Wednesday, October 28, 2009

Additional Thoughts on "Is a Stock Market Correction and Dollar Rally on the Horizon?"

Today Eric Sprott came out with a newsletter titled "Dead Government Walking", where he confirmed what we alluded to yesterday in our post "Is a Stock Market Correction and a Dollar Rally on the Horizon?": that once the Fed end its program to buy back USTs in October, there will be a huge vacuum to fill. As Eric Sprott highlights, Fed repurchases accounted for as much as 50% of new treasury issuances:
"The Q2 Flow of Funds Report published by the Federal Reserve revealed that the Federal Reserve purchased as much as half of the newly issued treasuries in the second quarter. This means that the Federal Reserve isn’t merely supporting the market for US treasuries…it is the market for US treasuries".
 With ~$9 trillion in new Treasury issuances over the next 10 years, it is no wonder the Fed is panicked enough about long term rates rising, to send in PIMCO (the world's biggest bond fund) to plead its case. In his newsletter today Bill Gross made 2 key points:
1. That the Fed and the U.S. Treasury have supported prices in asset markets such as equity and housing through their various programs (covert and overt we might add, and quite the opposite in spirit to the widely propagated "free market ideology").
2. The six-month rally in risk assets (equity, high yield debt and commodities) is likely at its pinnacle.
So we would once again like to remind our readers, that rest assured, the Fed will try its best to keep long term treasury bond interest rates low, either through:
1) Engineering another flight to safety trade (money moves out of risk assets such as equities, high yield and commodities, into safe assets such as USTs)
2) Continue to buy USTs by subterfuge (enter into currency swaps with foreign governments and ask them to use dollars to buy USTs).


Anonymous said...

You're right that the shenanigans are over for now. I think looking foward to next week the language in the FOMC release is going to be critical verifying which direction will be taken. Should the language be more hawkish I would be surprised but I think looking for subtle clues, early warning indicators in the verbage of the release. Discussion of exit strategy has been floated for quite some time and words indicative of actions in a more formal release (hashed out with all the gov's) would be the next step.

Arguably there is a lot of slack in the system, but I think historically the FRB has raised FF rates after unemployment stopped rising. If green shoots are to be believed then we should hear some language regarding the bottoming process (inherent weakness etc.).


The Firecracker Report said...

We agree with all the great points you make. Doubt if Bernanke is going to raise rates anytime soon, his strategy is all talk and no action.