After The Flash Crash, The Slow Motion Crash: The Disappearance Of Term Markets As Unsecured Lending Freezes
From Nic Lenoir
After sitting all day on supports yesterday, we were graced by an afternoon rally courtesy of a double P.O.M.O. by the Fed. These liquidity injections have so far maintained us above the 1,170/1,172 neckline of a potential H&S pattern as well as the 50-dma. As I have long highlighted, following my friend Julian Brigden's lead, financial asset prices since the dotcom bust have pretty much been a function of the global liquidity expressed in USD in the system worldwide. One could wonder why we are not through the roof in equity markets with the Fed now actively expanding the monetary base again. Well... the problem is the USD rally. Even in the face of Europe announcing it is joining the monetization frenzy allowing Irish bondholders to still be promised face values and socializing the haircut via currency devaluation, financial assets are struggling to catch a bid as the USD rally is eroding non-USD liquidity when expressed in USD. In a sense if the USD rallies it basically negates all the effect of QE 2.0 on asset prices... sorry Ben!
Technically I have been calling for a bottoming in fixed income over the past couple weeks, and the more constructive price action is definitely starting to shape up. We had initially recommended starting to get long in Schatz as the longer end was under pressure, but it now seems that even longer durations are catching a bid. The 10Y future chart attached shows that if TYH1 bypasses the 124-30 resistance the market will accelerate dramatically. Until then we remain bullish yet cautious.
Gold is back up challenging the 1,388/1,390 area which corresponds to the second shoulder of a H&S pattern. If that level is bypassed new highs are in the cards, but so far it is being held back by USD strength despite fundamentals being very favorable. We need precious metals to de-correlate from the USD or the USD to trade a bit weaker to see this materialize. On the flip size if we traded below the 50-dma currently at 1347 then we risk to go trigger that H&S breaking through 1,327.
In similar fashion to equities, copper which is an excellent indicator of the risk on / risk off trade is sitting right above the support of the bullish trend. A break is most likely to coincide with equities breaking through 1,170/1,172. With European CDSs widening again, risk aversion seems logical but so far the Fed is holding the fort.
Perhaps the most interesting consequence of the European debacle can be seen in the cash market. Our money markets desk this morning is seeing banks pulling back their offers for term cash and money funds are starting to be cautious again. Remember 3M cash lent today means whoever you lend to shows up on your balance sheet at year-end... there are definitely some names people are eager to avoid, and year-end considerations is always prime to accentuate funding crises. Watch 99.40 as the support in EDH1 as a good indicator. If that support which coincides with last week's lows is taken out the widening of Libors will very much become self fulfilling as lending will freeze. In the same spirit we have been calling for wider swap spreads and that trend is starting to catch some proper pace.
As we all know, the Euro experiment is doomed in its current structure, and we are watching it unravel layer by layer like an onion being peeled, except there will be no tears in this case, at least not from me. The only wonder is how slowly this story has been to unfold, with governments in Europe and around the world trying to keep a broken economic model afloat. In the end though, nature always wins...
Good luck trading,