Monday, June 8, 2009

Cuff Em

Friday’s slight improvement in the jobs number has found a way to quickly make a mockery of US monetary policy. The less bad headline number of -345,000 jobs lost in the month of May 2009 has prompted the expectations of the Federal Funds rate, set by the Federal Reserve Committee, to sky rocket. With short terms rates at 0% and talk of it staying that way for a long time to come from Chairman Bernanke, the FED now faces an interesting quandary. Expectations on what the FED will do during the upcoming meetings based on FED Funds Futures are as follows: 33% possibility of a 50-basis-point interest rate hike by September, a 40%-plus chance of a Sept hike and a 100% possibility by December. This after a report of a contraction of over 300k jobs!

If we think back to a similar situation where the FED was faced with this predicament, it can be last seen in the 1931-1934 period during The Great Depression. The FED saw the economic data improving and decided to raise rates prematurely. This backfired and sent the economy back into a downturn. As we all know, Ben Bernanke has dedicated his life to studying the Depression, so in my estimation, this policy action will be avoided (Fed Fund Futures are wrong in my opinion).

Leaving the question of whether we should currently be at 0% in the first place aside, this is where the FED has to make some decisions. Do they want to disappoint the American people and send us back into a depression they worked so hard to avoid, or will they continue to inflate the economy through low interest rates and liquidity programs? Inflation vs. Deflation, we have seen that the FED has chosen inflation, why will it change?

Now, the interesting part. The elephant in the room is foreign ownership of US Treasuries and T-Bills. Because the FED policy thus far has been one of ZIRP (Zero Interest Rate Policy) everyone and their mother has shortened duration in the treasuries they hold. For example, if I owned 10-year treasuries, I have decided to swap those in for 2–years as we know they are “safe” and tied to short term rates by the FED, who has told us time and time again they are on hold for “an extended period of time.”

So, two roads. Fed Funds Futures market is correct, and the FED decides to raise rates by the September 2009 meeting. OR, they stay on hold as implied by the last eight months of statements. Some believe the FED does not control the short end, the market does, which is quite possibility true. Either way, raising rates will cause a catastrophe in the short end of the curve due to enormous over crowding and will send us back on depression watch. Due to FED policy, banks have had the opportunity to make obscene profits from the record steep yield curve; this will go away. If they stay on hold, long-term rates will continue to climb, but this time at faster speeds thus squashing any housing recovery due to exploding mortgage rates. In addition, by upsetting what the market wants will create a dollar debacle, something our creditors have been staunch opponents of as they hold immense dollar assets.

Either way, their hands are tied.

Thursday, June 4, 2009

The new financial center?

In the 1700's New York City gained prominence as THE financial center of America. It established itself as a major trading port due to the Hudson River availability and for a brief time was the capitol of the US. As time went on, it grew in importance as a financial, cultural, fashion and entertainment mecca. In the financial realm, it is best known for Wall Street. Wall Street has been a key driver for the local economy in Manhattan fueling real estate, retail, fine dining, and nightlife. I believe this is changing. Manhattan will always be a cultural and entertainment hotbed, but the demise of finance will bear great strains on the city. You can see it walking around the streets. New Yorkers don't march up and down 5th Ave. shopping, it's foreign buyers here on vacation. Much of the real estate boom in New York was driven by lofty bonuses and a foreign buyer. What happens to a city that is reliant on one industry, a city that is not self sustaining?

The real question is what will be the next great financial center of the United States?