Talk To Your Elected Representatives Before Considering An Investment In Any US Security

Update from Nic Lenoir of ICAP

Bonds are chopping quite a bit because of two key issues today. The latter one which triggered the sell-off is a rumor about a Medley report out "quoting" two senior Fed officials wishing to hike and end quantitative easing.

The other issue, which is less obvious in the direct price action, but of much more importance, is the decision this morning to reduce the Supplemental Funding Program from $200Bn to $15Bn. This was revealed by the WSJ, and our sources tell us the Treasury is very unhappy as they were scheduling a proper announcement at 11AM in line with their usual procedures. What this means is that $200Bn of funding provided through Bills to the Federal Reserve is being removed. Either this means the Fed is planning to start shrinking its balance sheet, either this is only a move to avoid hitting the debt ceiling. I strongly believe the latter is the answer. We are about 6 weeks away from hitting the debt ceiling, and while Fed or Treasury officials thought raising the ceiling would be a mere formality, it appears this will lead to a full blown political battle. In that sense, we definitely think that the object of this morning's move is to buy time in order to get Congress to pass a higher debt ceiling. Beyond this, there are many questions about whether the Fed is willing, and is capable, to withdraw a lot of the extraordinary policy measures in place. This move also helps Fed officials show they can flex a bit of muscle  and get things done when needed, though it was not the primary objective.

Short term the effect is that bill rates are likely to drop because there is less supply, and the Fed will instead find itself with an additional $185Bn in excess reserves, so the Fed Effective rate should be under pressure, and that could well translate onto Libor rates. Lower cash rates should be expected in the next few days/weeks.

The debate regarding Quantitative Easing, extraordinary policy measures by the Federal Reserve, and their possible removal, joins the concerns over deficit and currency valuation. Nouriel Roubini's stance "damned if you, damned if you don't" seems perfectly accurate. Personally my take is that the imbalances that have been built are such, that a smooth application and removal of never tried before policies is bound not to happen smoothly. Which way the market cracks (inflation/relapse) depends what the government will do. Talk to your elected representatives before considering an investment in any US security.

Good luck trading,



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