Market Update: Risk Surges Back As Confusion Reigns
Today's market action highlighted the perfect chaos that has engulfed the markets over the past several weeks, with most investors suddenly having no idea what to do with the mountain of cash on the "sidelines", and as a result putting most of it in Treasuries (remember the whole crash the markets hypothesis?), threatening to unwind the steepener trades that have become all the rage over the past several months. This is despite the just voted through $1.9 trillion debt ceiling increase, the ridiculous US budget deficit, looming state and municipal defaults, and the just cancelled MTA bond auction. Adding uncertainty to it all is tomorrow NFP report which as the BLS noted today, could probably see even greater revisions than the 824,000 presented before, coupled with rumblings of an incipient trade war between China and the US which could cause this major buyer of US heavy manufacturing to scale back its purchases. All of this is occurring on the backdrop of plunging markets everywhere, but especially in Europe where sovereign default risks are now spreading like wildfire, hitting stock and corporate levels without discrimination. And the cherry on top is that the contagion fears are spreading globally, with the Bovespa now closing 4.7% and the BZL plunging.
Yet sidelined investors, especially Insurance companies which allegedly are still in possession of a lot of dry powder, can not afford to wait. However, with structured product no longer deemed interesting due to the end of the TALF program imminently which would result in a spike in yields, the lesser of two evils is now between stocks and bonds, stocks which suddenly seem extremely risky, and bonds which are yielding nothing in light of the supply threat we are facing. Nonetheless, the winner was bonds. Yields on the 2 and 10 year Notes fell 8 and 9 bps, but neither breached the critical 0.80% and 3.60% levels. Supply on the corporate side is also surging courtesy of an $8 billion bond offering by a just-downgraded Berkshire in connection with its acquisition of Burlington Northern, as well as $9.5 billion from Kraft to finance its Cadbury purchase. We have yet to see if the massive corporate supply will be easily absorbed. Keep in mind BlueMountain just said the easy money in fixed income is over. From here on, any incremental profits will be much more difficult. And on the supply side there is a major supply coming on in the Treasury area as well, with $40, $25 and $16 billion 3s, 10s and 30s hitting the auction docket next week.
Yet the rush to dollar safety may be premature, as Hoenig announced that MBS purchases are likely to continue past March (suprise) and the Fed for now actively continuing its single-handed propping of the mortgage market, with another $12 billion in MBS purchases.
In sum, confusion prevails, and the best summary so far of the situation coming from Pimco's Tony Crescenzi:
In the past investors did not question actions taken by the fiscal authority to help the private sector. Even in recent times, investors have welcomed such actions worldwide," he said. But, "this view is evolving.
No longer are investors sitting ready with blank checks to underwrite any amount of debt that governments wish to issue.
In 2010, signs of discomfort are surfacing, with investors putting upward pressure on interest rates in developed nations in Europe, in particular the PIGS nations - Portugal, Ireland, Greece (especially), and Spain, all of which are part of the European Monetary Union.
For the U.S., its immense power means that any loss of hegemony will occur over many years.
This will help to sustain the U.S. dollar as the world's reserve currency. Moreover, with Europe under duress, there is no alternative to the dollar and there is no other bond market for the world to house its $8 trillion of reserve assets. Investors can't turn, for example, to China, whose balance sheet is unmatched, because China has no bond market. This all means that the U.S. probably can kick the can down the road before it has to worry about whether foreign investors will continue to invest in U.S. Treasuries,
Still, with the dollar now back to July levels, gold is still only back to where it was in November. That is because gold has shifted from a dollar safety play to a fiat-currency alternative. And thanks to fiat banking, there is a whole lot more to "alternate" from.
In summary, despite all the confusion, the one underlying theme is that risk is back. Welcome back to efficient markets.