Notes From Underground: Bad data from Philly and the jobless claims surge to more than 500,000

The news on the economic front is tepid at best, which has given rise to the long end of the treasury market. As the BOND and NOTE futures continue to rally, the airwaves are full of talk about a bubble in the fixed income market. We don’t think a BUBBLE is forming, but what is happening is that many HEDGE funds overstayed their welcome on the 2/10 steepener. The steepener trade was a great trade as the FED pushed rates down on the front end to help aid the Banks in their profitability in a very uncertain credit market. (This was the same policy that the FED used back in the early nineties when the FED eased the pain of the banks, and Savings & Loan crisis. It created a very steep curve.) The FED did it again beginning in 2007 as the current DEBT crisis unfolded and the BOND VIGILANTES pushed the 2/10 curve out to more than 280 basis points, which provided banks with an easy profit center to help shore up its balance sheets. Of course bank profits came out of the pockets of anyone who had savings in short-term money instruments.

The problem is and has been is that the VIGILANTES and hedge fund traders have remained in this trade and now that the DEFLATION discussion has gained momentum, the long end has been the darling of all those believing that U.S. mimics Japan. Throw in the FED’s recent FOMC announcement about Treasury purchases and the steepener has lost momentum and the great unwind has caused some pain. Does this make for a bubble? We say no because the 2/10 curve is still historically wide. If the 2/10 were to get back under a 150 basis points in this current environment, we would become very concerned. Until then, let the bloodletting continue.

This weekend will bring the Aussie elections. The election is presently too close to call as LABOR has lost votes to the GREEN party. If the Labor party is forced to coalition with the Greens, that will be a negative for it will give the Greens a larger voice in the government and will force a revisit to the dreaded raw materials tax surcharge. It was the TAX SURCHARGE that caused this election as the previous prime minister, KEVIN RUDD, was pushed out by his party for advocating an onerous 40 percent rate on mineral extraction–nothing like squeezing the Golden Goose. But in a tribute to the Labor party, they sent Rudd packing as Labor’s standing in the polls fell. If the Conservatives were to run strong and control the government, it would give us a bullish outlook for the the Aussie but that would really be a surprise. Throw in the uncertainty in the equity markets and the BHP pursuit of Potash and the Aussie is a tough trade for it has a little of everything. Capital flows, uncertain politics and the addition of high interest rates, plus the mix of fundamentals make the Aussie a very tough trade.We will know more come Monday.

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12 Responses to “Notes From Underground: Bad data from Philly and the jobless claims surge to more than 500,000”

  1. Arthur Global Practice Says:

    What about a bubble in European bonds? German Bund yields hit record lows on Wednesday and Spain Sells 5.5 Billion Euros of Treasury Bills as Borrowing Costs Decline‏:http://www.bloomberg.com/news/2010-08-17/spain-sells-5-5-billion-euros-of-treasury-bills-as-borrowing-costs-decline.html

    Few people is examining the overvalued or bubble housing market in Australia.

  2. Arthur Global Practice Says:

    1982? Volcker acted drastically to restore confidence in the dollar, raising interest rates repeatedly, squeezing out the credit from the system and forcing the US into another recession… Unemployment hit 10.8%

    By going to such extremes, Volcker had earned credibility, say John Authers (FT).

  3. Cheryl Galante Says:

    Yra, every trade is a tough trade these days!

  4. yra Says:

    Cheryl yes that is true–no easy trades but as the herd is culled and certain strategies are left to lay fallow many opportunities will arise

  5. yra Says:

    Arthur-the Volcker success showed the assymetric nature of monetary policy and that is why Bernanke fondly hopes and fervently prays for inflation

  6. Arthur Global Practice Says:

    Cheryl, I agree with Yra. Don´t follow the herd, i.e., according to Bloomberg, the biggest money managers (JP Morgan, … ) say concern the U.S. will slip into a recession is overblown and that individuals piling into fixed-income securities for their relative safety are making a mistake.

    If Bernanke fondly hopes and prays for inflation, why is not following Volcker´s steps, i.e., raising interest rates? As you said (Notes, The Fed-All Theory and No Practice): If we ran the FED, we would raise short term rates to 2% immediately for that would act to anchor the DOLLAR, lead to a selloff in the GOLD and other commodity markets, and give the FED and Treasury some breathing room.

  7. yra Says:

    Arthur –because they fear deflation and would desire a weaker currency at this time and that rules out a rate rise—the economic data continues to deteriorate making theFED and politicos very nervous–so the rate rise is way off the table–therefore inflation would be a good sign and they want to see it emerge and not quash it before they see it —Hoenig says otherwise but he is the lone dissenter

  8. Arthur Global Practice Says:

    OK. I see, very clear. Thank you so much.

  9. Arthur Global Practice Says:

    By the way, Jeremy Siegel Warns That We are Headed For a Bond Bust in a recent article WSJ: http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748704407804575425384002846058.html

  10. yra Says:

    Yes Jeremy is out there on this but it is an easy call –problem as a trader is when for the Keynes line—markets can remain irrational for longer then you and I can remain solvent

  11. Arthur Global Practice Says:

    Yes, I understand the trade´s perspective but as you said, markets aren´t wrong. If you´re right at the wrong time, you´re wrong. So maybe there´s something else out there on the horizon that we don´t know about. And money is always going somewhere no matter what… thinking about your global macro matrix!

  12. Arthur Global Practice Says:

    Our friends from FT Lex, “For investors, the only thing worse than a low-yielding world is denying that it exists.” I like it.

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