Replies to Post #6422 onVelocitySharesTM 3x Long Silver (USLVF)

Replies to #6422 on VelocitySharesTM 3x Long Silver (USLVF)

10/21/19 9:10 AM

#USLV: End of the month SHORT SQUEEZE...:-}

Why The Fed Might Have To Cut 50 Basis Points At The End Of October

https://www.forbes.com/sites/vineerbhansali/2019/10/10/why-the-fed-might-have-to-cut-50-basis-points-at-the-end-of-october/#3cdbcfc18b31

Why The Fed Might Have To Cut 50 Basis Points At The End Of October

As an investor, I try not to get snared by the “shoulda, coulda, woulda” trap that people interpret as excuses for false premises, bad execution, or just being wrong. As a corollary, I try not to give my opinion on what the Fed should or should not do. This is because they are economists, I am not, and also they have more data than I will ever get. But having observed the Fed for almost thirty years, I do think I have a tiny edge in forecasting what they will do because they generally, and eventually (1) do what’s the easiest solution to multiple problems, and (2) they like to appease markets by confirming market expectations.

Now I am no Donald Trump, so my pronouncing that the Fed is going to most likely cut 50 basis points next time will have no impact whatsoever in what they actually do. But the problems from not cutting the funds rate aggressively are accumulating, and as always, the market and data, and pure logic, I think, will convince them to potentially cut 50 basis points as soon as the next meeting.

First, as I wrote in the last piece in this forum, the Fed is trying to clean up the repo plumbing problem with a plunger. Well, they actually went a step further in the last few days, promising to use “Drano” of sorts by possibly buying short term Treasury Bills, which is better but still not the solution to the structural problem of an inverted short term yield curve and large cross currency differentials. The market thinks this Treasury buying is QE4 starting up, but Chair Jerome Powell denied this is QE. I think it’s a stealth way to get set up to cut rates. The real solution, of course, is to bite the bullet and cut rates - not to make money cheaper necessarily, but to re-steepen the US yield curve and to compress the interest rate differential between US short term rates and the short term rates in the rest of the world.

The market has already priced in an aggressive easing path which the Fed is certainly aware of. Looking at the Eurodollar futures curve, we can observe that 3 month LIBOR drops from 1.85% in October 2019, to a U-shaped low of 1.20% in September of 2021 (Source: Bloomberg). In other words, the LIBOR market is already pricing in 0.65% of cuts over the next two years. Backing out the implied probabilities from the Fed Fund futures contracts, the market thinks there is a 92% probability in October of a 25 basis point cut, and a 55% percent probability of rates being 50 basis points lower by the December 11, 2019 meeting. I think the October cut could be larger, i.e. 50 basis points, and this will result in the yield curve re-steepening in the short end, a rally in risk assets and a repricing of the easing expectations further out. In other words, an aggressive cut now will require less of a cut in the future, and possibly normalize both the “plumbing” and the pricing of the US yield curve relative to the rest of the world.

Today In: Money
Why, you may ask, is it important for the US yield curve to play ball with the rest of the world’s rates markets? The simple answer is that if the US yield curve is both inverted and US rates are higher than the rest of the world, it discourages foreign investors, who have to clean up the increasing Treasury issuance, to buy them, and also discourages US banks from buying these same Treasuries. Foreign investors are less likely to buy them in the current environment because the high interest rate differentials makes currency hedging very costly and wipes out the yield of the still positively yielding US bond market. It is also a discouragement for US investors, since buying longer assets and financing them with a higher short term rate in a negative yielding environment is a negative carry trade - and banks hate negative carry. And the same currency hedging logic makes it more profitable for US investors to even buy foreign, negatively yielding bonds and get yield from the currency hedge. Cutting short rates aggressively now could partially solve both of these problems, and hopefully will have the bonus gift of increasing longer term yields moderately as well, which will make the whole US yield curve more normal, which equities will like.

So coming back full circle, I think the Fed will cut 50 basis points not only because it should, but because it is the easiest, most logical path to restoring the global debt markets to normalcy. It is such a low hanging fruit I doubt that politics will even come into the picture. As an investor, locking in short term T-Bills at almost 2% yield seems like the easiest investment while we wait for the Fed to do what makes eminent sense from almost every perspective. For those who worry this might result in an asset price bubble, let me assure you that the market, which is much smarter than me or the Fed, collectively has probably already reached this conclusion and has priced it in.