Notes From Underground: There’s something happening here, but it ain’t just exactly clear

Buffalo Springfield must have been singing about Fed and Treasury policy when they wrote those words. Treasury officials announced that they were adding $200 billion of short-term debt through the issuance of 56-day Treasury bills. Proceeds from the sale during the next eight weeks would be stored at the FED, thus effectively removing $200 billion of short-term liquidity.

Analysts were arguing whether or not this represented the next stage of tightening. We will await Bernanke’s testimony on this issue tomorrow as he commences with his Humphrey-Hawkins mandated bi-annual visit to the Hill. Under the Supplemental Financing Program (SFP), the Fed and Treasury are seemingly working together to begin the process of liquidity reduction. This cooperation between fiscal and monetary authorities is what makes us so nervous about the immense power of an uncapped Fannie and Freddie. Although this Treasury move left the market with more questions than answers, the final result was that the DOLLAR rallied further, risk was sold off and the 2/10 curve flattened a bit further by the end of the day. In the cloud of uncertainty, the equity market rallied back a little by the end of the day so as not to close on its lows. If Bernanke is not firm in his testimony tomorrow about the incipient moves in liquidity reduction, we could expect risk to make its way back to being bought.

In news from around the globe, the Japanese Finance Ministry and the Bank of Japan (BOJ) were busy trading jabs over who should be responsible to stem disinflation from grabbing a bigger hold on the Japanese economy. The BOJ doesn’t want to keep buying JGBs as its balance sheet is already stuffed with them, and the MoF is afraid of running bigger deficits. This battle between MOF’s KAN and the BOJ’s Shirakawa is heating up, and with a looming upper house election this summer it will become even more intense. Prime Minister Hatoyama needs to get the economy growing to avoid further slippage in the polls. As to be expected, even with all the talk for further QE or largest deficits the YEN strengthened considerably in a risk-off environment … and so it goes.

European bond markets rallied today as the news out of Germany was negative for the European economy. German consumer confidence slipped and that led to a rally in the BUNDS taking all debt markets (except Greece) with them. Furthermore, we heard some interesting comments from Hans- Werner Sinn, president of the IFO economic institute. He accused the Greeks of blackmailing Europe by putting pressure on the EURO due to their years of unfettered profligacy. For Sinn this is not a problem, as he said:

“The euro is overvalued anyway by all measures of purchasing power parity. It is way out of line, and a weakening of the euro would be quite useful for Europe to stimulate its exports.”

He also added that it should be the IMF that aids Greece for that is its role. I wonder if Herr Sinn realizes that an IMF bailout would rally the EURO. Oh,what a tangled web we weave … and Buffalo Sprinfield was correct.

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4 Responses to “Notes From Underground: There’s something happening here, but it ain’t just exactly clear”

  1. Stan Says:

    Hi Yra,

    Great insights. What do you think are the chances of the IMF bailing out Greece?

    So are you saying that a Europe led bailout would rally the dollar whereas an IMF led bailout would rally the Euro?

  2. yra Says:

    I think both would rally the euro–but IMF might have a little more power

  3. Anon Says:

    SFP adds 200b to the supply already scheduled to hit the market, even if it is in the form of bills. Any thoughts on implications of this?

  4. yra Says:

    no not in its initial form—but what it means for liquidity drain is the issue and will listen to bernanke today—-but I am concerned by the treasury and fed being in sync on this—-let the fed worry about monetary policy and the treasury fiscal policy

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