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Leveling the Playing Field

March 23, 2015


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What if I told you the Philadelphia curse extends to colleges?
No matter how many 30 for 30s ESPN trots out, you cant make me yearn for the Laettner era
Bill Simmons! Maybe he should turn his attention to Philadelphia, because picking Nova for the
Final Four is like saying the Fed isnt going to hike this year its a losing proposition. I dont
even feel bad for you at this point if you are on that side of either trade. I grew up a Philly fan so
I would love to see Nova do well, but they are the Peyton Manning of college hoops. Or for you
SEC fans, they are the South Carolina football of college hoops. Dont bet on them when the
stakes are high.
What if I told you that removing patient doesnt mean we are going to be impatient?
Yellen delivered a dovish message Wednesday, basically confirming the timing of the first hike
while suggesting the path to normalization will be a gradual one. This reinforces our
expectations that a hike is coming, but that it also wont be a typical tightening cycle.
Just because we removed patient doesnt mean we are going to be impatient, Yellen said,
trying to avoid a market shock as much as possible. The official statement was more hawkish
than markets think, so we think the reaction was overdone. But, just as importantly, the Feds
blue dots forecast for Fed Funds showed a drop across the curve of about 0.50%, even more than
we suggested in our last newsletter. This helps close the 1.00% gap between Fed forecasts and
market expectations, but still leaves a discrepancy of 0.50%+. We dont think the Fed will
decrease the forecast again materially, which means rates would have to move up half a point.
Last week we suggested that the FOMC could use the blue dots forecast as a way to signal the
market outside the scope of the official statement. Blah blah blah blah official stuff here and
there and then sneak in the hey, you guys should probably pay attention to this stuff over
here Call us if you need help translating that highly technical analysis, but the market was
largely reacting to the Fed blue dots, not the statement itself. That means a change in blue dots
in the future could have an opposite reaction and push rates higher.
Rates plunged across the curve while equities rallied. The Fed is as accommodative as an
NCAA referee calling one of our games! said Coach K in an interview with the WSJ. The 10yr
ran down to 1.93% following the news. The belly of the curve saw an even bigger move, with
5yr rates down 0.17%.
But she also indicated that every meeting is a live one and a hike could come at any meeting.
Although I hate to beat a dead horse, the message is the same as it has been for quite some time
the Fed is hiking soon but it will be a gradual hike.

What if I told you 1 month LIBOR can actually move?


Its been so long since the Fed changed Fed Funds, lets spend a moment talking about how
LIBOR responds. Traditionally, 1 month LIBOR resets about 0.07% - 0.12% above FF. If FF is
0.25%, 1mL would be around 0.32% - 0.37%.
LIBOR also prices in expectations for hikes/cuts ahead of Fed meetings, so it will move ahead of
the FOMC meeting. A 100% probability of a hike to 0.25% and a 25% probability of a hike to
0.50% would typically push 1mL to around 0.375% - 0.42% ahead of the Fed meeting. If the
FOMC hiked to 0.25%, then 1mL would dip a bit and settle in around 0.32% - 0.35%.
But this cycle is going to be different in that the Fed has suggested it will hike using a range
instead of a precise target. For example, the first hike this year will likely be to 0.25% - 0.50%.
What does that imply for LIBOR and your floating rate borrowings?
No one knows. And if they say they do, ask them how their bracket is doing. They are probably
one of those guys that has only missed one game and it was because they had Ga State beating
Xavier because I watched Ga State earlier this year on the Ocho and knew they were for real. I
cant stand That Guy.
But, as long time readers of this newsletter can attest, lack of insight has never prevented us from
speculating. And we certainly arent going to start today.
Assuming the Fed hikes to 0.25% - 0.50%, I would guess 1mL starts climbing in May because
Yellen said an April hike was a low likelihood. But June is in play, so 1mL will start pricing in a
hike heading into that meeting as long as the Fed keeps it on the table. The higher the likelihood
of a hike, the higher LIBOR will move ahead of the meeting.
I suspect 1mL will move to around 0.35% - 0.40% and 3mL will move to around 0.50% - 0.55%.
You should expect your floating rate invoices to start moving higher in May/June. Tell your
controller there isnt anything wrong with the billing, it turns out floating rates can actually move
around.
For those of you that have been treating LIBOR as a fixed rate, those days are
overtemporarily. I still think the Fed will get to some level (0.75% - 1.00%) and then pause
for quite some time, but there will be some recalibration on the way up.

What if I told you this week would be a quiet one?


Very little domestic data this week, but quite a few Fed speeches scheduled to help
reinforce/clarify last weeks message, starting with Mondays speech by Stanley Fischer called
Monetary Policy Lessons and the Way Ahead. Then Yellen closes the week on Friday at an
SF conference called The New Normal for Monetary Policy. You think maybe they are trying
to let the market know what Fed policy is going to look like during the upcoming tightening
cycle?
Expect Yellens message to be the same as her Q&A prepared statement. The dovish FOMC
members will highlight global headwinds, strengthening dollar, lower oil prices, etc as potential
reasons to delay on a hike. The hawks will mention the labor market and falling behind the
curve. The messages will roughly balance each other out and allow the Fed to remain datadependent in the coming months.

What if I told you this newsletter is done because Id rather watch hoops than talk rates?

Economic Data
Day
Monday

Tuesday

Wednesday

Thursday

Friday

Time

Report

8:30AM

Chicago Fed Nat Activity Index

10:00AM

Existing Home Sales

8:30AM
8:30AM

Forecast

Previous

0.13

4.94M

4.82M

CPI MoM

0.20%

-0.70%

CPI YoY

-0.10%

-0.10%

9:45AM

Markit US Manufacturing PMI

54.7

55.1

10:00AM

New Home Sales

475K

481K

10:00AM

Richmond Fed Manufact. Index

7:00AM

MBA Mortgage Applications

-3.90%

8:30AM

Durable Goods Orders

0.50%

2.80%

8:30AM

Durables Ex Transportation

0.50%

0.30%

8:30AM

Initial Jobless Claims

295K

291K

8:30AM

Continuing Claims

2417K

11:00AM

Kansas City Fed Manf. Activity

8:30AM

GDP Annualized QoQ

2.40%

2.20%

8:30AM

Personal Consumption

4.20%

8:30AM

GDP Price Index

0.10%

0.10%

10:00AM

U. of Mich. Sentiment

91.8

91.2

Speeches and Events


Day

Time

Monday

11:45AM

Fed Vice Chair Stanley Fischer Speaks

Wednesday

6:30AM

Fed's Evans Speaks on Economy, Monetary Policy

London

Thursday

4:45AM

Fed's Bullard Speaks on U.S. Economy and Policy

Frankfurt

9:00AM

Fed's Lockhart Speaks on Economy, Monetary Policy

3:45PM

Fed's Yellen Speaks on Monetary Policy

Friday

Report

Place
New York

Detroit
San Francisco

Treasury Auctions
Day

Time

Report

Size

Tuesday

1:00PM

2 Year US Treasury Note

$26 Billion

Wednesday

1:00PM

5 Year US Treasury Note

$35 Billion

Thursday

1:00PM

7 Year US Treasury Note

$29 Billion

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