Archive - Aug 14, 2010 - Story

The week's notable moves in swaps, swaptions, yields, asset swaps and mortgages. Pay particular attention to the fireworks in the 6.0 swap, the 4.5/5.0 swap, and the 4.5 butterfly. Thank you Fed.

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Now that QE Lite, or whatever one calls it, is here, the most appropriate market strategy reverts back to March of 2009, when life was very simple: "Buy what the Fed is buying." And with the benefit of QE1 in hindsight, namely the Fed's prior purchase of $700 billion in Treasurys in 2009, it is possible to determine precisely which bonds the Fed will focus on, and which are likely to be excluded, thus benefiting the least from the latest bout of monetization. Morgan Stanley has come up with a list of which bonds are likely to be targeted by the Fed in the upcoming 5 Open Market Operations beginning on August 17 and continuing through September 1. Those looking for a quick (and levered) return on investment will be wise to pick up the issues determined as most likely to be monetized, while potentially shorting those that are ineligible for buybacks.

Some days ago, Business Week pointed out that "Warren Buffett shortened the duration of bonds held by his Berkshire Hathaway Inc. after warning that deficit spending could force inflation higher." As the article further pointed out, twenty-one percent of holdings including Treasuries, municipal debt,
foreign-government securities and corporate bonds were due in one year
or less as of June 30, Omaha, Nebraska-based Berkshire said in a filing
Aug. 6. That compares with 18 percent on March 31, and 16 percent at the
end of last year’s second quarter. The conclusion: "It may be a sign that Buffett expects interest rates to start rising, maybe sooner than the conventional wisdom." Yet very curiously, as we pointed out, another capital markets titan, Bill Gross with his trillion+ in fixed income securities courtesy of Pimco's numerous asset managers, has done precisely the opposite. As the chart below demonstrates, Gross' flagship Total Return Fund has been doing the inverse of Buffett, and has been actively increasing the duration of his bonds over the past two years, with the current blended maturity profile being the most long-end weighted in years: in fact the percentage of bonds maturing in 3 years or less is now the lowest it has been since October 2008. Using the above logic, it would signify that, unlike Buffett, Gross is now more primed for deflation than ever. In the great inflation-deflation debate, this will be the primetime heavyweight cagematch to watch. Between Buffett's empire and Pimco's FI monopoly, one of the two will have to lose. Our question of the weekend is who will it be?

After a brief hiatus, Jim O'Neill is back, and this time is taking it easy on taunting the bears. In his weekly letter he has some rather lucid questions, the first one of them being the observation of the paradox of the surging Chinese trade deficit in light of the weakening renminbi. O'Neill states: "the GS trade weighted CNY has actually weakened by around 1.75pct since
they “ de-pegged”, by “undershooting” the rise of the Euro, Yen et al." Don't anyone tell Schumer that China's whole revaluation bluff was nothing but (and in fact a smokescreen for further devaluation) or there will be more theatrical demands for blood. O'Neill also looks at recent Chinese regulatory developments and notes that the push "to bring any off balance sheet vehicles for disguised lending, back on
the balance sheet, and to be prepared to raise fresh capital" is sensible but hopes that "if this is going to be implemented, if necessary, offsetting stimulatory measures would be introduced." Sure enough, China also has to pay for the Keynesian funeral for a long, long time. Not surprisingly, O'Neill looks at the one-time record pick up in the German economy courtesy of a massive EUR devaluation and extrapolates far into the millennia: "there seems to be a belief that Germany is on the verge of a jobs “ miracle” , and there is more and more talk of a period of stronger domestic demand." Sorry no. It is nothing like that and is purely a function of the ever more volatile seesawing in key FX crosses, on a trendline to global deleveraging contraction. Germany merely borrowed from the future courtesy of a plunge in EURUSD. It is already paying for this now and this quarter's data will be a major disappointment.

In a surprising act of lucidity, David Kostin recently reduced his 2010 S&P target from 1,250 to 1,200. Now, the Goldman strategist has penned his own version of David Rosenberg's SIRP (Safety and Income at A Reasonable Price), by introducing two strategies for a low GDP environment: Low Operating Leverage And Dividend Growth (LOL-DG - yes, we prefer Rosenberg's acronym).Hopefully, this means that the GARP abortion is finally dead and buried.