A View from the Trenches, November 4th, 2009: "It is caution, but not indifference"
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Yesterday’s session was not crowded with important macroeconomic
data releases or major central banks’ interventions. There were,
however, three important events.
The first one was the increase of Australia’s overnight cash target
rate to 3.5%. This is the second consecutive 25bps increase since
October 6th. What is so relevant about this? The market did not react
(i.e. the AUD did not appreciate on the news).
The second event was the sale of 200 metric tons of gold by the IMF to
the Reserve Bank of India, which paid $6.7BN for the bullion. What is
so relevant about this? The Indian Rupee did not react (i.e. appreciate
on the news).
The third event is related to my two previous letters. As I wrote
earlier, my view is that governments absolutely have to refrain from
causing any noise during this difficult week. They must neither confirm
what they are doing nor deny what they are rumored they may do.
However, in the UK, authorities disagree. Overnight, it was reported
that the Royal Bank of Scotland and Lloyds Bank, in aggregate, would
receive an additional (i.e. second) GBP 31.3BN bailout from the UK
government. What is so relevant about this? The British Pound closed
higher (i.e. 1.643USD).
To me, none of the reactions to these three events seems to have
IMMEDIATE DIRECT logical explanation. Thus, there must be a counter
intuitive, under the radar, explanation. The relevant reaction however,
seems to have taken place in the gold market, in USD terms in
particular, with the ounce reaching 1,087.80 intraday. How do we
interpret all this?
The indifference in the AUD could mean firstly that this consecutive
increase was somehow expected and secondly that it is considered ill
advised. The indifference in the INR can be understood: The purchase of
bullion was an off-the-market transaction. USD reserves (I assume) in
the balance sheet of the Reserve Bank of India that are not circulating
in the market are going to be transferred to the IMF. Therefore, no
impact in the value of the rupee in terms of USD should be expected. It
does not matter that gold, which is now backing an increasing portion
of the Rupee, gained +2.3% intraday.
The intraday volatility in the British Pound is nothing else but the
reflection of the confusion in terms of the final capital structure the
banking sector will have there, the final cost for the taxpayer and
how, whatever the outcome, the bailouts will be financed (i.e. with or
without quantitative easing).
I also checked the sovereign credit default swaps market, to see if
the indifference seen in the land of foreign exchange was also ruling
the land of credit. The result was positive: sovereign credit default
swaps barely moved.
Finally, I realized that in US Treasuries, the yield curve finished
steeper on the day (2Y10Y at 255.4 bps or +5.3 bps). That was perhaps
when I first put the two and two together…
In my view, yesterday’s action was all about the fear that the Fed
will have no alternative but to delay any increase in rates. It may be
as simple as that. Thus, the vote of non-confidence on the AUD. Thus,
the Reserve Bank of India seeks to protect its reserves. Thus, the
British Pound did not plunge, credit default swaps did not reflect much
and the so-called bear flattening trades in US rates were challenged.
Thus, lastly, gold reached 1,087+ and stocks stopped their free fall.
Was there some kind of indifference after all? I don’t think so.
What I think is happening is that unlike last spring, investors are now
realizing that this situation will only lead to overextended
imbalances, which if allowed to develop, will cause a catastrophe when
rates finally rise. Therefore, investors move with caution, which may
be wrongly interpreted as “indifference”.
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