Notes From Underground

The IMF announced that they will sell the remaining 197 tons of GOLD of the previously-agreed 400 tons. The IMF made the initial announcement Sept. 18, 2009 and you can consult your charts to see the impact it made on that Friday to the following Monday. The initial 200 tons that were sold were done in a negotiated sale with the Reserve Bank of India (RBI) at the beginning of November. This time the IMF will sell the GOLD in the market at much smaller amounts which should not make our friends in Beijing very happy. It is interesting how the IMF overseers determine when to make this announcement and why it isn’t done in the morning when the markets are more robust and able to handle the news in a more liquid environment. Oh well, the market has digested, and as we write, GOLD has actually turned higher from the COMEX pit close of yesterday.

The FED released FOMC minutes yesterday and there was little that was new. But the pundits were busy concentrating on how much time was devoted to the discussion of removing the stimulus the FED has provided, and especially how to rid itself of all the mortgage-backed securities on its balance sheet. Traders seem to have taken this to mean that there was an imminent tightening to take place via the selling of the MBSs. If the FED was to tighten, we wondered why the yield curve (2/10 Treasury spread) did not flatten on the news. In discussions with others we respect, they made the point that the long-end failed to rally because of the knowledge that the FED has so much long-end to sell off. We say fair enough, but we can’t help but focus on the fact that with such a large negative output gap and the FED removing stimulus, the yield curve OUGHT to flatten somewhat–and the market did not react that way at all.

In fact, as we write, the curve is STEEPENING further, which we believe is giving a bid to equities and other assets. The FED has really created  a mutant curve with its robust quantitative easing, and, as we have stated previously, the FED has ill served the market and the market will exact its price.  Many have written that the mortgage markets have been held artificially low, which prevents investors from taking part in the mortgage market. As the FED starts selling off their purchases, the market will demand higher rates to make up for past discrepancies. This is what the FED models fail to perceive. This steepening curve is more than interesting to watch for its impact will drive investment decisions and it will make the DOLLAR uneasy after the EURO concerns diminish.

But Philadelphia FED President Charles Plosser’s speech was lost in yesterday’s market drivers. His speech was on the theme of the need for the FED to return its balance sheet to pre-crisis levels. He criticized the FED for overreach for its aggressive use of article 13.3 of the Federal Reserve Act for Treasury securities. Under duress, the FED took collateral on their balance sheet that they need to remove sooner rather then later. He also stressed that the FED needs to remove itself  from blurring the lines of monetary and fiscal policy as they did by invoking 13.3. We finish up by citing a quote from Plosser which we would all do  remember:

“We live in a world of highly mobile capital and financial markets that are constantly assessing the credibility of governments and their central banks to maintain price and economic stability. In such a world, the mere threat that monetary policy might become politicized can damage the nation’s credibility. It can raise fears of inflation that send interest rates higher and currencies falling.”