Wednesday, September 21, 2011

Paul Brodsky "The Twist Is All About The Banks Income Statements"

The Twist in essence reduces to a bank subsidy. How?

1)    Banks are taken out of levered long duration Treasury paper at cycle lows
2)    Banks increase their net holdings in the short end on a levered, positive carry basis (by repo-ing purchases of short paper with the Fed)

Is the Fed’s solvency at any lesser or greater risk? NO.

1)    Despite the duration extension of the Fed’s balance sheet, there is no incremental risk
2)    The Fed must now, however, be THE BID for the long end
3)    Real risk to bondholders, regardless of duration, is dollar devaluation (real risk), not rising interest rates (nominal risk)

So, in the near term, banks win, Fed breaks even, dollar and unlevered bondholders risk of devaluation is escalated.

Where from here?

1)    Incremental QE is no more or no less needed as a result of The Twist
2)    Incremental QE is ABSOLUTELY still necessary to shrink the unreserved debt to base money stock ratio
3)    Future QE may very likely require the Fed to bid out through the long end to defend yields across its holdings maturity spectrum

In sum, this is a move to help recapitalize banks under the guise of supporting the housing market and any wealth effect that might flow from that outcome. This is all about the banks income statements. Future and imminent QE will be about their balance sheets (dollar devaluation which then boosts nominal asset/collateral pricing).

Lee Quaintance & Paul Brodsky
QB Asset Management Company, LLC

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com


  1. What are your thoughts on the fact that a flat yield curve actually puts downward pressure on bank's net interest margin, which actually goes against Paul's claim that twist is a bank subsidy? Perhaps the benefit from twist is greater than the loss from the compression of net interest margin? Welcome your thoughts.

  2. I think that QB's point of view is the immediate effect. In Day 0 a flatter yield curve will boost banks' income statement. That is actually very straight forward and there shouldn't generate much debate.

    The other aspects to be analyzed are that the flat yield curve doesn't bode well for confidence.
    Historically the steepness of the curve tells investors that things don't look too good.
    Second, with low yields across the entire curve investors are pushed further out to generate some yield income and that means adding duration risk to one's portfolio.

    I am not really worried about short-term inflation at the moment, but what will the world look like in a few years? What the global central banks are trying to do is devalue their currencies. The Fed has a bazooka while smaller countries have and guns.

    I am afraid that some day the USD will get slapped in the face, losing a lot of purchasing power (inflation) and causing bond holders lose money due to 1. inflation (in real terms) and 2. in nominal terms because widening yields will cause bond prices to plunge.

    What I believe QB guys wanted to tell us is that Bernanke is engaged in sustaining the global banking system for longer as he understands deleveraging well, understands the impact of deflation well, meaning he understands that in the world we currently live in (in DM) lower rates don't necessarily make people invest/spend/etc.

    Dangerous days ahead.... buy some USDCNY Calls, go long gold / short silver or study hard what's behind these corporate balance sheets.
    It seems to me that things might get much uglier... but still, look for things that, at the right price, whatever the right price is for you, you will want to buy.

    I am already doing my list here in Brazil!