Notes From Underground: Back From Vacation and Was Subjected To the Government Shutdown

As I drove along the Blue Ridge Parkway many of the Federally manned information spots and federally run conveniences were closed. But it did not detract from the grandeur of the Carolina mountains and majestic valleys. The Parkway itself was an allegory for the markets as it winds it way a forest of trees with danger all along the way. It is best to stop at the lookouts along the way as an astute trader/investor would take the time to analyze charts to see where the road leads. The present standoff in Washington has brought profits to the SHORTS, but as Friday’s rally revealed. This market is fraught with danger for bulls and bears alike. More important than the shutdown of some federal government operations is the looming issue of the DEBT CEILING. Many analysts have rightfully pointed out that the government defaulted in 1979 and although Treasury bill yields rose 60 basis points, the overall effect was minimal. Beware of faulty historical correlations.

The financial markets of 1979 are nothing similar to 2013. The importance of a default would be the havoc a default would have on the most prized collateral for the global REPO market. U.S. Treasuries are the lubricant of global finance and if the paper was downgraded and credit haircuts increased, the short-term effect will be dramatic. UNQUESTIONED! There was already word out today that some central clearing platforms would begin instituting haircuts on collateral and doing cash raises as most securities are held in the form of short-term governments. I am not attempting to be dramatic. The plumbing of the financial system is heavily dependent on Treasury debt. What the outcome will be I have no idea but it is a treacherous road we are traveling on. The markets seem to be mirroring my journey, for I too left the Blue Ridge Parkway at a spot called Little Switzerland: beautiful and not as treacherous.

***In looking at the end of the third quarter:

A. The dollar/yen is at the 200-day moving average. The YEN has been the recipient of the risk-off money and has therefore caused a short covering rally. The highs in the YEN were made a year ago prior to the G-7/G-20 meeting finance minister meetings during the October 2012 weekend when it seemed the Japanese government bought acquiescence from the other developed economies that the Japanese were going to promote more aggressive easing type policies. Last year I noted that it appeared that Japan would buy European debt in a quid-pro-quo type of nod and wink for allowing a weaker YEN. The euro/yen cross is 30% higher since that week and has certainly been helped by the election of Shinzo Abe in December 2012 and his economic policy of the three arrows. As the world’s uncertainty increases the YEN and its action at the 200-DMA will be a good barometer. Remember that the 200-DMA has much more significance as a barometer of a weekly close.

B. The British pound has recently been a repository for anti-DOLLAR sentiment, especially as the U.K. economic data has shown improvement and the BOE‘s Monetary Policy Committee has not favored further QE. Last week, the POUND became unchanged on the year  and corrected. The CQG system close was 1.6252 on December 31 and last week’s high was 1.6252. It doesn’t have to be exact to be a valid test, but it proved a good resistance level and will mean that the pound and all the crosses need to be monitored. Sentiment is heavy against the dollar and many developed-economy currencies are proving good alternatives in a very stressful market of financial uncertainty.

C. Speaking of currency crosses, an interesting cross to watch is the Swiss/yen (CHF/YEN). In August 2011 when the Swiss franc rallied to its all-time high of 0.7064 the CHF/YEN cross made a high of 1.0864 on the same day. Since the Swiss National Bank has embarked on a policy of INTERVENTION TO WEAKEN THE SWISS, the CHF/YEN cross is the only currency pair to retrace its move against the Swiss Franc. All the other major developed market economies are significantly off their lows against the FRANC. I’m not sure of the meaning but it is a tribute to the efforts of the BOJ and the ABE government. The Swiss and YEN were fellow placeholders of the risk-off environment during the post-Lehman financial uncertainty. The YEN has vacated its post and left Lieutenant Swiss to “DANCE WITH THE WOLVES.” Is the SNB concerned at all about the YEN level or is it solely the EUR/CHF that drives policy?

***SPECULATION FROM YRA: There was an article from Forbes today that caught my attention, “Obama May Be Leaning Toward Donald Kohn As Next Fed Chief.” The article is filled with much conjecture and almost Kremlinology-like in its analysis. The writer parses words and expressions to draw out the possibility of it being Don Kohn. I have thought that Mr. Donald Kohn would be the best pick and would have been a better pick than Ben Bernanke. I BELIEVE KOHN was Greenspan’s personal choice but there was no way the Bush family would allow Greenspan to anoint his successor (much animosity between Bush I and Greenspan). Go back and read some of Kohn’s Fed speeches. He is very balanced and has a deep respect from the signals that emanate from the financial markets. Recently, he is on record as an opponent to the present state of QE and that would seem to put him out of the running, but remember that Larry Summers was also opposed to the latest QE programs. If President Obama strikes an independent stance, he may well choose someone of his own rather than have the consensus candidate forced down his throat. If it is Kohn, the DOLLAR OUGHT to get a BID for the markets will like a well known and respected hand as the Chair of the FED. Again, just thinking outside the Beltway.

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6 Responses to “Notes From Underground: Back From Vacation and Was Subjected To the Government Shutdown”

  1. jonathonbking Says:

    Reblogged this on jonathonbking and commented:
    Great analysis of FX pairs here

  2. rich goldman Says:

    Why is nothing being written or said regarding the risk to NAV in government backed money market funds? If T bill spreads are widening,its logical that the $1 share price of funds is under stress to some degree. Are people prepared to see principal risk( even slight amounts) in government backed money funds? The SEC has been considering this and redemption limits now for months. How ironic that a debt ceiling fight might become the backdrop for testing this.

  3. Dustin L. Says:

    Yra- Now that we know it is Yellen I can’t help but think back a while to your post where you quoted Janet Yellen in which it was clear she is at heart a central planner and has little respect for the market. Lord help us all!

    P.S. Thanks for the heads up on the CHF/JPY, interesting indeed as the EUR/JPY has been perking my interest of late as well.

  4. Yra Says:

    Rich, I think there are a few reasons why no one is talking about the risk to NAVs for government-only money market funds.

    1. Money market investors are more optimistic that a deal will be reached before any technical default so they are staying put … for now.

    2. Instead of fleeing Treasury bills entirely, money market funds are merely moving out the curve. The indicator of this move is the spread between 1-month and 3-month bills is at the widest level since March 2008–right around the time of Bear Stearns’ demise, to be exact.
    Also, yields on Treasury bills are somewhere around 3.5 basis points to 4 basis points for issues maturing from January on.

    3. Lastly, with the expiration of the FDIC’s unlimited insurance on non-interest-bearing accounts, there’s very few places left for money market investors to wander.

    One more thing to keep in mind, repo accounts for about 54% of money market funds’ total assets. We’re more likely to see more panic there, and, as a result, a greater dislocation in Treasury bills between short-term maturities and those further out the curve.

    • Rich Goldman Says:

      Makes sense. Will disruptions in the repo mkt have any negative impact on money markets? Do you think retail investors who are parked at the shortest part of the curve have any nav risk or will moving out the curve remove that risk?

      Something is gnawing at me saying that safe isn’t really safe so I am trying to dispell that fear by asking if money mkts pose any appreciable degree of risk now.


  5. yra Says:

    Rich–it used to be that fair was only a line in baseball,but in terms of the sentiment of your question I will add it is also an umpire’s call ;in terms of bonds and notes I believe the idea of safe has a very short shelf life and the world’s largest bondholder is also the umpire,the grounds crew ,seller of tickets and oh yes,the owner—hmmm,home field advantage was just redefined

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