The Weekly Report

By: Mick P | Sun, Apr 20, 2008
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Welcome to the Weekly Report. This week I have to highlight conditions in the bond markets as a priority, we maybe about to endure a bust of quite large proportions. I will also look at some longer term stock market indicators, confirmation that the Bank of England will follow the US and show why the current rally in stocks is due to a visit from an old friend, as readers at Livecharts.co.uk will know only too well.

Before we begin I need to comment on something I read this week.

Who wrote this, some socialist leaning European, a US Treasury/Fed spokesperson? Maybe it was the remnants of a socialist/communist government in the Caribbean? No, no one like that, it was none other thanAmbrose Evans-Pritchard, International Business Editor at The Telegraph.

Here is how he describes his orientation to all things economic:

Well at least he has all the bases covered, I suppose. Unfortunately all it shows is a confused methodology toward economic thinking. Some of his influences are in direct conflict (vitally about the Slump) and Ludwig von Mises is probably spinning in his grave.

What is more worrying is that AE-P is allowed to write such bilge as we see in his remarks about Hedge Funds. (I have no connection, in any way, to Hedge Funds.) Hedge Funds didn't cause the rise in soft commodities, they did not enable it. To say that they did (even partly) and are responsible for mass starvation shows a complete lack of understanding about the true nature of monetary inflation and Central Bank sterilisation methods and their destabilising effects on free markets. Yet thousands of readers will have taken that statement as a fact.

Without me saying this is the cause, a simple point about the rising costs of transportation of foodstuffs, shortages and pricing mechanisms blows his statement out of the water. He also seems to forget a very simple rule, for every buyer, there is a seller. Who sold to the buying hedge funds at prices that were acceptable? No mention of that I see.

Hedge Funds operate in a (supposedly) free market. They buy and sell as they feel fit, just like everyone else does. They make profits and when they make losses, they go bust, unlike certain banks or brokers who get centralist protection and bailouts. Capitalism polices Hedge Funds, they either survive or go under. If they do something illegal, fine, regulators should get the batons out and beat them to a pulp.

Instead what do we see in the mainstream media - shrill and hysterical statements pointing the blame at those funds operating correctly in a free market. Calls for more regulation and as I mentioned would happen not long ago, calls to restrict margin availability. If AE-P truly believes what he wrote, he needs to expand upon it. If he wrote it to garner readers he should change his "credentials".

Ambrose, if you read this and want to reply feel free.

I am seriously concerned that many are not ready for what is to come in the US bond markets, especially US Treasuries. As we have witnessed the Federal Reserve is happily swapping lower rated debt, stuff that no other lender wants as collateral, for US Treasuries to enable Bank and Broker credit to be continued.

Now, in a way this could be viewed as a neutral debt creation policy, a swapping of assets rather than new issuance. However that situation is about to change and bond markets are beginning to price in the effects:

As discussed in the last 2 Occasional Letters this should come as no surprise, issuance of Government debt is required to lend credibility to increased inflation expectations. (You didn't think I did all that theoretical work for no reason did you?) It will not be the last surge of treasuries into the markets either.

Bond markets are faced with further supply, as we can see here:

On top of all this is the new muscle beginning to be flexed by the GSE's, for example:

I am not going to discuss all the ins and outs of the debt issuance and credit expansion again as it has been covered elsewhere. What we can see is the emergence of debt issuance has been reignited, thanks to the back stop provided by the Federal Reserve. Here is moral hazard writ large, as new debt is used not to shore up current positions but is creating further liabilities.

For the first time in many a year, it appears that the bond markets are reacting to this increased supply as confirmation that the US Govt and the Federal Reserve truly intend to inflate over the longer term and are decoupling from the Fed Fund Rate(2.25%) along with LIBOR.

Why do I think this is an inflation related move, rather than LIBOR reacting to tightness in credit conditions? Simple, supply of debt is increasing and the financial market is underwritten by the Fed. As Doug Noland puts it (and I agree):

From my viewpoint I expect yields to go north and I may have something that shows this beginning:


Click on the image to view the live yield curve at Stockcharts.com.

The black line is the latest curve, the green shadow is the recent past. Yield across the curve is rising, not just in the 2year-5year window. As Doug Noland said, if markets are set up for an anticipated scenario, in this case a recession and slowdown and have priced accordingly, then intervention will have a destabilising effect.

For bonds that means a sell off, and the possibility of the long end (30 year) yield climbing significantly. If the Fed cut at the next meeting, it could be enough to trigger a panic steepening trade, reinforced by stops being hit.

Here is the nasty bit.

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Mick P

Author: Mick P

Mick P (Collection Agency)
About Collection Agency

An Occasional Letter From The Collection Agency in association with Live Charts UK.

For some years now I have written an ongoing letter, using macro-economics, to try and peer into the economic future 6 to 18 months ahead. The letter was posted on a financial bulletin board to allow others discuss its topic.The letter contains no recommendations to buy or sell, indeed I leave that to all the other letters out there and to the readers own judgement. The letter is designed to make us all think about what may be coming, what macro trends are occurring and how that will affect future trends and how those trends will filter down to everyday life and help spot weak or strong areas to focus on for trading or investing.

To contact Michael or discuss the letters topic E Mail mickp@livecharts.co.uk.

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