Notes From Underground

The Greeks have arrived in the U.S. to ask the Americans for help in reining in hedge funds’ speculative activity. Papandreou and his minions are asserting that the speculators are driving interest higher by continuing the assault on Greek debt. The huge spread between the Greek debt and those of more qualified borrowers in the European community has angered Greek officials. We have warned for two months that the debt spreads were creating a NEGATIVE FEEDBACK LOOP. The higher rates go, the higher the financing costs and the more the budget cuts are needed to meet the promises made to Brussels. This is the problem now and will be until Greek rates return to a much lower level, hence they need a co-signer to guarantee the debt to lenders.

The eurocrats are presently trying to deal with this by suggesting that the EU form a European Monetary Fund (EMF). This concept is fraught with problems. It presently falls afoul of EU law and the bigger problem is that it will be frowned upon by Washington and Asian countries. During the Asian financial crisis, the Asian community wanted to initiate an Asian fund to help meet the needs of struggling TIGER economies. Washington and European policy makers rebuffed the idea because they saw it as a disruption to the global process. It will be interesting to see how the IMF reacts to the creation of an EMF, since the IMF head is a powerful Eurocrat. It is a very tired old saw that the Europeans love to blame the speculators for their problems. As we have said for 18 years, the Brits should have built a statue to SOROS in Trafalgar  Square as he saved them from themselves (and we are not a blind disciple of Soros). Speculators are the first warning signal of ill-conceived policies for the markets, though not efficient 24/7, do the analysis that policy makers often avoid for reasons of political expediency. We don’t defend the wanton use of all financial instruments, but we do and will always defend the market’s ability to vote with its money. Nothing has done more damage to the human zoo than arrogant policy makers defending bad policy. Mr.Papandreou we remind you, when you point a finger there are three others pointing at you.

One of our favorite topics is the U.S. yield curve and its impact on the DOLLAR, EQUITIES and COMMODITIES. The Fed has been out talking about many things and placing many weapons in their arsenal to rein in the vast amount of liquidity. There has been recent action on the reverse repo scenario, such as raising the DISCOUNT rate, and much talk about the interest rates on bank funds held at the FED. All of these actions and the chatter have led to a little bit of tightening on the 2/10 U.S. curve but nothing earth-shattering as the market continues to come to terms with the timing of these actions.

In a speech delivered yesterday, New York Federal Reserve Bank Executive Brian Sack laid out the important strategy for the FED in its need to remove the huge amount of MBS and Treasuries presently on its balance sheet. As Sack stated, $2.0 trillion of the $2.3 trillion is MBS and Treasury instruments. There has been an ongoing argument about whether or not the Fed’s QE program has forced the whole risk curve lower. Brian Sack lets the world know in footnote 3 that he believes there is evidence that the FED asset purchases have contributed to the lower levels of long-term risk.

This is important because it supports Bernanke’s Feb. 10 statement that the FED will be very reticent to aggressively start unwinding their balance sheet. It seems that they will let securities roll off as the securities mature or are prepaid. We have been warning that the FED models suggest that the disposal of assets would have minimal impact on the mortgage market. It seems that Sack’s work indicates that the aggressive unwinding would be very disruptive, especially if the economy is still in a fragile recovery. As Sack said, it will shrink the “balance sheet in a gradual and passive manner.” We will keep our eyes on the yield curve for this FED stategy should keep the curve from steepening. If the curve were to start a bear flattener as the FED actions begin, and, without the inclusion of any disposing of the assets on the FED balance sheet, the market’s response will reveal a great deal of information. The all-important variable will be timing this, both for the FED and the trading world.