The 10th Man

Calling an Audible

March 17, 2016

I had something else planned for The 10th Man today and scrapped it because of the stupendously amazing Fed meeting yesterday.

There are some things we need to talk about—immediately. I’ll save the other piece for another time. I know you’re accustomed to my grandiloquent prose, but today I’m just focused on getting words down. And I’ll have a special announcement at the end.

So let’s review.

This $5 Trillion Market Is Just Getting Started.

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First we thought the Fed was going to hike four or five times in 2016.

Then we changed our mind and thought the Fed was not going to hike at all.

Then we changed our mind again and priced in four Fed hikes.

The rates market has been really schizophrenic about this, and the guidance from the Fed has been less than clear.

So going into the FOMC meeting yesterday, a consensus was building that inflation was starting to ramp and the Fed was going to have to address it. Nobody was expecting a rate hike yesterday, but people thought the Fed would be pretty hawkish and maybe start pricing one in soon.

Didn’t happen—it was the most dovish directive I have seen in some time. They explicitly took out two of the four rate hikes, moved down the dots on the dot plot, downgraded their assessment of the economy, and most important of all—expressed little or no concern whatsoever about inflation.

I have seen a handful of sea changes in Fed policy over the years, and this was a big one. This was a Fed that went from being concerned about inflation pressures building to being fairly glib about it. And the market did pretty much what you’d expect in response to a central bank being glib about inflation:

  • Gold went up
  • Emerging markets went up
  • The yield curve steepened dramatically
  • Base metals went up
  • Commodity currencies rallied

In other words, the inflation trade is back and bigger than ever, just like we’ve been talking about here and elsewhere.

This is no small thing. Pretend for a moment that I were credible. I am telling you that there is going to be inflation. How do you prepare?

The first question I would ask is: What percentage of your portfolio is in fixed income?

Let me parse this for a moment. Earlier, I said that the yield curve steepened dramatically yesterday, which means the spread between short-term interest rates and long-term interest rates increased. That is because short-term interest rates are driven by fed funds expectations and long-term interest rates are driven by inflation expectations. Two-year notes rallied hard, ten-year notes less so, and bonds were almost down on the day.

The curve has been flattening pretty steadily for a year now, so a six-basis-point steepening is a big deal.

This might sound like mumbo-jumbo to someone who isn’t all that familiar with the bond market, so let me be succinct: You do not want to hold long-term bonds when inflation expectations start to ramp up. I have a feeling that people are going to find out the meaning of duration.

I have said this before in Street Freak. We are going to look back at negative yields and say, “Yup, that was a bubble.”

It’s a bond market bubble—complete silliness. Holding paper with no or negative yields when inflation is steaming ahead flank speed is unwise, to say the least.

This $5 Trillion Market Is Just Getting Started.

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Admit it: the risk-reward ratio here is terrible. What do you think will be the real rate of return, after inflation, on a 30-year bond yielding less than 3%? 30 years is a long time.

If you asked me what the dumbest thing in the market is today, this is it.

All the Evil of This World

I am very pleased and thrilled to announce the publication of my second book: All the Evil of This World.

I believe that this is the first book of its kind: a Wall Street novel of real literary quality. There exists Wall Street fiction, but it tends to be of the financial-thriller genre. And the rest are non-fiction and memoirs. Here is the cover copy, which will tell you what it is about:

There are humans behind the big, bad investment banks. There are humans behind the calculations of Wall Street. There are humans behind the legal and illegal financial manipulations in the news. They’re not always the best humans, and they’re not always the worst humans, but All the Evil of This World tells their stories with abundant curiosity, empathy, and honesty.

On March 2nd, 2000, the technology company 3Com spun off its insanely profitable hand-held computer subsidiary, Palm. It was one of the most high profile, complex, and bungled trades in history, and it’s a story about much more than the millions and millions of dollars that instantly came into play. All the Evil of This World tells it via seven separate voices from seven separate players, including an ambitious low-level clerk fresh out of school, a drug-addicted, party-throwing broker with bad taste and gross amounts of money, and a seemingly infallible hedge fund manager tortured by his own good luck. The 3Com/Palm trade is what weaves their stories together. They all collide into it and out of it, and it sometimes unites them, implodes them, saves them, or destroys them.

It isn’t for the faint of heart—these characters are just as troubled and intense and volatile as their surroundings, and not a single punch is pulled—but it’s an examination into a cast of characters that we rarely examine fairly or patiently, and who we often find it too easy to dehumanize. The people who inhabit this world aren't cartoon heroes or villains—as it turns out, they’re just like us.

There’s no other book that captures how real, how raw the world of trading is.

It’s also an interesting piece of historical fiction, about what the markets were like 16 years ago, when open outcry was at its peak, before technology, before decimalization.

A warning: If you wouldn’t see an NC-17 movie, you might not want to buy this book. It is graphic, jarring, and relentlessly dark. But if you think you can handle it, it might be the most important financial book you will ever read.

It’s available for pre-order on Amazon (and other places) in e-book form right now. The hard copy will be available for sale when it is released on June 21, if you’re the kind of person (like me) who likes holding a physical book.

I’d be honored to have you read it.

Jared Dillian
Jared Dillian


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Irb Laster

March 23, 2016, 10:44 p.m.

In the end, the market controls long bond rates, not the gov’t nor central bankers.  Throughout thousands of years of history, gov’t has repeatedly tried to thwart market forces like in this decade, and while they can appear to do so temporarily, the market ALWAYS reasserts itself.  Per Newton’s third law, for every action there is an equal and opposite reaction.  So long gov’t bond can be a trade, but not a LT investment strategy.

March 21, 2016, 5:57 a.m.

Agree that 30 years is a long time but in the long run we are all dead. All the supersmart bond fund managers who sold the bonds at 2.30% + yields in December had to buy them back at 1.90%- just a couple of months later. The market on the whole understands that 3% is little value for 30 years but they will still buy these bonds in the hope of making a killing in the short-term as Fed will be forced to follow the other central banks into negative territory.

March 17, 2016, 12:07 p.m.

Hi Jared, thanks for this note.  However, something doesn’t quite add up for me.  It seems to me that if the Fed is intent on following other Central Banks down the router of lower and even negative interest rates, the value of a 30-year govt bond purchased recently will go UP.  Won’t 3% look really great when the Fed is targeting -0.1%?  Obviously if inflation really takes off the value will drop but as a trade vs an investment I think long bonds will do well in the short term.  Thoughts?