Flooding the markets

Rates in the US are going up again.
The 2-year auction of Treasury paper was a disappointment. Again.
42 bln USD were auctioned. Who bought?

And it’s not over. Also today 27 bln 1 year were auctioned, tomorrow we have 39 bln 5-years and on Thursday there is 28 bln USD 7-year paper;
Good luck. Well the Chinese are in Washington (150 people) so they have something to discuss, I suppose.

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Themes

Theme 1.
China = commodities. All these shipping movements are caused by inventory building by the Chinese. But production is still going down compared with the figures from the same month last year.
Ship owners are now charging 58.000 USD a day for large bulk carrier freighters but just 24.000 USD for next year and 2011.

Theme 2.
Indices are moving at the start of a week. Not at he end. This week is an expiration week. And the opening gambit was down.
Technically we’re moving in a very narrow range for weeks now. The reflation trade is a very crowded trade as is the ‘dollar is weak, bonds are weak’ trade.

Theme 3
This week Research in Motion is reporting results. RIMM, AAPL, GOOG and the semiconductors ETF SMH are holding up the NASDAQ. If they go, the NASDAQ will go too.
Not to forget: there was a time you had to be invested in individual names but the market has transformed to ETF/sector dominance.

Theme 5
The inversion of short term LIBOR-rates and short term Treasuries. Normally LIBOR is yielding more than the ‘safest’ investment on this planet. However, this is not the case for the moment as everybody is dumping govvies.

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The shape of the interest rate curve

Security KAG has created a chart of the US Yield curve describing how the spread between rates of 3 months, 5 years and 30 years are developing since 1991. The yield curve went almost flat in 2006. That was the time to set up a steepener. Now we’re on our way back to flattening.
Well… we all could have been rich by following this chart.

Flattening was the case until recently.
The long term interest rates of US Treasuries are rising and prices imploding.

We can make the same exercise for Europe.

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Treasure no more

The big story in the markets is the continuing sell off of the benchmark 10yr US Treasury. The question is: what’s happening? Is this simply the unwinding of an unsustainable bubble caused by the flight from risk a couple of months ago? A so-called ‘normalization’ process. Or is this caused by inflation fears and triggered by the enormous debt levels the US is building?

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Corporate bonds

Risk appetite is returning in the markets. Everybody says: ‘yes we know’. But do we realize the consequences? No. Because we can’t. The best we can do is guessing.
In the mean time we observe that corporate credit is back. The US CDX five year investment grade index is now on levels prior to the Lehman debacle. The spreads have tightened sharply.
This goes to the expense of another segment of the credit markets: government bonds. Rates went up last weeks.
We know it’s the intention of the FED to keep rates in this asset class low. So will this lead to another round of quantative easing. We place a positive bet on that one, this afternoon at Paddy’s.

We don’t know if this is a positive sign. Unprecedented money creation is causing this ‘normalization’ which is not for real anyway…

To illustrate we mention this morning news, coming from Belgium and illustrating that not all is well with European banks so far:

Business newspaper De Tijd is reporting that the Belgian government is working on a new rescue plan because KBC - market value €8bn - is set to write down the value of its CDO portfolio by a further €1bn. This fresh hit seem to have been triggered by a downgrade of bond insurer MBIA.

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Bear - part 2

Something else we want to look at.
Interest rates and debt.
As snake eating its own tail, the FED creates paper and buys it up later in order to keep rates low. This is working fine as long as you can create 10 units and you only needs 2 units to reach this goal.
And nobody starts to do foolish things.
The rise of ProShares UltraShort Lehman 20+ Year Treasury ETF (ticker: TBT) shows that the price of paper is declining. And that means that long term rates are rising.

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Bookkeeping

The FOMC remains very concerned about the economic and financial outlook. The Fed's balance sheet recently has shrunk modestly, but that does not reflect any deliberate actions. The Fed's support of commercial paper has unwound as activity in that market has declined. The Fed's balance sheet should start to grow again as the TALF program ramps up. Moreover, the decision to boost purchases of agency debt and mortgages, and to start directly buying Treasuries, suggests that the Fed's balance sheet will mushroom in the months ahead. The key point is that monetary policy will remain highly accommodative and proactive until there are signs that financial intermediation is working more effectively. The Fed's actions should be positive for both stocks and bonds.

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The game is on....

The Bank of England lowers rates to 0.5%, the ECB cuts to 1.50%...

The game is on.

The inevitable is coming. And it is coming quicker than everybody thinks: financial institutions will fail. At least some of them. Governments should act on the knowledge that is doesn’t makes sense anymore to rescue institutions who are sucking billion after billion after billion.
Take AIG.
This company is a black hole taking the rescuers, who try to save it, into the abyss. Yes, a bankruptcy will cause misery for a couple of years, but what’s the alternative…
As Jim Rogers says:
"I think it's astonishing, they're ruining the US economy, they're ruining the US government, they're ruining the US central bank and they're ruining the US dollar,"

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Que sera, sera

And where do we go from here?
Nobody knows.
How can we summarize the situation?
The banks will be saved.
The shadow banking system will suffer the pain of free markets.
The assets (housing, commercial real estate, CMB, ABS, and many more) will be saved.
How?
This question is not structured, but we will print the money.
Anyhow.

The market believes that this monetary stimulus at the end will increase the odds of inflation. When inflation runs high Treasury Inflation Protected Securities (or TIPS) outperform regular Treasury Bonds. When inflation expectations are low, the opposite is true.
Now, this is what the markets believe:

Yes: more inflation. As the ratio climbs TIPS are performing better than the 20-year Treasury.

That’s the news from Ireland, friends.
It’s cold here, the mood is icy, people are queuing for hours for the dole and property prices are swinging. Downwards, that is.
Banks are living on the edge.
The Celtic Tiger is no longer.

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