bonds Markets

How Many Trillions Equals Negative 1? (And 100-Year Floods That Happen All The Time)

Don't forget the lessons from March.

"These are administered markets", Deutsche Bank's Stuart Sparks begins, in his latest note. It's a familiar refrain. In fact, he used the same phrase earlier this month in the course of projecting the Fed will ultimately accommodate (i.e., monetize) the entirety of the virus relief packages delivered by Congress. And that includes an expected "phase four" bill. Sparks is unequivocal and quite blunt in his assessment of the rates market. "Outcomes will be driven by the policy goals of the Fed and the tools it elects to deploy to achieve them", he says, flatly. "The Fed must engineer and maintain financial conditions that are conducive to economic recovery such that it ultimately meets its employment and inflation policy objectives". There's just one problem: Policy is still too tight. For everything that's been done - the trillions in congressionally-approved relief funds, the trillions in assets already purchased by the Fed over the past six weeks, and the myriad liquidity facilities rolled out to ensure that virtually any asset can be posted as collateral for cheap cash - it's not enough. There's no mystery here. I talked, for instance, on Sunday about the extent to which a s
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15 comments on “How Many Trillions Equals Negative 1? (And 100-Year Floods That Happen All The Time)

  1. “The incidence of ‘historic’ events has been rising for years…even adjusting for the usual heteroskedasticity of financial asset returns, the rate of 3-sigma and larger events is not only many times what one would expect from a normal distribution, but that has nearly doubled since 2010.” Methinks a visual representation of the phenomenon described would look a lot like “Gallopin’ Gertie” — the Tacoma Narrows Bridge on opening day:

  2. 100 year floods happen much more frequently. I believe it is more than just “fat tails”. Returns are not normally distributed. Time to throw that assumption in the trash can along with capm and the emh.

    • I thought these assumptions were thrown in the trash about 20 years ago… clearly Bachilier’s work was useful BUT wrong. Markets are complex, dynamic systems, with power curves.

  3. Perhaps the occurrence of heteroskedasticity is because markets are not “normally distributed”. Benoit Mandelbrot proved 60 years ago security prices are distributed via a power law. Mean and variance DO NOT settle to a single value and therefore standard deviation is undefined. (Cauchy, Pareto) Wall Street chose to ignore his research even though markets, and JP Morgans analyst in the analysis above, have proven him correct.

  4. heteroskedasticity–even does not have a definition for this word….

  5. That term I believe describes error terms that are correlated rather than random in a regression. Fat tails refers to skewness or kurtosis meaning each side of a normal looking distribution have a higher probability than a standard normal distribution. In practical terms this means seemingly unlikely events at each end are more likely…… so the hundred year flood is more like a 5 year event. Or a 5 standard deviation event is more like a 1 or 2 standard deviation event.

  6. The question begged is whether the Fed has enough ammunition to backstop not only the domestic economy, but also the global order. Or perhaps i is more a question of how long can they keep up and whether it will be long enough. I’ve never considered gold as a viable “investment” until this pandemic, but it seems to me that the rules have changed yet no one has the new rule book…

  7. heteroskedasticity: In statistics, a collection of random variables is heteroscedastic (or heteroskedastic; from Ancient Greek hetero “different” and skedasis “dispersion”) if there are sub-populations that have different variabilities from others.

    • That might be a nice way to think about antigenic drift and virus mutation and a reason as to why a vaccine is sorta tuff to invent, e.g. one reason the common cold has never been cured. .

  8. One can never assume a full gaussian distribution but of course lately and in the future I would expect tails to be fatter simply because actions by the federal reserve in the past 2 and a half decades have had the major effects of making debt cheaper and ever increasingly pushing capital further out the risk curve. Simply put with every major fed intervention in bond markets eventually, longer term, risk increases as money is pushed further and further out reaching for yield

  9. All the answers wind up being questions in the end or as my father always referred to these issues “mental Gymnastics”…. Good post…H…!!

  10. The implications of some of these comments is that the bond market is now more of a “greater fool” market than I could ever imagine, especially on the long end. I just dumped a large 7.5% stripped treasury that was selling near par with more than six years to run. Put the cash in an insured CD which will pay me triple what the UST would. Also, turned a huge pending OID liability into a smaller capital gain with less than a quarter of the tax liability. This s**t is crazy.

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