Leveling the Playing Field August 4, 2014

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Spent the weekend moving, so this is going to be short and sweet. Quite an interesting
week we just had, huh? Wednesday opened with a 4% print on GDP, sending rates up by
10-15bps across the curve. The 10yr Treasury ran up to 2.57% and then paused to await
the Fed decision.

The Feds rate announcement on Wednesday was slightly more hawkish than expected,
pushing yields up another 0.03%, with the front end of the curve experiencing the most
movement. As expected, Philly Fed President Charles Plosser dissented, saying the Fed
shouldnt provide forward guidance dependent on time (considerable period of time)
but rather provide guidance that is data-dependent. There were some rumblings that
Dallas Fed President Fisher may dissent, but he did not. He has been making more
references lately to the Fed falling behind the curve and may be setting the stage for a
dissent at one of the upcoming meetings. And during an interview Friday morning he did
indicate that the hawks are gaining traction behind Fed walls. A hike is coming, and the
first rate movement in over six years will be a big deal.

Fridays job reports came out reasonably strong, but the fickle market swooned. The
economy added 209k jobs last month, the six straight month with 200k plus jobs a first
since 1997. The last two months were also revised higher.

Although 209k was less than expectations of 230k, this is still a good print. July is a
seasonally volatile number anyway. A 200k/month average translates into 2.5mm per
year and a 1% decline in the unemployment rate. This just reinforces the notion that the
UR could easily be approaching 5.5% by spring 2015.

Speaking of which, the UR actually ticked up to 6.2%, but only because the labor force
participation moved higher. Although we are still below Marchs participation level, this
is a good sign that discouraged workers are optimistic enough to look for jobs again.

Lastly, this type of print implies GDP trend comfortably north of 2%. This is a good data
release, and yet rates fell across the curve as if we were heading for another recession.
We suspect much of Fridays movement was short-covering. So many traders had
positioned themselves short ahead of the job report expecting a gangbuster number that
the modest print forced them to cover their positions. Monday morning should be a good
indicator of what the market actually thinks about US yields.







While US fundamentals suggest rising rates, there are quite a bit of global concerns
keeping a lid on rates.
- Agentina defaulted (again) and it could get messisee what I did there?
- Portugals financial system is being stressed with Banco Espirito on the verge of
bankruptcy (there may be an EU bailout Sunday night/Monday morning by the
time we come into the office)
- the eurozone economy continues to lag
o interesting article in Fridays WSJ about Japanese investors seeing a lot of
similarities between the EZ and the Japanese lost decades. With 10yr
JBGs yielding at 0.50%, EZ bonds look quite attractive if you believe low
inflation will keep EZ rates anchored near zero for the long term. From a
US standpoint, it seems absurd that yields for Italy and Spain are on top of
our yields. But if the ECB is going to explicitly back all EZ sovereign
debt AND you think yields could head to 0.50% just as they did in your
own country, maybe 2.50% isnt so bad.
o Japanese investors have bought the most Italian bonds since 2005 and the
most Spanish bonds since 2011.
o ECB meets Thursday. Very low inflation plus sanctions on Russia do not
a strong economy make
- Russia. What are you going to do Comrade Putin?
- Gaza

In general, I would say that domestic factors are more important than the global factors
listed above for determining the direction of US rates going forward. The bias is towards
higher rates, but those global issues are keeping a lid on rates for the time being.

Much quieter week ahead, with very little data and no Treasury auctions. Well be
watching Fed-speak for any clarification on the FOMC meeting and then Saturday I get
married (presumably), so no newsletter next week. Have a great week!








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Economic Data
Day Time Report Forecast Previous
Monday None
Tuesday 9:45AM Markit US Services PMI - 61.0
9:45AM Markit US Composite PMI - 60.9
10:00AM ISM Non-Manfufacturing Composite 56.3 56.0
10:00AM Factory Orders 0.60% -0.50%
Wednesday 7:00AM MBA Mortgage Applications - -2.20%
8:30AM Trade Balance -44.5B -44.4B
Thursday 8:30AM Initial Jobless Claims - -
8:30AM Continuing Claims - -
3:00PM Consumer Credit 18.0B 19.602B
Friday 8:30AM Non-Farm Productivity 0.00% -3.20%
8:30AM Unit Labor Costs 2.20% 5.7%
10:00AM Wholesale Inventories MoM 0.60% 0.5%
Speeches and Events
Day Time Report Place
None
Treasury Auctions

Day Time Report Size
None