Will the Fed Keep Fueling the 'Huge Casino'?
Federal Reserve officials widened a rift over a commitment to keep rates near zero through late 2014 as an unexpected increase in claims for jobless benefits added to evidence of a weakening labor market.
William C. Dudley, president of the New York Fed, and Vice Chairman Janet Yellen said the 2014 time-frame is needed to lower unemployment from 8.2 percent. Minneapolis Fed President Narayana Kocherlakota said rising inflation may prompt an interest-rate increase as early as this year, while Philadelphia’s Charles Plosser said policy should hinge on economic performance, not a calendar commitment.
Central bankers next meet in two weeks to consider policy for an economy that Dudley and Yellen said may be sapped by cuts in government spending and the European debt crisis. Dudley and Yellen backed Chairman Ben S. Bernanke’s view that progress in reducing joblessness may not be sustained as growth cools.
“There is a debate going on, but right now the power rests with the chairman and governors” favoring the 2014 rate outlook, said Joseph Lavorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. Even so, the comments suggest “the Fed does not feel it has to take additional easing,” he said.
Atlanta Fed President Dennis Lockhart and the St. Louis Fed’s James Bullard have expressed skepticism in recent days over the need for more easing. Lockhart is a voting member of the Federal Open Market Committee this year, while Bullard, Plosser and Kocherlakota are not. Dudley has a permanent vote and serves as vice chairman of the FOMC.
Some investors, including Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., are betting that the Fed will embark on a third round of large- scale asset purchases. In its first two rounds, the Fed bought $2.3 trillion of bonds from December 2008 to June to avert deflation and spur growth.
U.S. stocks rose yesterday, giving the Standard & Poor’s 500 Index (SPX) its biggest two-day rally in 2012, after Yellen and Dudley spoke. Both officials hold permanent votes on policy. The S&P 500 advanced 1.4 percent to 1,387.57.
Jobless claims increased 13,000 in the week ended April 7 to 380,000, the highest since Jan. 28, data from the Labor Department showed yesterday. The median forecast in a Bloomberg News survey called for 355,000 claims.
The Fed is likely to miss its goals to achieve maximum employment over the next several years, though there is uncertainty about the outlook, Yellen said. “I consider a highly accommodative policy stance to be appropriate,” she said April 11 in a speech in New York.
The end of the so-called Operation Twist program in June won’t amount to a tightening of monetary policy because the level of accommodation is dependent on the amount of assets the Fed holds, she said. The Fed announced in September it would replace $400 billion of short-term debt with longer-term securities to reduce borrowing costs.
Still, the Fed is “quite willing and committed to take whatever actions are necessary” to achieve its goals, she said.
“I haven’t seen any set of information that should suggest to me we should change that view” Dudley said yesterday in Syracuse, New York, referring to the 2014 time horizon for low rates.
Dudley, in a speech to business leaders, said recent “upbeat” data on the U.S. economy suggest that “the recovery may be getting better established.” Still, “it is still too soon to conclude that we are out of the woods, as underlined by the March labor-market release.”
U.S. employers added 120,000 jobs in March, less than the most pessimistic estimate in a Bloomberg News survey of economists. Joblessness fell to 8.2 percent from 8.3 percent as people stopped looking for work. The rate has fallen from 9.1 percent in August.
Inflation will probably rise above the central bank’s 2 percent target next year, contributing to a need for tightening in central bank policy, Kocherlakota said.
“My own belief is that we will need to initiate our somewhat lengthy exit strategy sometime in the next six to nine months or so, and that conditions will warrant raising rates sometime in 2013 or, possibly, late 2012,” he said.
The Fed should aim to follow a “systemic” policy rule whereby changes in the economy prompt predictable responses from the central bank, Plosser said.
“The committee’s description of how policy will be conducted is not entirely clear,” he said to the National Economists Club in Washington.
The Fed said in its Beige Book report on April 11 that the economy expanded “at a modest to moderate pace” from mid- February through late March as manufacturing, hiring and retail sales showed signs of strength in the face of higher fuel prices.
The economy may be strengthening, while still having a “long way to go,” Fed Governor Sarah Bloom Raskin said yesterday in a speech in Los Angeles.
“Some economic news has been encouraging and may be suggesting that the pace of the recovery is picking up,” Raskin said. “Even though general economic activity and labor-market conditions have improved modestly in the past two and a half years or so, house prices have continued to trend down.”
Other policy makers have signaled resistance to further easing. The Atlanta Fed’s Lockhart said on April 11 that the March jobs report doesn’t alter his view that the economy is growing moderately, and he would be “reticent” to support additional purchases of assets by the central bank.
“I am still not convinced that another round in this time frame would achieve a great deal,” Lockhart said to reporters in Stone Mountain, Georgia.
The St. Louis Fed’s Bullard said the economy will probably grow by 3 percent this year and the unemployment rate may drop to 7.8 percent by year-end. Speaking in a Bloomberg Radio interview, Bullard said he “wouldn’t go too far” with last week’s “mediocre” jobs report.
San Francisco Fed President John Williams said April 4 that the “probability of needing to do additional stimulus is lower.”
I agree with Bullard, doomsayers are reading way too much into last week's jobs report, just like they're reading way too much into China's latest GDP figure. I'll repeat, all those bracing for a hard landing in China will underperform in 2012.
As far as Fed policy, it remains extremely accommodative and I'm not convinced that QE3 is a done deal. Sure, traders will show their displeasure by selling risk assets if QE3 doesn't materialize, but that dip will be bought hard by top funds who understand that there is plenty of liquidity in the global financial system to propel risk assets much higher.
Interestingly, Erik Schatzker, Christine Harper and Mary Childs of Bloomberg report, JPMorgan Said to Transform Treasury to Prop Trading:
JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon has transformed the bank’s chief investment office in the past five years, increasing the size and risk of its speculative bets, according to five former executives with direct knowledge of the changes.
Achilles Macris, hired in 2006 as the CIO’s top executive in London, led an expansion into corporate and mortgage-debt investments with a mandate to generate profits for the New York- based bank, three of the former employees said. Dimon, 56, closely supervised the shift from the CIO’s previous focus on protecting JPMorgan from risks inherent in its banking business, such as interest-rate and currency movements, they said.
Some of Macris’s bets are now so large that JPMorgan probably can’t unwind them without losing money or roiling financial markets, the former executives said, based on knowledge gleaned from people inside the bank and dealers at other firms. Bruno Iksil, a London-based trader in Macris’s group, gained attention last week after moving markets with his trades, drawing a comparison to Federal Reserve Chairman Ben S. Bernanke’s power in the government-bond market.
“What Bernanke is to the Treasury market, Iksil is to the derivatives market,” Bonnie Baha, head of the global developed credit group at DoubleLine Capital LP in Los Angeles, where she helps oversee $32 billion, said in a telephone interview.
Macris’s team amassed a portfolio of as much as $200 billion, booking a profit of $5 billion in 2010 alone -- equal to more than a quarter of JPMorgan’s net income that year, one former senior executive said.
The shifting role of the CIO group at JPMorgan, which reported record firmwide profit for 2011, underscores how blurry the line can be between “proprietary trading” and hedging, and it highlights the challenge U.S. regulators face in curbing speculative bets by federally backed lenders under the so-called Volcker rule.
JPMorgan, whose $2.27 trillion of assets at year- end made it the biggest U.S. bank, says the CIO manages the firm’s risks, with trades like Iksil’s forming a part of that effort.
The CIO is “focused on managing the long-term structural assets and liabilities of the firm and is not focused on short- term profits,” Joe Evangelisti, a spokesman for the bank in New York, said on April 5. He didn’t elaborate when asked to comment on the changes described by former employees.
The CIO’s growing size and market power have made it an increasingly important customer to Wall Street’s trading desks and a market influence watched by hedge funds and other investors, the former employees said. Iksil’s positions in credit-derivatives have become so large that some market participants dubbed him “Voldemort,” after the villain of the Harry Potter series who’s so powerful he can’t be called by name.
May Keep Bets
Yet it’s Macris, not Iksil, who was behind the strategy that led to an unprecedented build-up of credit risk in JPMorgan’s chief investment office, three former employees of the bank said. While they expressed doubt Iksil can unwind his positions without causing a dislocation in the markets he trades, they also said JPMorgan probably can afford to hold the assets until they mature and so won’t be forced to sell them.
London-based Macris, 50, didn’t reply to a call seeking comment. He, Iksil and JPMorgan haven’t been accused of any wrongdoing.
JPMorgan, which reports first-quarter earnings today, doesn’t break out revenue or profit for its chief investment office. The bank lumps the office into a “corporate” line item that also includes treasury and the firm’s centrally managed divisions such as audit, finance and human resources.
Surge in Holdings
In 2011, corporate revenue of $3.3 billion included $1.6 billion of securities gains and produced $411 million of net income, the bank said in an annual filing on Feb. 29. By comparison, JPMorgan’s investment bank reported $26.3 billion in revenue and $6.8 billion of net income in 2011.
Since 2007, the value of securities held in JPMorgan’s chief investment office and treasury has more than tripled to surpass $350 billion from $76.5 billion, according to company filings. The biggest jump was in 2009, when the company disclosed that the CIO made “significant purchases” of government-backed mortgage securities, asset-backed securities, corporate securities, as well as U.S. Treasury and government- agency securities, according to the filings.
“These investments were generally associated with the chief investment office’s management of interest-rate risk and investment of cash resulting from the excess funding the firm continued to experience during 2009,” according to the company’s 10-K report for 2009, filed in February of 2010.
Profit, not risk management, guided the purchases, according to the former employees. One of the employees, who previously held a senior executive position at the bank, said Dimon even ordered some of the trades himself.
The transformation of the CIO has its origins in Dimon’s arrival at JPMorgan with the purchase in July 2004 of Bank One Corp., where he was CEO. Less than three months later, Dimon’s long-time lieutenant Michael Cavanagh became chief financial officer. He replaced Dina Dublon, a 23-year veteran of JPMorgan and its predecessors.
At the time, JPMorgan also said Ina Drew, who ran global treasury at JPMorgan prior to the acquisition, would report directly to Dimon. Drew’s title changed in February 2005 to “chief investment officer,” according to the 2005 year-end filing.
Missile in Flight
Dimon pushed the unit to seek bigger profits by buying higher-yielding assets, including structured credit, equities and derivatives, and ramping up speculation, according to two former employees. While Drew’s unit previously had small teams of traders who took speculative “macro” positions in currencies and interest-rate products, people who worked there at the time say the focus shifted and traders were given permission to put more capital at risk.
In London, Macris expanded his team, adding expertise in credit and fixed-income trading. A Greek citizen, Macris previously was co-head of capital markets at Dresdner Kleinwort Wasserstein before joining JPMorgan in 2006. In that role he helped oversee a unit that made proprietary trades, or bets with Dresdner’s own money, according to two people who worked with him at the time.
One former colleague at Dresdner said he remembers visiting Macris’s London apartment in 2004 for a gathering of fellow colleagues from the firm. He said he was struck by a picture on the wall in a room that contained more than six trading screens. The picture, which he estimated was more than six-feet high and six-feet wide, was of a missile in flight.
Before joining Dresdner, Macris oversaw currency trading at Bankers Trust, now part of Deutsche Bank AG. Macris was an idea- generating machine who was blunt and didn’t suffer fools, said Duncan Hennes, who worked with him at Bankers Trust.
“He always had off-the-wall ideas, but in hindsight sort of smart ideas,” Hennes said in a telephone interview. “He was always thinking out of the box.”
David Sandelovsky, who reported to Macris at Bankers Trust in the 1990s, remembers being impressed with his “great knowledge” of art, wine, politics and history. He was an active trader -- “a big hitter” -- as well as a manager, Sandelovsky said.
“It wasn’t just a simple ‘Let’s go long the dollar against the yen,’” Sandelovsky said. “He had serious ideas, and they were macro, involving interest rates, foreign exchange. He didn’t think in simplistic terms.”
At JPMorgan, Macris hired Evan Kalimtgis, a former head of credit portfolio strategy at Dresdner, to help with risk management, according to one former employee.
In 2007 Javier Martin-Artajo, who had been Dresdner’s head of credit-derivatives trading, joined JPMorgan in London. George Polychronopoulos, who worked at hedge fund Endeavour Capital LLP, also joined the London office in 2009.
Martin-Artajo, Polychronopoulos and Kalimtgis didn’t return calls and e-mails seeking comment.
Iksil, whose credit-derivatives trades have earned him the moniker “London Whale,” joined JPMorgan in 2005 and has held his current role since 2007, according to his career-history record with the U.K. Financial Services Authority. He worked at the French investment bank Natixis from 1999 to 2003, according to data compiled by Bloomberg.
While Macris had a mandate to make money from the beginning, he didn’t start putting on big bets until after the credit crisis in 2008. Two of the former executives said the following year he bought AAA-rated pieces of collateralized debt obligations. As competitors dumped securities and prices slumped, Macris’s group at JPMorgan emerged as the biggest buyer in some markets, said one former executive at the bank who was familiar with the trades at the times.
In one example, a New York-based CIO trader named Jonathan Horowitz bought about $1.1 billion of AAA-rated portions of collateralized loan obligations for about 80 cents on the dollar in November and December 2008, people familiar with the matter said at the time. Horowitz declined to comment.
One public sign that the chief investment office does more than hedge: Its trading risk is on par with that of JPMorgan’s investment bank.
JPMorgan’s annual report for 2011 shows that the CIO stood to lose as much as $57 million on most days of the year. That compares with $58 million for the investment bank, which includes Wall Street’s biggest stock- and bond-trading units.
Another sign: The relationship between the CIO and the investment bank’s sales and trading desks is strained, two former employees said. Employees in the CIO get a smaller share of their trading profits than those in the investment bank, giving Dimon a cost-management incentive to direct more trading through the CIO, one former executive said.
Last year Drew, 55, hired Irene Tse, a former Goldman Sachs Group Inc. partner, to oversee the CIO in North America. Tse more recently was a portfolio manager for Stanley Druckenmiller’s hedge fund Duquesne Capital Management.
JPMorgan “offers an extraordinary platform for me and the entire CIO group to invest and manage risk,” Tse said in the January 2011, press release announcing her appointment.
Drew and Tse didn’t reply to e-mails and phone calls seeking comment.
JPMorgan, like rivals, has shut groups in the investment bank that specialized in speculative bets with the company’s own money, anticipating implementation of the Volcker rule. The ban, part of the Dodd-Frank financial-reform law, will prohibit banks backed by the federal government from engaging in so-called proprietary trading. One former JPMorgan employee said the number of risk-taking traders in the chief risk office has been reduced in recent months.
As I reported a couple of days ago, big hedge funds and big banks always find ways to circumvent new regulations. The irony in reading the article above is that while Greece is sinking, some of the most powerful banksters in the world are of Greek origin, running the biggest derivatives behemoth in the world.
One should never underestimate the power of banksters in shaping monetary policy. It's not about inflation or economic conditions. Central banks around the world will keep pumping the jam to help global banks shore up their balance sheets, allowing them to profit off of money for nothing and risk for free.
This is why even though I believe we do not need QE3, there is always the possibility that banksters will force the Fed's hand to provide further stimulus so they can keep trading and profiting from this liquidity tsunami. Interestingly, the latest Citigroup survey shows fewer investors ruling out more quantitative easing ahead.
Below, Bloomberg's Sara Eisen, Stephanie Ruhle, and Erik Schatzker report on the details behind this morning's headlines. They speak on Bloomberg Television's "Inside Track." Listen to Sara Eisen's hedge fund story saying that Citadel and Millenium's assets soared nine times as they increased their leverage to pre-financial crisis levels (same for big banks).
Also, William Cohan, author of "Money and Power: How Goldman Sachs Came to Rule the World" and a Bloomberg View columnist, talks about the investment strategy of Achilles Macris, head of JPMorgan Chase & Co.'s chief investment office in Europe and Asia. Cohan speaks with Erik Schatzker and Stephanie Ruhle on Bloomberg Television's "InsideTrack." Bloomberg's Christine Harper also speaks.