Thursday, October 05, 2006

Rick Santelli of CNBC Gets Even Smarter: The Impact of Derivatives On Spreads

This morning, as I was reading the Wall Street Journal and watching CNBC's Squawkbox, Rick Santelli was debating the recent confusion in the debt markets regarding inflation, interest rates, and economic growth.

Joining the debate were Joe Kernan, Steve Leisman, the show's under-educated 'senior economic reporter,' and a guest host.

Kernan is always a level-headed, sensible, and smart commentator. Leisman is typically self-impressed, and blind to his own lack of basic economic education.

Santelli, the network's Chicago-based reporter from the options pits at the CBOT, is among the most intelligent, informed, educated, and plain-spoken bond market reporters that I have ever seen on television. Bar none.

This morning, Rick gave the most lucid example I've ever heard of how the existence of credit derivatives affects, and has permanently affected, bond market spreads. He explained how, when one can buy protection for the drop in value of a bond, it necessarily puts upward pressure on the price, because the lowest value it can now attain is much higher than it otherwise would be.

He then went on to note that many people have missed this important development in the bond markets. And that even Fed officials might be misinterpreting the meaning of the now-closer spread relationships, versus their historic wider margins.

Leisman asked, to paraphrase,

"can it now be that, and I don't really understand this, that the bond markets are existing on one plane, setting rates, and the Fed is on another plane, or level, with its rate setting views?"

Santelli responded that, yes, the two might not agree contemporaneously, but in time, would gravitate to the bond market's view. Kernan laughed, and Leisman sort of looked puzzled, which was to be expected. But Santelli clearly meant that, over time, the closer spreads for yields between various debt instruments are here to stay, and the Fed will have to adjust to this. The money markets will overwhelm the Fed's interest rate manipulations every time, until the Fed takes the market's judgments into account.


What really impressed me is Santelli's matter-of-fact command of bond market reality, and its impact on economic theories that others believe are governing that reality.

He is one CNBC correspondent who I could watch all day, and probably never feel I'd learned everything I could by listening to him.

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