggesting tactical and strategic plans for dealing with the extended downturn.
My apologies to students, casual readers, and potential clients for the absence of this weblog.
Paterson is back, explaining the situation and suggesting tactical and strategic plans for dealing with the extended downturn.
Saturday, August 16, 2008
Disaster in Gold, Currencies
Gold Plummets to $791 at Friday's Close
After touching $1000 per ounce in July of 2008, gold prices have dropped more than 20% in little more than a month.
Friday's price action in the gold market confirmed our fears - and exceeded them!
This is a disaster of monumental proportions for analysts who are confident of gold's value as a hedge against inflation.
Inflation is done.
Currencies fall
The value of the British Pound and the Eurodollar also fell sharply.
Paterson has never been able to successfully predict currency movements except as they relate to inflation.
In this case, it looks like the rest of the world is inflating, while the US restricts its money supply.
Monetary Base Growth Below 5%
With the base growing at 2% per year, there is plenty of room to add high-powered money to the system.
MZM Growth Slows
Bonds Rally
In the past weeks the bond market has faced
* $27 billion in new 10 and 30 year securities
* CPI of 13.2% on an annual basis.
Credit Spreads Continue to Widen as Corporate Yields Increase
Put Options on Bear Stearns
A trader gambled $1.7 million on out of the money puts on Bear Stearns. The options had only a week till expiration, and were $30 out of the money.
The position made $270 million.
Read it all.
http://tinyurl.com/59mwwz
TACTICS
Continue money market arbitrage, extend the maturity of liabilities, add assets.
STRATEGY
Announce a major change in the economic future of the United States.
Inflation is finished for the future, until money growth resumes.
Be wary of hedging liabilities, and consider hedging assets when spreads widen and yields are attractive.
Asset quality is the topic of the year.
After touching $1000 per ounce in July of 2008, gold prices have dropped more than 20% in little more than a month.
Friday's price action in the gold market confirmed our fears - and exceeded them!
This is a disaster of monumental proportions for analysts who are confident of gold's value as a hedge against inflation.
Inflation is done.
Currencies fall
The value of the British Pound and the Eurodollar also fell sharply.
Paterson has never been able to successfully predict currency movements except as they relate to inflation.
In this case, it looks like the rest of the world is inflating, while the US restricts its money supply.
Monetary Base Growth Below 5%
With the base growing at 2% per year, there is plenty of room to add high-powered money to the system.
MZM Growth Slows
Bonds Rally
In the past weeks the bond market has faced
* $27 billion in new 10 and 30 year securities
* CPI of 13.2% on an annual basis.
Credit Spreads Continue to Widen as Corporate Yields Increase
Put Options on Bear Stearns
A trader gambled $1.7 million on out of the money puts on Bear Stearns. The options had only a week till expiration, and were $30 out of the money.
The position made $270 million.
Read it all.
http://tinyurl.com/59mwwz
TACTICS
Continue money market arbitrage, extend the maturity of liabilities, add assets.
STRATEGY
Announce a major change in the economic future of the United States.
Inflation is finished for the future, until money growth resumes.
Be wary of hedging liabilities, and consider hedging assets when spreads widen and yields are attractive.
Asset quality is the topic of the year.
Saturday, August 09, 2008
Markets at Major Turning Points
Gold at Major Support
Most of the evidence suggests the bounce will be small, and prices will continue to drop. But, traders don't bet it that way.
Bond Refunding Successful
US Treasury sold $27 billion of notes and bonds following the largest increase in CPI since the Volcker years.
Treasury Note Futures
Treasury Bond Futures
Note that ond prices surged following a successful auction.
Corporate Bond Spreads Falling
Stocks finding Support
NYSE Composite
S&P 500
Russell 2000
SUMMARY
10 years from now this time will be seen as a major turning point in stocks. With inflation banished, and the bull market in bonds ended, only stocks will have the investment potential for the future.
Remember, stock prices rise when interest rates come down and stay down.
Most of the evidence suggests the bounce will be small, and prices will continue to drop. But, traders don't bet it that way.
Bond Refunding Successful
US Treasury sold $27 billion of notes and bonds following the largest increase in CPI since the Volcker years.
Treasury Note Futures
Treasury Bond Futures
Note that ond prices surged following a successful auction.
Corporate Bond Spreads Falling
Stocks finding Support
NYSE Composite
S&P 500
Russell 2000
SUMMARY
10 years from now this time will be seen as a major turning point in stocks. With inflation banished, and the bull market in bonds ended, only stocks will have the investment potential for the future.
Remember, stock prices rise when interest rates come down and stay down.
Wednesday, July 16, 2008
Fed and Treasury Up Again
Recent moves by the US Treasury to purchase equity in Fannie and Freddie tell us two things.
1. They are in danger of going bankrupt.
2. The treasury will not allow them to go out of business.
Even though shareholders might lose all their money, the companies will still be reconstituted by injections of US government cash.
Along with this announcement came the news that the Fed will lend to the mortgage buying behemoths if necessary.
These two actions will support home lending by ensuring the ability to sell mortgages in the secondary market.
1. They are in danger of going bankrupt.
2. The treasury will not allow them to go out of business.
Even though shareholders might lose all their money, the companies will still be reconstituted by injections of US government cash.
Along with this announcement came the news that the Fed will lend to the mortgage buying behemoths if necessary.
These two actions will support home lending by ensuring the ability to sell mortgages in the secondary market.
Saturday, July 05, 2008
Stock Market at Support
Investors will be watching the stock market closely for the next few weeks at prices approach support levels seen twice before in the last 6 months.
NYSE Composite
S&P 500
Russell 2000
Technical traders will be buying the Index here, and selling if the market trades below these levels.
SUMMARY
The usual rule is to buy the market when the situation looks bleakest.
That certainly is the case here.
NYSE Composite
S&P 500
Russell 2000
Technical traders will be buying the Index here, and selling if the market trades below these levels.
SUMMARY
The usual rule is to buy the market when the situation looks bleakest.
That certainly is the case here.
Friday, June 27, 2008
Inflation and the Bond Market
Bonds sank through support this month and are now back at May's support levels, now resistance for this instrument.
The question now is how low will prices go, and how high will long rates rise?
To answer this question we look at the money supply and the dollar. The first causes inflaton, and the second makes inflation worse.
MONEY SUPPLY
The monetary base is growing, but growth has been slowing for years.
This is a good sign for inflation, showing the Fed's commitment to control the supply of high-powered money.
In recent months, however, growth has accelerated slightly, but not enough to cause inflation.
Bank generated money has grown substantially in the past years, as businesses work their way through the recent Fed-caused disaster.
In recent months, growth in this leading indicator has slowed, leading to renewed confidence in the Fed's management of interest rates and the money supply.
In summary, inflationary pressures are not building, and there is no need to raise interest rates.
INFLATION AND THE DOLLAR
Price rises in the United States are connected to the falling dollar. Import prices are soaring as international demand for primary commodities pulls at suppliers.
The rise in commodity prices is directly related to the fall in the value of the dollar.
Notice the plunge in the dollar in 2006, and the simultaneous rise in PPI.
TACTICS
Prudent A/L managers will continue to lengthen liability maturities, shorten asset maturities, and work for higher spreads in lending.
Money market arbitrage is more profitable than ever, and those clients pursuing this activity have found their yields soaring dramatically.
The key to this business is a careful analysis of credit quality. High quality credits have been pushed off the curve hundreds of basis points, providing opportunities for lenders with excess cash.
STRATEGY
Now is the time to report to senior management and the Board on the A/L condition of the portfolio.
The institution is liquid, carrying good credits, good spreads, and profitable liabilities. In short, we are ready to lend to our existing customers, and prepared to take business from our weaker competitors.
The Asset/Liability department can take a bow.
The question now is how low will prices go, and how high will long rates rise?
To answer this question we look at the money supply and the dollar. The first causes inflaton, and the second makes inflation worse.
MONEY SUPPLY
The monetary base is growing, but growth has been slowing for years.
This is a good sign for inflation, showing the Fed's commitment to control the supply of high-powered money.
In recent months, however, growth has accelerated slightly, but not enough to cause inflation.
Bank generated money has grown substantially in the past years, as businesses work their way through the recent Fed-caused disaster.
In recent months, growth in this leading indicator has slowed, leading to renewed confidence in the Fed's management of interest rates and the money supply.
In summary, inflationary pressures are not building, and there is no need to raise interest rates.
INFLATION AND THE DOLLAR
Price rises in the United States are connected to the falling dollar. Import prices are soaring as international demand for primary commodities pulls at suppliers.
The rise in commodity prices is directly related to the fall in the value of the dollar.
Notice the plunge in the dollar in 2006, and the simultaneous rise in PPI.
TACTICS
Prudent A/L managers will continue to lengthen liability maturities, shorten asset maturities, and work for higher spreads in lending.
Money market arbitrage is more profitable than ever, and those clients pursuing this activity have found their yields soaring dramatically.
The key to this business is a careful analysis of credit quality. High quality credits have been pushed off the curve hundreds of basis points, providing opportunities for lenders with excess cash.
STRATEGY
Now is the time to report to senior management and the Board on the A/L condition of the portfolio.
The institution is liquid, carrying good credits, good spreads, and profitable liabilities. In short, we are ready to lend to our existing customers, and prepared to take business from our weaker competitors.
The Asset/Liability department can take a bow.
Saturday, May 31, 2008
Credit Crunch is Over
Bonds broke support this week, signaling the end of the credit crunch and the return of investors to non-Treasury securities.
As the chart shows, bond prices have fallen through the 114 level on the CBOT and look likely to head lower as fears of inflation power sellers of long term securities.
At the same time, corporate securities have continued to climb in yield adding 500 basis points since the beginning of the year.
Inflation Tactics
The problem at this stage is inflationary expectations. The falling dollar combined with aggressive policies by the Fed concerns bond holders who are shedding long-term securities in fear of a long term commitments.
In our view, the Fed has not been particularly inflationary, as it has sold Treasuries to compensate for the extension of credit to banks and primary dealers. But, as long as inflationary pressures continue, and the business cycle expands, prudence requires reducing long-term assets and lengthening the maturity of liabilities.
Tactics
Continue money market arbitrage, shorten the maturity of assets and lengthen the maturity of liabilities.
Strategy
Senior management must aggressively prepare for new business as credit conditions improve. Prudent credit analysis can add high quality assets to the portfolio at bargain prices.
The risk is that lenders will not have the resources available to take advantage of these opportunities.
The board must understand the situation we are in, and must be appraised of the changes underway at this juncture. The economy has emerged from a potential catastrophe in better shape than any of us imagined.
It's time to take some risk, and prepare for the coming boom in lending opportunities.
As the chart shows, bond prices have fallen through the 114 level on the CBOT and look likely to head lower as fears of inflation power sellers of long term securities.
At the same time, corporate securities have continued to climb in yield adding 500 basis points since the beginning of the year.
Inflation Tactics
The problem at this stage is inflationary expectations. The falling dollar combined with aggressive policies by the Fed concerns bond holders who are shedding long-term securities in fear of a long term commitments.
In our view, the Fed has not been particularly inflationary, as it has sold Treasuries to compensate for the extension of credit to banks and primary dealers. But, as long as inflationary pressures continue, and the business cycle expands, prudence requires reducing long-term assets and lengthening the maturity of liabilities.
Tactics
Continue money market arbitrage, shorten the maturity of assets and lengthen the maturity of liabilities.
Strategy
Senior management must aggressively prepare for new business as credit conditions improve. Prudent credit analysis can add high quality assets to the portfolio at bargain prices.
The risk is that lenders will not have the resources available to take advantage of these opportunities.
The board must understand the situation we are in, and must be appraised of the changes underway at this juncture. The economy has emerged from a potential catastrophe in better shape than any of us imagined.
It's time to take some risk, and prepare for the coming boom in lending opportunities.
Wednesday, May 07, 2008
End of a 25 Year Bull Market in Bonds
The bull market in bonds is over. Never again will investors see a run like this.
Since Paul Volcker crushed inflation back in 1980 bond yields have made new lows with every cycle.
10 year US Treasury notes peaked at 15% in 1981, and have fallen consistently till the lows of 3.5% in 2003.
During this period real estate values boomed as capitalization rates fell and the cost of borrowing tumbled.
Refinances further fueled the mortgage banking business, bringing profits to finance companies.
Companies like GE, which based their growth on this trend will now see that portion of their earnings disappear, never to return again.
STRATEGY
For diversified companies, reduce expectations of future growth from financial activities. Explain to senior management and the board that lower interest rates will not happen again - ever.
For finance companies, explain to senior management and the board that the competition in the finance arena is about to get as tough as it gets, with more competitors chasing every deal, and lowering profits in order to compete.
TACTICS
Asset and Liability Management will dominate the discussion on adding assets and liabilities.
As the Fed moves to more market-based allocation of Fed Funds, expect to see more volatility at the short end of the curve.
Lengthen liability maturities and focus on solid spreads.
Since Paul Volcker crushed inflation back in 1980 bond yields have made new lows with every cycle.
10 year US Treasury notes peaked at 15% in 1981, and have fallen consistently till the lows of 3.5% in 2003.
During this period real estate values boomed as capitalization rates fell and the cost of borrowing tumbled.
Refinances further fueled the mortgage banking business, bringing profits to finance companies.
Companies like GE, which based their growth on this trend will now see that portion of their earnings disappear, never to return again.
STRATEGY
For diversified companies, reduce expectations of future growth from financial activities. Explain to senior management and the board that lower interest rates will not happen again - ever.
For finance companies, explain to senior management and the board that the competition in the finance arena is about to get as tough as it gets, with more competitors chasing every deal, and lowering profits in order to compete.
TACTICS
Asset and Liability Management will dominate the discussion on adding assets and liabilities.
As the Fed moves to more market-based allocation of Fed Funds, expect to see more volatility at the short end of the curve.
Lengthen liability maturities and focus on solid spreads.
Tuesday, April 29, 2008
Recession is Over
The danger from Greenspan's blundering is past, thanks to prompt action by the Board of Governors to reduce the Fed Funds rate and pull down the short end of the curve.
Without this action, a recession was inevitable. The yield curve was flat for nearly 18 months, from mid 2006 to the end of 2007, usually long enough to stall the economy.
That danger is now past.
Today, the spread between 3 month bills and 10 year notes is fully 250 basis points, a growth signal.
There is still a danger of a continued slowdown in the next few months, but the risk of a protracted recession is past.
This action, when combined with a massive injection of liquidity by the Fed's Open Market Committee to banks and primary dealers, suggests there is little danger of a prolonged recession.
YIELD SPREAD SIGNALS GROWTH
The spread between 3 month Bills and 10 year notes is the best predictor of recession.
Notice the last three recessions were preceded by a flat yield curve.
In Volcker's recession back in the early 80s, the yield curve was negative for an extended periond, signaling an unusually severe contraction.
CURRENT YIELD SPREAD
As the chart below shows, the spread between 3 month bills and10 year notes is about 250 basis points.
This is sufficient to allow for new bank lending and economic growth.
STOCK MARKET CONFIRMATION
The stock market confirms the forecast that the recession is over.
Notice the volume spike back in August of 07. As the effects of a flat yield curve spread throughout the banking and lending communities, the path to recession was clear and the stock market fell below the levels at the volume spike.
The market is now trading above those levels and finding support there.
INFLATION
The problem now is a continued rise in domestic prices both from additional liquidity in the system and from the falling dollar.
TACTICS
Continue to extend the maturity of liabilities to 5 years or longer. Borrowing now will lock in rates for the long term and fuel growth in assets. Be prepared to lock in profitable spreads on new assets.
Money market arbitrage is more profitable than ever. Aggressively raise deposit rates and expand the portfolio. Use the additional funds to acquire high-yield assets knocked down by credit concerns.
STRATEGY
Warn senior management of coming inflation.
Prepare hedging programs to take advantage of any spike in prices to hedge against the future sale of liabilities.
Evaluate credit risks and prepare to take advantage of distressed assets.
Insulate the portfolio from currency risk.
Without this action, a recession was inevitable. The yield curve was flat for nearly 18 months, from mid 2006 to the end of 2007, usually long enough to stall the economy.
That danger is now past.
Today, the spread between 3 month bills and 10 year notes is fully 250 basis points, a growth signal.
There is still a danger of a continued slowdown in the next few months, but the risk of a protracted recession is past.
This action, when combined with a massive injection of liquidity by the Fed's Open Market Committee to banks and primary dealers, suggests there is little danger of a prolonged recession.
YIELD SPREAD SIGNALS GROWTH
The spread between 3 month Bills and 10 year notes is the best predictor of recession.
Notice the last three recessions were preceded by a flat yield curve.
In Volcker's recession back in the early 80s, the yield curve was negative for an extended periond, signaling an unusually severe contraction.
CURRENT YIELD SPREAD
As the chart below shows, the spread between 3 month bills and10 year notes is about 250 basis points.
This is sufficient to allow for new bank lending and economic growth.
STOCK MARKET CONFIRMATION
The stock market confirms the forecast that the recession is over.
Notice the volume spike back in August of 07. As the effects of a flat yield curve spread throughout the banking and lending communities, the path to recession was clear and the stock market fell below the levels at the volume spike.
The market is now trading above those levels and finding support there.
INFLATION
The problem now is a continued rise in domestic prices both from additional liquidity in the system and from the falling dollar.
TACTICS
Continue to extend the maturity of liabilities to 5 years or longer. Borrowing now will lock in rates for the long term and fuel growth in assets. Be prepared to lock in profitable spreads on new assets.
Money market arbitrage is more profitable than ever. Aggressively raise deposit rates and expand the portfolio. Use the additional funds to acquire high-yield assets knocked down by credit concerns.
STRATEGY
Warn senior management of coming inflation.
Prepare hedging programs to take advantage of any spike in prices to hedge against the future sale of liabilities.
Evaluate credit risks and prepare to take advantage of distressed assets.
Insulate the portfolio from currency risk.
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