A View from the Trenches, October 5th, 2009: "It's all about rates"
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If the release of employment data) we had on Friday (i.e. change in
non-farm payrolls, which surprised to the downside, would have taken
place a year ago, I am sure we would have seen a rush to the exits.
Even more so, given the recent trend in the 3-mo Libor - OIS spread,
which showed another increase to 13.19bps in the early morning.
But what did a rush to the exits look like a year ago? In general,
for instance, you would have seen an INCREASE in the value of the USD,
a decrease in the value of commodities, a widening of the CDX IG index
and an increase in the value of Treasuries. What happened instead?
Stocks finished lower (S&P500 at 1025.17 pts, -0.45%), the USD lost
against the Euro and the CAD (DXY closed at 77.09 ), both oil and gold
finished higher at $69.67/bl and 1,002.32/oz respectively, the CDX IG
Series 13 tightened from 111/112 to 105/106 while the 30-yr Treasury
closed -0.9%.
How should we read this? In my view, this is unanimously speaking of
a bearish view on the USD. In other words, this speaks to more
monetization of fiscal deficits, which by the way is NOT necessarily
bearish of stocks. This view would be consistent with early Friday
morning’s statements by Eric Rosengren, President of the Federal
Reserve Bank of Boston, as well as efforts of world leaders to stress
the need for a strong USD.
It would also be very consistent with the tightening move we saw in
credit. It is true that the technical picture there is supportive,
given that issuances are expected to slow down for the remainder of the
year. But it is also true that if liquidity conditions are to remain
USD bearish, there will be enough liquidity to keep jump-to-default
risk in check, even in the face of unwinding of quantitative easing
programs by the Fed. Perhaps an early indicator challenging this
conclusion is the trend to the upside in the 3-mo Libor - OIS spread.
Since September 22nd, when “A View from the Trenches” turned neutral on
stocks (www.sibileau.com/martin/2009/09/22
), this spread has been making higher highs, clearly on the rise, and
is now 20+% higher. I know, I know, 3 bps should be no big deal, but
until September 22nd, the trend was from the upper left to the lower
right, and since then the trend has changed. And I pay a lot of
attention to this metric, as well as to changes in its trend.
In conclusion, the market seems to be only and exclusively trying to
figure out what will happen with rates. Rates, rather than currencies,
are the priority for central bankers. As long as non-negative
fundamental macroeconomic data is taken for granted under this
liquidity perspective, surprises like the employment data we saw on
Friday are going to test our nerves, as we weight them vs. our
expectations on the liquidity picture. If we are constantly changing
these expectations, our nerves may not make it!
What is the risk to this status quo? As we highlighted on Monday 21st (www.sibileau.com/martin/2009/09/21 ),
the risk consists in a sudden currency shift that might destabilize the
existing managed set of currency crosses, driving gold to the status of
a deflator for some of them (= reserve asset) in the beginning, and to
all of them in the end. I am not a gold bug. I truly believe that if
central bankers are consistent, they can inflate our way out of this
mess. By denying us a way out via currency swaps and coordinated
reserves manipulation, they may succeed in forcing us to hold their
notes. The problem thus lies in fiscal policy. Given the non-neutrality
of money expansion, if on top of the dislocations created by central
banks governments further enact legislation that hurts price
flexibility or supports higher fiscal deficits, the little successes
central bankers might obtain will be wiped out with violence and
desperation will win the day.
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