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It was a very tense period, one of those moments in time when you just knew there would be no going back from it. We’ve been able to deconstruct several of these over the years, more recent years, and they always seemed to play out in exactly the same fashion. Possibility, denial, inevitable disaster.

The plain reason for this pattern and its repetition was and remains the very human instinct toward confirmation bias. No one likes to receive bad news, and we all become even less receptive to it when the news hits very close to home. It’s one thing if you hear your own neighborhood is under serious threat of harm, difficult enough to accept, but quite another when the harm may have been introduced by your own action (or inaction, as the case may be).

On July 5, 2018, the Federal Reserve’s Open Market Committee (FOMC) released the policy minutes from its meeting held in the middle of June, the 12th and the 13th. That latter date would become ingrained in the consequences of what followed, which would become the opposite of what was “supposed” to.

As policymakers gathered to discuss more rate hikes and speeding up the pace of any future moves, inflation on the rise, dark clouds loomed ominously over the proceedings. The yield curve suddenly on the lips of even the emptiest talking heads, flattening so starkly it was too hard to ignore – though they tried.

What the public knows of the yield curve is some very basic and rather misleading correlations, mostly pertaining to an inversion in the calendar spread between the 2-year note yield (sometimes the 3-month bill yield) and the benchmark 10-year note rate. When the latter goes under the former, either one, this had consistently signaled recession.

Even as newly-installed Chairman Jay Powell took his seat barely months earlier, coming in with a decidedly public “hawkish” bias, the yield curve was instead already acting strangely, at least by way of the FOMC’s models on robust economic conditions and the generally higher inflationary potential such would represent.

By mid-June 2018, the yield curve wasn’t yet in any danger of inversion, merely flattening though it was substantial. What “should” have happened was the opposite; higher inflation expectations, including the market anticipating Powell’s hawkish stance therefore higher short-term rates upon which to pile upward growth and inflation prospects, the yield curve should’ve undertaken gross steepening like it had during 2013’s “taper tantrum.”

That’s the thing about this whole inflation puzzle going all the way back to before the full-blown crisis erupted in September 2008. It’s not really about consumer prices; rather a modest bit of inflation, even a tiny bit more, this would’ve confirmed for policymakers their ultimate success, our success, or what we’d all love to call a completed recovery.

At max employment therefore economic potential, competition for workers leads to higher wages and then this wide swath of companies paying more for labor passes those costs along to consumers in nearly all the products and services they buy. Inflation isn’t just pain at the pump and the grocery store, it is left to be the last tumbler to click into place, marking the full unlocking of legit economic expansion and a true boom which would have more than cushioned these modest inflationary pressures leaving everyone, everyone, far the better for it.

If it would ever show up.

Many, including Bernanke, were predicting how labor market numbers presented to the US 2013 were moving in just the right way so that by 2014 and 2015 inflation would confirm that, yes, QE had indeed effectively eliminated all macro impediments (slack) to the complete satisfaction of real recovery. This was the substance behind “taper.”


It didn’t work out that way in one sense because the world even now misunderstands the “tantrum.” Looking back from June 2018, Jay Powell’s Fed knew enough to at least investigate the possibility of committing to the same mistake (now in the form of additional rate hikes). And they already didn’t like the yield curve’s downward twist having anticipated instead upward steepening.

Their alarms, however, were quite easily, too easily, assuaged by the Economists on staff. Presenting a range of interpretations as to other markets, such as federal funds futures, the conclusion reached was that the yield curve flattening couldn’t have been what it clearly was, it must’vebeen due to other factors (ridiculous stuff like R* and even the leftover influences of QE bond buying).

“Several participants cautioned that yield curve movements should be interpreted within the broader context of financial conditions and the outlook, and would be only one among many considerations in forming an assessment of appropriate policy.”

What did “the broader context of financial conditions and outlook” actually mean? Well, it was not a broad context of financial conditions and outlook. While the minutes cite the staff having studied federal funds futures (which were actually alarming in their own way), there was no mention whatsoever of eurodollar futures.

This latter money market and its curve, tied to, and priced in 3-month LIBOR, didn’t conform to FOMC expectations, either, even as 3-month LIBOR is very, very heavily influenced by whatever future position Federal Reserve policymakers set. Thus, you’d expect eurodollar futures to look like, for instance, the FOMC “dots.”

No. By mid-June 2018, the eurodollar futures curve had only an upward sloping bend in the whites but then flat – I mean totally flat – getting into the reds and especially greens (the color scheme relates to contract maturities). In other words, setting aside the chromatics, the eurodollar futures curve had already become even more contrarian than the yield curve – by quite a lot.

What this had meant was that this unimaginably huge, deep market (especially in comparison to the small niche that is federal funds futures) was increasingly skeptical of the inflation, growth message and expectations put in for all these rate hikes.

The unemployment rate wasn't the full story.

And once the FOMC released its typical hawkish, inflation-is-on-the-horizon statement on June 13, that skepticism changed into outright rejection. Inversion. At first small, a few basis points between 2020 and 2021 contract years, then much more inversion over the months that followed with the yield curve continuing in its, not the FOMC’s, direction.

Eurodollar futures, again tied directly to future levels of 3-month LIBOR, weren’t betting on Jay Powell’s view today, but what the world would look like over the few years ahead which would then influence Jay Powell’s view at that time – whether he ever liked it or agreed with it over the interim. Inversion merely indicated how this huge came to more forcefully conclude that the Fed and its read of the labor market situation – and what that ultimately would mean for inflation or deflation - was all wrong.

Which it was. By July 2019, barely a year forward, rate cuts were put into place where once only rate hikes were thought possible outside these curves.

Powell’s major error wasn’t that he hiked rates too far, rather it was that he hiked rates for illegitimate reasons; there was no recovery in any of the cards just as the curves had pointed out all along.

Despite some effort to avoid making the same mistakes as 2014-15, they ended up repeating them because of the same confirmation bias.

And such bias always begins with a wholly incorrect approach to interest rates and futures markets. This had been ably demonstrated, too, by 2013’s taper tantrum.

You hear nothing whatsoever about how that thing ended, only some misconstrued recollections as to its origination. The facts at its front are easy enough: Ben Bernanke on May 22, 2013, had said the FOMC was considering a “step down in our pace of purchases” (Bernanke did not, in fact, coin the term “taper”) because the Fed’s staff models (like ferbus) had viewed recent developments in the labor market (rapidly declining unemployment rate) as more likely to lead to full employment maxing out economic potential therefore a rising potential to more quickly bring about the wonderful modestly inflationary validation.

The bond market routed.

It sold off not because the Fed was openly considering “tapering” its rate of bond purchases, rather it was because the market began to judge the economic risks in the same way as those staff projections supporting taper. Higher growth and inflation expectations, not fewer UST purchases.

But if that was how the so-called "tantrum” began, how and why did it actually end?

The more useful context is when it ended! And it wasn’t when you might have thought, as I wrote back in early 2017:

“On September 5, 2013, eurodollar futures broke forever from QE.   Though QE3 and 4 were still running throughout later 2013 and almost all of 2014, it didn’t matter any longer.  The total amount of flattening that took place in the nearly three years after that inflection was simply astounding, a level of pessimism and bleakness that I struggle to describe adequately.”

I still struggle. One reason why the taper tantrum’s backside is rarely if ever referenced is because the whole thing began to unravel just this quickly – in a little over three months, deflationary potential had crept right back in, of course, eurodollar futures.

The FOMC itself hadn’t even tapered yet, and wouldn’t until December 2013, and over those months in between this curve (and then the yield curve in 2014) was already rethinking its prior “tantrum” behavior. Growth and inflation expectations, the potential for higher 3-month LIBOR in the future, all those were being recast downward even as, previewing Powell, Fed officials kept plowing ahead with taper, confident in their recovery view.

And that view, like Powell’s five years later, was predicated near entirely on the labor market assessment. This only makes the whole affair the more confounding and infuriating. What was it that had ultimately sparked this first eurodollar futures rejection on September 5, 2013?

Would you believe: labor market data. On September 6, 2013, the BLS reported not just a weak headline payroll figure (Establishment Survey), a preliminary estimate of +169,000, the fact that this was quite in-line with the rate of previous monthly gains. This (or rather the employment estimates drawn from the Household Survey) relatively slow pace had still created a fast drop in the unemployment rate if only because something was missing.

Something big (I wrote the following on that particular September 6):

“Since January [2013], we are supposed to believe that the jobs market is recovering when the official labor force contracts by 168,000 persons? I cannot think of any economic reality where that incongruity can be resolved outside of a central planning paradise. What that means, strictly according to the numbers, is that the civilian non-institutional population rose by just shy of 1.3 million while those not in the labor force rose more, by 1.47 million.”

I further wrote how there was little or no precedent for this, especially since a robust labor market, a real one, would’ve been drawing back in those millions of poor souls still left out of the labor force even though the Great “Recession” was already four years behind. On the contrary, the unemployment rate fell quickly - the very thing the FOMC wanted to see, the same thing which, if it had been real, would’ve confirmed all their dreams about QE’s - if only because the participation problem kicked it up a notch.

Because this was unparalleled in post-war economic history, “because we have never encountered such dysfunction that mainstream economics simply ignores it.” Yep, the FOMC did and continued to do so…while the eurodollar futures market did not.

Who is better at economics (small “e”)?

While the eurodollar futures curve would spend 2014 flattening out (deflation) more and more, joined by the yield curve doing the same thing, the participation problem kept going as did taper and an eventual end to QE’s 3 and 4 by December 2014. In early 2015, Economists were plain stumped:

“Since January 2014, 10-year yields have declined by more than 100 basis points. That sizable decline surprised market contacts, as it occurred in spite of developments widely expected to push yields higher: the wind-down of Federal Reserve purchases of U.S. Treasuries, a strengthening of the U.S. economy, and broad-based market expectations that the Federal Reserve will begin raising interest rates this year.”

The above was written and published in April of 2015 by the US Treasury’s Office of Financial Research (OFR), an agency supposed to be on-the-money (pardon the pun) when it comes to the financial world’s details. Yet, in the paragraph above there’s only one correct fact in it: that yields had declined by a lot. 

Everything else was just wrong but remains the official story to this day. Bias.

Why go through and review all this labor data history and its relation to eurodollar futures?

Jay Powell’s current Fed is likely to announce tapering its current QE, once again based solely upon recent payroll figures and a quickly falling unemployment rate. With those, he is preparing the public for the stepping down the pace of its purchases. This Chairman doesn’t want Bernanke’s tantrum.

And he’s not at all likely to get one! There is very likely to be taper without a tantrum in one part because no one seems to care why – and when - that 2013 episode actually ended. The current Fed Chairman sure didn’t in 2018; that prior FOMC went to exhaustive lengths to feed their same bias instead.  

For all these big payroll gains this year, and the unemployment rate’s swift decline, the labor force hasn’t rebounded but marginally since last October. Given what I just wrote, you probably don’t even have to look up what the eurodollar futures curve is doing right now, and has been doing for months (since late March).

The FOMC has gotten only more confident about the US economy since then, while eurodollar futures (like global bonds) increasingly certain such confidence is once again misdirected. Yet, we’re going to hear the one version of 2013 and how big a deal this next taper will be. It is a big deal, though for very, very different reasons. 

TL/DR: forget taper, pay attention to eurodollar futures.
Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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