Notes From Underground: For All You Youngsters

Well after the Chinese monetary authority raised the rate 3 basis point last week, the powers that be were at it again. This time the Chinese monetary authority raised the interbank rate 8 basis points, and the reserve requirement by 50 basis points. The Chinese actions led to a selloff of all highly leveraged risk-based investments. Gold, copper, equities and even some currencies sold and of course the YEN rallied as the carry trade was unwinding.

It is a painful reminder of how difficult the trading environment is and will be going forward, as there is much leverage applied to very risky assets. We believe that this year will be the onset of volatile moves based on creation of more trading strategies by sovereign wealth funds (SWF). The huge pools of capital that many nations have at their disposal can and will be used to develop different trading strategies. For you youngsters,this is not a new strategy as the Monetary Authority of Singapore and Bank Negara were very active currency traders 15-20 years ago. Interestingly, Brazil recently announced the creation of a SWF and one of its goals is trade in the markets to protect the value of the REAL.This proliferation of deep-pocketed traders is just another variable added to the global financial pool. It is one of the reasons that we can expect to hear more chatter from government authorities in an attempt to move markets. Central banks and their trading arms could be a treacherous foe but that makes the fundamental and technical preparation that much more important. Get ready as we travel the road of volatile and erratic markets: 2+2=5.

As if it isn’t murky enough, today the European Commission “condemned” Greece for falsifying it budget data. The commission said the deficit number is so unreliable that it is difficult to ascertain what the real number is on the budget shortfall. The German/Greek 10-year spread widened out 15 basis points to 236, making us realize how cumbersome this European issue is and how long it is going to play out. The EURO sold off slightly but in the bigger picture held up fairly well–even as the EURO/YEN cross got crushed as risk trades were removed.

The Treasury market in U.S. was well bid as the 3-year note auction went very well and tomorrow brings a sizable 10-year auction, followed by a 30-year on Thursday. If these auctions both go well it should lend some support to the DOLLAR–for at this moment the failure of the DOLLAR to stage a significant rally today was perplexing. We should add that the Chinese Investment Corp (CIC) issued a statement that they thought the DOLLAR was ready for a rally and that the YEN would be weak going forward–hmm, it is a good thing they have deep pockets.

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