This place is always crowded.
And it's that kind of uncomfortable crowded where people periodically lean in between you and the guy sitting next to you to ask the bartender for this or that.
I always sit at the very end of the bar next to the wall. That way at least, I can ensure that the leaners only come in from one side. There's not enough room for a magazine, let alone a laptop, so I'm actually writing this on my iPhone as a note. I'll e-mail it to myself later and add the charts.
Pretty much the only reason I come here is for dirty martinis. They have these blue cheese-stuffed olives that are also crammed with bacon bits, so obviously that's awesome.
I'm picking through this cheese and charcuterie board trying desperately to find the prosciutto amid an exceedingly superfluous array of garnishes.
I think a lot about how to frame stories. Nobody wants to read something with no soul. Sometimes I'll have the entire second half of a piece pretty much memorized but will wait days to write it. I'm waiting to hear or see or remember something that I think will bring the piece to life.
Tonight it's a cocktail napkin.
A while back I got hooked on an appetizer. It kind of reminds you of Oysters Rockefeller only instead of oysters you get shrimp. The unfortunate thing about this appetizer is that it's served at a chain restaurant, which I generally abhor. Don't get me wrong, it's a nice chain restaurant -- you won't find Heisenberg at TGI Friday's -- but it's a chain nonetheless.
So I get to know the bartenders. One is a bubbly young lady with a passion for marine biology. The other is a deadpan, sarcastic petite girl, who seems to share my disdain for stupidity.
So one night I pay my check and the bubbly one is kind of giggling when she hands me the faux leather book with the receipts and the pen. I open it and what she's done is written the other girl's name and number on a cocktail napkin for me.
Now if I were extremely dense, I might call the number that night and say "Hello, I was given this number by your coworker. How can I help you?" Instead, I called the next day and said the following: "So this is proof it's not always bad news when you get the check." (Props, right?)
That may seem like a trivial story but there's a lesson in there about markets believe it or not. In that situation, me (and hopefully every guy on the planet) automatically says to himself "effectively what that means is, this girl wants to get to know me."
You should condition yourself to have the same automatic response when you think about trading and investing. The phrase "effectively what that means is..." is a powerful, powerful tool when it comes to analyzing markets.
Here's a simple example (then we'll get to the "minutiae"). It's 2:00 p.m. ET on a Wednesday. Steve Liesman pops up on CNBC: "Unchanged. The Fed keeps rates unchanged." And then there's usually a split screen with like eight commentators talking over each other.
But here's what you have to realize. They may have technically kept rates unchanged but "effectively what that means is" they hiked. Why? Because the ECB, the BoJ, and now the BoE are still actively easing and adding to existing accommodative programs. In other words, if the Fed stays on hold while three of the other big four are easing more, then the Fed is de facto hiking.
Ok, so let's tie this in with the conversation we've been having lately about money market reform. As you're now aware (and if you aren't, read this) prime money market funds are transitioning to a new regulatory reality that will require them to report a floating NAV. For investors, that basically means $1 no longer necessarily equals $1 in those funds. Naturally, everyone is moving their money to government funds, which invest not in commercial paper and CDs, but rather in government debt and repos collateralized by that debt.
The shift is tectonic. For their part, BofAML sees as much as $800 billion fleeing prime funds by the time the dust settles. That's $800 billion in dollar liquidity that's not available for companies to tap. I'm not going to recount the whole story here, but again, I encourage you to read the article linked above.
Now then, this exodus from prime funds has played a part in driving up LIBOR. See this is where you have to condition yourself to think about markets like you would the cocktail napkin with the number. "Effectively what a spike in LIBOR means is" a rate hike. Consider this from Goldman (emphasis mine):
Since mid-June, three-month US dollar LIBOR has increased by about 15 basis points (NYSE:BP) despite an unchanged stance of Fed policy. We agree with many other
observers that this increase likely reflects adjustments to new money market regulations, which will take effect in October, rather than signs of systemic risks in the banking system. Regardless of the underlying cause, the increase will result in higher borrowing costs for some households and firms, as LIBOR serves as the benchmark rate for a sizable share of private nonfinancial debt.
For households, fixed-rate home mortgages account for the bulk of outstanding debt. Adjustable rate mortgages (ARMs)-which typically reference LIBOR-account for 20% of the value of loans outstanding and 15% of the value of new issuance.
Combined, the share of household liabilities referencing LIBOR likely ranges from 15% to as much as 20%, depending on how we classify loans in the "other" categories.
We find slightly higher numbers for the nonfinancial business sector. For business lending, the use of LIBOR as a benchmark rate differs significantly by firm size. According to the STBL, 52% of loans of less than $100,000 were prime rate-based. For loans of $1 million to $10 million, 25% were prime rate-based, and for loans of $10 million and up only 5% were prime-based. Therefore, the recent pickup in LIBOR will have a more immediate impact on borrowing costs for larger firms.
So essentially, that money market reform that some people view as a boring, esoteric conversation topic, is driving up LIBOR, which will not only impact 15% to 20% of household debt but will have an outsized effect on big-time corporate borrowers.
But you should have already surmised that. It's the whole "essentially, what this means is..." thing. You have to think about how all of this fits together. Let's look at one more excerpt from Goldman (emphasis mine):
The tightening of swap spreads in 2015 was driven by a combination of factors all working to either richen swaps or cheapen Treasuries. Our earlier research has emphasized the increase in repo funding costs, in particular, as a key driver of swap spread tightening during 2015H2. Exhibit 2 shows that repo rates at the time were actually higher than LIBOR rates, an unexpected result given that repo is collateralized and LIBOR lending is not. The re-widening of short-term swap spreads seen in Exhibit 1 has occurred in two phases. First, in January 2016, repo rates moved back below LIBOR, making it possible for short-term swap spreads to begin normalizing. Second, and more recently, new regulations are forcing non-government money market funds to report and redeem shares on a floating NAV basis; this, in turn, is leading to a broad sector shift towards government funds, which can still report and redeem shares at par. The regulations become binding in October 2016, but sector rotations are already taking place. In effect, the regulation leads to lower funding costs for the US Treasury, but higher rates for international banks and other commercial paper issuers, and hence lower Treasury rates, higher LIBOR rates and wider short-term swap spreads.
Again, it's important to remember that these are key metrics. Your iPhone sales channel checks and Tesla pre-order numbers mean nothing compared to these numbers.
These are the numbers that determine how much you pay in interest on a fifth of your household debt (statistically speaking, that is). They are the numbers that determine how much it costs for giant multinationals to borrow overnight funds and thus keep the shelves stocked and the employees paid. And these rates are being influenced by this:
Oh look, there's that LIBOR-OIS spread I've been talking about that no one has ever heard of. Apparently the folks at Goldman have. Imagine that.
Goldman isn't sure how dramatic the impact of this shift out of prime and into government is going to be. Frankly, neither am I. And neither are prime MMF managers, which is why they're stacking liquidity and stacking maturities in early October. Goldman is correct to point out that what you're seeing in LIBOR, etc. is indicative of the MMF regulatory shift and thus not necessarily a harbinger of funding stress. But as the Squid also notes, higher borrowing costs are higher borrowing costs. Whether the system is freezing up is a different discussion.
So again, if you're serious about understanding how the Matrix works, you have to make "essentially what this means is..." just as instinctual when it comes to looking at markets as it is when looking at a cocktail napkin with a nice girl's phone number written on it.
If you don't, you're the market (NYSEARCA:SPY) equivalent of the guy calling and saying "Hello, I was given this number by your coworker. How can I help you?"
Don't be that guy.
Incidentally, she turned out to be a very nice and remarkably intelligent young lady. But, in the end, Heisenberg is a bit of a loner. She didn't like that so ultimately, we split.
But not before I bought her an iPad. Which she kept.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.