Leveling the Playing Field

February 16, 2015

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The markets collective optimism gained momentum over the course of last week, as no bad
news out of the EU meetings was interpreted as good news. This pushed rates up across the
curve, with the 10yr Treasury testing the key psychological level of 2.00% much of the week and
finally breaking through Friday. Wednesdays emergency meeting had no immediate fallout,
Thursdays scheduled EU meeting rolled into Friday with no negative leaks, and we slid right
into the weekend without any major red flags coming out of Europe. Stocks decided it was a
good time to set all time highs.
We expect that tone to change this week.
The deadline for an agreement is today, but as we have learned over the years any phrase with
the word deadline needs to end with ish. Market optimism is likely to be tested Monday, as
we believe no deal will be formally struck. Merkel stood her ground at the end of last week,
stressing that Greece needed to comply with existing requirements. Tsipras, emboldened by the
democratic mandate that thrust him into office, reiterated that Greece has no interest in
complying with austerity measures that have crushed the Greek economy. Much like our own
Congressional agreements, we believe this will go to the 11 th hour. Both sides need to save face
but neither side can afford to walk away.
Therefore, we wont be surprised if rates actually retrace some of last weeks upward movement.
The longer it takes to reach an agreement, the more likely the market will turn conservative. The
ECB released an additional 5B euros to Greek banks last week via the ELA, hoping to help with
the emerging liquidity crisis we discussed in last weeks newsletter. But if no deal is reached by
Wednesday, the ECB can cut off additional funds and put the screws to the Greek financial
system at its bi-weekly ELA review meeting. This would probably go hand in hand with a
formal statement from the ECB announcing limits to the existing bailout package. If nothing
else, the ECB wants to talk tough in the hopes of spooking Greek leadership into reaching a
compromise.
If, however, a deal is somehow struck on Monday, we would expect US rates to continue their
upward trend, with the 10T heading to 2.10% - 2.15% range. Again, we view this outcome as a
low likelihood. Politicians are politicians after all, whether they are American or European.

If we were placing a bet, it would be on some sort of extension of the existing bailout package to
allow negotiations to continue without a gun to their heads. But that wont happen until the last
second, meaning this week will likely be a risk off kind of week, with rates moving lower as
the game of chicken escalates.
With rates on the fence heading into the weekend, that means we would take any dip in rates as a
potential opportunity to lock. A deal will be reachedeventually.

FOMC Minutes
The market is extremely headline-sensitive right now, particularly to anything out of Europe.
But domestically this week, the main headline will be out of the FOMC Minutes from the last
meeting. We dont expect any shift in sentiment, but a deviation would have ripple effects in
front end rates. We will be paying particular attention to any discussion around the removal of
the word patient, which the market is using as the last remaining obstacle to the first hike.
As any long time reader can attest to, we are at odds with market expectations regarding the first
hike. We believe the first hike is most likely to come at the June or September meeting. The
market believes low inflation will keep the Fed on hold until the beginning of 2016. Although
the Minutes could provide new insight persuasive enough to change either forecast, we dont
expect them to.
Last week, two Fed presidents (Lacker and Williams) reiterated that a June hike was still on the
table, a sentiment raised the week prior by St Louis Fed President Bullard. All of this recent
chatter feels like the Feds way of managing expectations. Low inflation will allow the Fed to
remain patient, but ultimately Yellen will want to move away from ZIRP.
The next big Fed event is February 24th when Yellen testifies before Congress as part of the
semi-annual Humphrey Hawkins testimony. We doubt anything earth shattering will be
revealed, but markets are definitely interested to hear her take on the impact Europe and oil
prices will have on the Feds tightening strategy.

Bottom line on rates this week momentum is still for higher yields, but if a deal isnt reached in
Brussels we should see a short term retracement. And the louder Greece protests, the greater the
opportunity for rates to move lower.

Economic Data
Day
Tuesday

Wednesday

Thursday

Friday

Time

Report

Forecast

Previous

8:30AM

Empire Manufacturing

10:00AM

NAHB Housing Market Index

7:00AM

MBA Mortgage Applications

8:30AM

Housing Starts

8:30AM

Building Permits

1068K

1058K

8:30AM

PPI Final Demand MoM

-0.40%

-0.20%

8:30AM

PPI Ex Food and Energy MoM

0.10%

0.30%

8:30AM

PPI Ex Food, Energy, Trade MoM

0.10%

0.10%

8:30AM

PPI Final Demand YoY

0.40%

1.10%

8:30AM

PPI Ex Food and Energy YoY

2.00%

2.10%

8:30AM

PPI Ex Food, Energy, Trade YoY

1.30%

1.30%

9:15AM

Industrial Production MoM

0.30%

-0.10%

9:15AM

Capacity Utilization

79.90%

79.70%

2:00PM

FOMC Minutes from Jan. 27-28

8:30AM

Initial Jobless Claims

290K

304K

2330K

2354K

9.0

6.3

8:30AM

Continuing Claims

10:00AM

Philadelphia Fed Business Outlook

8:30AM

Revisions: Consumer Price Index

9:45AM

Markit US Manufacturing PMI

8.5

9.95

58.0

57.0

-9.00%

1070K

1089K

53.6

53.9

Speeches and Events

Day

Time

Report

Tuesday

12:45PM

Fed's Plosser Speaks on Monetary Policy

Wednesday

5:00PM

Fed's Powell Speaks on Regulation

Place
Philadelphia
New York

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