Yesterday, Minn. Fed President Narayana Kocherlakota held an impromtu conference call with reporters. The gist was to remind markets of the gravitational pull of the ZIRP. As we proposed last week, we feel the markets are adjusting to a Quantitative Easing Big Bang of real rates, dollar carry trades and international FX reserve flows. This complex and violent adjustment has been neatly packaged as the “tapering boogeyman.” Kocherlokota put it this way, “We must bring that point forward and hammer it every time we talk about policy.” “That point” was/is that the Funds rate would remain 0-25bp long after LSAPs not just tapered but ended.
We believe the unwind of several years of dollar carry has mostly taken place. We are watching China closely because we believe their cash crunching shadow banking (tipped by rising real yields here) was a precursor to floating the Renminbi. Contrary to Congressional calls of “manipulation”, after some volatility, we think the Yuan would fall. (Since the 90′s the Chinese have been very cognizant that floating the ccy was more a banking system risk than a trade flow risk.)
The credit component in money markets perked up yesterday as seen in Eurodollar strips. Five contributing banks raised their setting. Meanwhile, CME Group raised margins on the complex and the growing cleared swap contracts. The system is already burdened with collateral obligations and BBG reported chatter that the Euros were considering restricting bank rehypothication activities. Financial System 2.0 appears to go into lock-down mode quickly.
If the ZIRP gravity has any strength left, then rates markets need to respond through the new (and considerably higher coupon) supply. Beyond that is a Holiday week and an employment report long over due for an upside outlier. In monetary policy, gravity’s more of a guideline than a law.
by Kevin Ferry, originally posted on The Contrarian Corner on June 25, 2013
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