Archive for April, 2011
The dollar continues to control the equities and commodities market with its inverse relationship to them. The past couple years it seems that the dollar does what it wants and the all other investments move according to their relationship with rising or falling dollar prices.
Most of you know that I follow the dollar very closely. And each morning I provide my analysis with what I feel will take place throughout the session or next 48 hours.
In Today’s (Wednesday’s) pre-market trading analysis I talked about the strength of the equities market in the past few sessions and that it looks as though it still has more power behind it.
Dollar Index 60 Minute Chart
Taking a look at the US Dollar I noticed this morning that it was pointing to even lower prices and that it would likely happen today. It was only a few hours later that the dollar went into a free fall blowing through my downside price target of $73.30. It was this sharp drop in the Dollar which sent stocks, silver and gold soaring higher yet again in our favor.
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Equities Market – SPY 60 Minute Chart
Stepping back a couple hours before the US dollar dropped in value sending stocks higher I did see fear creep into the market as traders started selling their shares and buying put options expecting the stock market to fall. When I saw this I got exciting because higher stock prices are usually just around the corner which they were! That’s when I sent an update out subscribers noting we should see some fireworks very soon.
While I am bullish on the stocks and metals at the moment and are long in several positions I am starting to see signs that a pullback is becoming more likely each trading session. This is when money management is important. I do not want to give back to much profit, but I must make sure we lock in some gains during times when the market is overbought like this.
Mid-Week Trading Conclusion:
In short, we continue to ride the trend of higher stock and precious metal prices as the US Dollar spirals down out of control. Our SP500 positions are deep in the money and we continue to ride it for all it’s worth raising our stops as we go.
The big question is if the Sell In May, and Go Away will take shape or not… Im thinking it will as when the time is right I will be looking to short the market.
Chris Vermeulen
by Tyler Durden
While today’s 2:15 pm FOMC press conference is still some time away, it is never too late to reserve your seats: the conference will be presented below live. We will liveblog the event in the off chance Bernanke says something that may be even modestly unexpected, such as the truth.
In case anyone is still confused about what is going on:
Chairman Ben S. Bernanke will hold press briefings four times per year to present the Federal Open Market Committee’s current economic projections and to provide additional context for the FOMC’s policy decisions.
In 2011, the Chairman’s press briefings will be held at 2:15 p.m. following FOMC decisions scheduled on April 27, June 22 and November 2. The briefings will be broadcast live on the Federal Reserve’s website. For these meetings, the FOMC statement is expected to be released at around 12:30 p.m., one hour and forty-five minutes earlier than for other FOMC meetings.
The introduction of regular press briefings is intended to further enhance the clarity and timeliness of the Federal Reserve’s monetary policy communication. The Federal Reserve will continue to review its communications practices in the interest of ensuring accountability and increasing public understanding.
Live link. We have picked a green frame border for obvious reasons.
Today’s FOMC meeting and press conference has the potential to either put in a daily cycle bottom in the dollar index or initiate a waterfall decline into the dollar’s three year cycle low. There is a lot riding on this meeting.
Let me explain. Today will be the 26th day of the current dollar cycle. That cycle typically lasts about 20-25 days. So it’s already starting to stretch here. The last few days the dollar has been consolidating while it waits to hear what the Fed has to say. I suspect if the Fed clearly states it will close down QE2 in June that will give the dollar the impetus for another dead cat bounce.
Make no mistake though, this will only be a dead cat bounce. Just because Bernanke ends QE2 in June doesn’t cure the problem of the trillions of dollars he’s already printed. The foolish attempt to print prosperity is going to have dire consequences, it is going to cause a dollar crisis. There’s no way Bernanke can avoid that now. The damage has already been done. There’s no way to push the toothpaste back in the tube.
In the event that the Fed does clearly state their intention to end QE (and I think this is the most likely scenario) the minor dollar rally should drive a continuing correction in gold and silver. They are due for a daily cycle correction. It will only be a correction though. The dollar catastrophe isn’t done yet and Gold’s C-wave still has further to go (alot further).
The other scenario, and the one I think is less likely, Bernanke doesn’t state a clear intention to halt QE and the dollar tanks. Thus initiating a final dollar crisis immediately.
Only an Keynesian academic would think lasting prosperity can be created, with no unintended consequences, by printing money. But only an imbecile would risk sending the dollar over the cliff that it’s hanging on. Bernanke had better say the right things this afternoon or all hell is going to break loose in the currency markets.
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By David Galland, Casey Research
In the last few weeks, I’ve become particularly “attentive” to the intentions of Fed policy makers following the scheduled June end date for QE2.
This is no small matter; an actual shift in Fed policy – as opposed to the smoke and mirrors sort – could temporarily play havoc on equities and commodities markets alike. How could it be otherwise, when under QE2 the Fed has been writing checks to the Treasury in amounts of upwards of $100 billion a month since last November?
As a point of reference, at the end of April 2007, the monetary base of the U.S. was $822 billion. At the end of April 2011, it will be $2.5 trillion, a three-fold increase. Call it what you want, “quantitative easing,” “stimulus,” “political payola,” “madness,” but monetary inflation is the correct term. And monetary inflation on this scale invariably leads to price inflation on a similar scale.
It is this “money,” steadily ginned out of thin air, that provides the fuel to keep the spendthrifts in Washington spending and props up the wounded economy.
It is also this “money” that sends equities and commodities soaring as investors look for higher returns and things more tangible to hold ahead of the rising inflation.
Removing the stimulus, therefore, will almost certainly have consequences.
Yet, because the politicos and their pets at the Fed have taken things so far beyond the pale at this point, so would a decision to keep the monetary pedal to the metal past June. As you can see in the chart below, technically speaking, the dollar is breaking down.
This steep downward slope of the dollar’s trend line over the last year begs for the Fed to attempt something to slow the dollar’s descent. Were they to signal a continuation of the same level of monetization now underway, past June, can anyone doubt that the dollar’s steep fall would only worsen, risking even collapse?
To my way of thinking, therefore, the logical starting point is for them to let QE2 expire in June, as planned, in order to show the world some monetary spine.
That is not to say that the Fed will leave its seat empty at Treasury auctions post-June – various members of the inscrutable institution have already made clear the intent to continue reinvesting the proceeds of maturing securities in the Fed’s portfolio back into Treasuries. Yet, even with that ongoing action – resulting in Treasury purchases to the tune of $17 billion a month – the net result will still be a monthly gap on the order of $80 billion.
All Eyes on Interest Rates
The dialing back of the Fed’s monetary machinations increases the possibility that interest rates will need to rise in order to attract buyers in sufficient quantities to fill the gap. And if there’s one thing we know, it is that rising interest rates would be devastating to an empire of debt such as the United States circa here and now.
One typically doesn’t like to see the empire in which one lives crumble into lesser states, as that is usually accompanied by a flagging quality of life and social unrest. Though there isbupkis that I, or any of us, can actually do at this point to rearrange things on the larger stage – it does behoove us to look after ourselves. Which, in the current case, requires a quick detour on the nature of interest rates.
We humans don’t really like change. And so we tend to embrace scenarios involving only gradual change – the soft sort that are easily coped with, with small and measured adjustments to the riggings.
The risk in such a passive perspective can be seen in the chart here showing the benchmark 10-Year U.S. Treasury rates from 1945 to 2010. While it is worth noting that over that entire 65-year period rates have never been lower than they are just now, a clear sign that today’s low, low rates are anomalous – and doubly so given the amount of outstanding debt – my primary purpose for presenting this chart is to narrow your focus to the period between 1975 and 1977.
As you can see, in 1975 – a period associated with a temporary calm before heading into a final inflationary blow-off – interest rates were actually on the decline and had fallen below the levels of 1970. Then, in the blink of the proverbial eye, 10-year rates started accelerating upwards, moving from just over 6% to over 15%, driven by the raging inflation and, in time, a Fed policy shift designed to crush that inflation. While rates subsequently peaked and began to ease, in fits and starts, it took a full decade before they returned to the 1975 level.
Unfortunately, the situation today is worse, which is saying something. As you can see from the next chart here, in 1977, U.S. federal debt was a third of where it is today as percentage of GDP, and this doesn’t reflect the coming ramp-up of trillions of dollars in additional debt that is now baked into the federal government’s spending plans.
Should we see a similar spike in interest rates to, say, 15%, it would create a black hole that wouldn’t just suck in all the government’s revenues, but pretty much the entire economy. This is a very real risk.
But back to the Fed and the crossroads it is soon arriving at. In the absence of anysubstantial reduction in government spending – a reduction on a scale that isn’t even being whispered about in the halls of power – the Fed is damned if it dials back its monetization (jacking up the potential for rising interest rates), or if it doesn’t (dooming the dollar and in time triggering higher interest rates as well).
The politicians and their friends down at the Fed can pretend, as they do, that the overhang on the economy of some $14 trillion in debt, and another $50 trillion or so in longer-term entitlements, is much ado about nothing. This view of theirs is confirmed by the current budget discussions that talk of slashing $4 trillion out of federal spending over the next 12 years – but ignore that this slashing still anticipates annual deficits on the order of $1 trillion. There are facts and fictions in this universe of ours, and it’s a fact that the notion of spending our way to better days is a fiction.
And so, in my mind, there is no question that the Fed will ultimately be forced to unleash QE3, and that will be followed by QE4, QE5 and so on through QE15 – or whatever number is in force at the time of the dollar’s collapse.
In the meantime, though, given the current ill health of the dollar, I remain convinced that the Fed will pause in its blunt-force monetization, come June. And that is likely to provide a shot in the arm for the dollar – versus the equivalent of a shot in the head to the dollar, should they reverse themselves and attempt to continue monetizing at the same elevated levels, past June. Among other consequences, a rising dollar could spell trouble for overheated commodities, at least over the short term.
The big unknown, of course, is what will happen to U.S. Treasury rates. And for reasons discussed a moment ago, this is a really important unknown. We shouldn’t have to wait overly long for some answers. But while we wait, a few scenarios to ponder:
- Best Case: For a time, post-June the Fed becomes a relatively less important player at the Treasury auctions, buying about $17 billion in Treasuries, vs. the $100 billion or so they are buying now, and the market responds favorably to the policy shift. The gap left by the Fed is filled in by institutions, and by friendly governments, looking to roll back their diversification into the euro and the yen – given the poor outlook for both. For a while Treasury rates remain relatively stable. And that encourages the U.S. government to continue spending willy-nilly and keeps the party for equities continuing for awhile longer, albeit with the participants on edge and watching the exits for any movement.A rebound in the dollar, one result of an inflow of renewed foreign buying, would hit the commodities, causing them to underperform until it becomes obvious to all down the road that the Fed will have to once again begin monetizing.
- Medium Case: Post-June, participation at the Treasury auctions weakens, but not disastrously. Rates rise, but also not disastrously. The economy teeters on the edge, but doesn’t fall. Neither does the dollar rise overly much, and something akin to a twitchy status quo continues as people wait for the other shoe to drop, as it inevitably must given that the overarching problem of sovereign and household debt has not been resolved. Volatility in equities and commodities increases, but there is no sustained move one way or the other. Yet.
- Worst Case: Post-June, auction participation falls significantly, and interest rates begin to accelerate to the upside, sending equities markets into a tailspin, dragging commodities down with them. The Fed quickly reverses course and begins writing the big checks to the Treasury, stabilizing interest rates but sending shock waves through FX markets as the dollar hits the floor and discovers the floor is made of glass.The precious metals and other commodities soar. With nowhere else to run, investors begin bargain shopping for fallen equities – which are linked to tangible businesses, after all – and they bounce relatively quickly as well. Meanwhile, as the dollar collapses, the cost of everything begins to soar, crushing the unprepared and triggering real hardship. Unable to push interest rates higher to head off the price inflation, the Fed heads retreat to a hidden bunker and begin looking for friendly countries willing to give them sanctuary.
Of course, no one can see the future – but I think all three of those scenarios are likely to materialize in the relatively near future, one after the other from Best to Worst.
If I am right, then the way to play it is to expect a near-term rally in the dollar. While the U.S. dollar is toilet paper, it is of a better quality than the euro or the yen. Which is not to say that it doesn’t deserve its ultimate fate – the fate of all fiat currencies – but rather that, as long as the Fed shows some restraint here, it may be able to stave off that fate a bit longer.
And that could put some serious pressure on commodity-related investments, especially the more thinly traded junior exploration stocks. The chart here shows the relative performance of the Toronto Stock Exchange Venture Index – the index offering the best proxy for micro-cap resource stocks – against the price of gold.
As you can see, there can be quite a divergence in the performance of these small stocks over the price of bullion. While gold’s rise has been remarkably orderly, the rise in the stocks has occurred in fits and starts, with some breathtaking setbacks along the way. Of late, the stocks have had a substantial run-up, which again gives me pause. I think it is a fairly safe bet, therefore, that if gold were to correct 15% or so, the juniors would again go on sale.
In time, however, because interest rates are so low and the sovereign debt problems so acute, the worst-case scenario – of rates spiking – followed by the Fed quickly reversing course, is a certainty.
Which is to say that, in the now foreseeable future, all things tangible will do the equivalent of a moon shot.
Again, you have to make your own decision as to which scenario we are most likely to see. In my view, from a risk/reward perspective, as long as you have a core portfolio in precious metals and other tangibles (including energy), then selling some of your more speculative positions (you know the ones) to raise cash can make a lot of sense. That way you’d have the ready funds available to snap up the bargains that will be created during the Fed’s brief attempt at slowing the dollar’s current fall.
The way I figure it, at this point you can find all manner of analysis that will tell you it’s all blue sky from here for the commodities. Thus, a cautionary note seems justified.
Be careful, at least for the next couple of months. If I’m right, then there is a helluva buying opportunity right around the corner.
[If David's right about what's coming next, then cashed-up investors will be positioned to capture some truly exceptional profit opportunities, maybe as soon as within the next month. Which makes this the perfect time to take advantage of the 3-month, 100% money-back-guaranteed, no-risk trial to the Casey International Speculator – dedicated to well-managed junior gold and silver companies with triple-digit upside potential. More here.]
By: Scott Redler of T3Live
Traders follow a set of rules and then live by them to stay disciplined and consistent. I pride myself on my routine and rules that I live and trade by. While I rarely miss a spin class, I’ve recently violated one of my steadfast rules trying to catch a top in silver.
Recently I’ve been fighting this trend in silver after booking profits from riding it previously. I’ve been trying to catch the home run short in silver, but all the while the other team is melting the precious metal higher with singles and doubles.
Recently silver rise has started to go parabolic. It’s a move that makes everyone feel frustrated, except for those ardent believers in silver and skyrocketing precious metal prices.
If you’re long and sell it to book profits, it goes higher and you are then frustrated to miss out. If you’re looking to enter but being responsible waiting for a pull back, you are frustrated because you missed the boat entirely. If you start trying to get cute by shorting it, thinking it’s come way too far too fast, you aren’t just frustrated, you’re feeling some pain!
I haven’t seen a move like this since the Internet bubble of 1999. Those who shorted early ran out of money before they were right… I’ve been trading around my silver short for a few days now, not in much size but feeling the losses nonetheless.
Trying to blindly pick a top breaks my rules and I will let you know when I see a more defined topping pattern or reversal which we have not yet.
Last time I did this was last November with Las Vegas Sands Corp. (LVS) after trading it at various points from $17 to $30, I stayed away and next things I knew it was at $49. Due my frustration over missing out on the long extension, I thought I would try to be cure and short it. I got stopped out of most of my size at $54 on a Friday at 2:30, then at 3:30 it broke and went from $54.50 down to $50 and then within weeks down to low $40’s. All you had to do is wait for the Reversal pattern on volume instead of trying to be cute and “catch a top”. Some of you who have been with us for a while may remember that trade.
So, foolhardy or not, I will continue to watch silver closely in anticipation of the big short. During this melt-up I will stay in light size and add on a more definitive reversal pattern. But it’s been a long week…
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It has been a very interesting week thus far. Monday kick started traders with a heart pounding equities sell off which sent money into the US Dollar, precious metals and bonds as the safe havens of choice.
A lot has happened this week on a technical analysis basis which I can’t really show in a written report like this. But can do so in detail within my video newsletter. There are just to many charts required and layers of analysis to cover… But I can cover some of the points and my thoughts using the charts below:
SPY 30 Minute Intraday Chart
This chart shows the volume traded at various price levels for the SP500 index. These high volume levels act as support or resistance depending if you are above or below them. On Wednesday we had large gap higher into a resistance level which the market could not break through. So I am expecting to see the market take a pause and fade back down to fill part or all of Wednesday’s gap window.
While most gaps tend to get filled. Gaps that occur right at the beginning of a new trend when momentum is strong. They generally do not fill all the way down to the bottom. I expect a couple days of sideways to lower price action. Buyers should step back in and send the market higher next week if this trend is to continue.
GDX – Gold Miner Stocks – Daily Chart
Gold stocks have been underperforming the price of gold bullion for several months. This typically is not a strong sign for physical gold prices. That being said I do feel the majority of investors are seeking true safety and want to own real gold and not some highly leveraged gold stock. This to me is more of a risk off trade for global investors and it explains the performance.
From the recent price action shown on the GDX chart I am expecting to see prices trade sideways or lower in the coming days. A sideways move would actually be bullish and would signal a possible breakout to upside. So that is what I am hoping will unfold in the coming days/weeks.
US Dollar Daily Chart
The dollar continues to get sold at a tremendous rate and the Fed is devaluing the currency as quickly as they can trying and save the world one dollar at a time…
The trend is strongly down but it’s starting to near a point where we should start to keep a closer eye on it for signs of a reversal to the upside. When the dollar makes a move higher and starts a rally it will put downward pressure on stocks and commodities. We must be prepared to move our protective stops ups and possibly take advantage of falling prices in the near future. Until then remain long equities and commodities.
Mid-Week Trend Conclusion:
In short, it looks as though stocks and commodities are in favor again. Monday’s panic sell off looks to have shaken the masses out of the market and the big money players were buying up all the shares they could. Members and myself are sitting nicely in our long positions and this could be the start of something exciting.
You can get my Pre-Market Trading Analysis Videos, Intraday Chart Updates and Trade Alerts with my Premium Newsletter: http://www.thegoldandoilguy.com/free-preview.php
Chris Vermeulen
by Tyler Durden
Goldman’s just released look at what the end of QE2 would mean should certainly be taken with a grain of salt: after all lately (and in general), the firm’s sellside recommendations traditionally are a gateway for its own prop traders to take the other side of what its clients are doing (observe recent performance in WTI). That said, probably the most insightful piece of data is that we now know what the upcoming Greece bankruptcy will be called in polite circles: wait for it – a “liability management exercise.” As for the overall impact on rates, Goldman is not surprisingly bearish on rates, and sees the bulk of the upcoming weakness as focused on the 5 Year point. Franceso Garzarelli summarizes his view as follows: “together with our forecast of above-trend growth in coming quarters and the idea that the compression of bond premium will decay as the Fed’s balance sheet (organically or voluntarily) shrinks, we think that short positions in 5-yr Treasuries remain attractive.” In other words, Goldman is expecting some flattening in the short end. Does that mean a steepening is inevitable. As for the broader perspective on the curve, Goldman says: “assuming the Fed’s bond holdings passively run off as securities mature, the bond premium should gradually rise. And our macro forecasts are consistent with higher real rates in coming quarters.” In other words, another extremely non-committal report from a firm that is rapidly losing its Master of the Universe status. Key highlights below.
- Concerns that a combination of higher energy prices and fiscal tightening will dent growth have supported global bonds. These concerns are overstated, in our view. Meanwhile, core inflation has turned (admittedly from low levels), and more European central banks are likely to follow in the ECB’s footsteps and tighten policy over the coming months.
- Our estimates indicate that ‘QE2’ could have shaved as much as 40-50bp off intermediate US bond yields. The effect of purchases is most visible in the 5-yr sector of the Treasury curve, which continues to look ‘rich’ relative to 2s and 10s.
- When the flow of purchases ends in June, there should be little immediate effect on bond yields—provided expectations are that the Fed will not sell securities back into the market any time soon.
- However, even assuming the Fed’s bond holdings passively run off as securities mature, the bond premium should gradually rise. And our macro forecasts are consistent with higher real rates in coming quarters.
- In Euroland, Portugal formally requested conditional financial support and talk of a liability management exercise on Greek sovereign debt has intensified. Although the latter could lead to bouts of risk aversion, we continue to expect further spread compression between the larger ‘non-core’ issuers (i.e., Spain, Italy and Belgium) and Germany/France.
And the full report:
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What Happens After the Fed Stops Buying?
The Fed’s QE2 program could be keeping intermediate maturity US Treasury yields around 40-50bp lower than would otherwise be the case. The effects of the central bank’s purchase are most visible in the 5-yr sector of the yield curve, which still looks ‘rich’ relative to adjacent maturities. When the flow of purchases ends in June, and on the assumption that the stock of bonds held by the Fed does not change, there should be little immediate effect on bond yields. Nonetheless, the ‘term premium’ should gradually rise as the Fed’s bond holdings passively run off as securities mature. Moreover, expectations of the Fed selling securities back into the market—which is not our baseline case but could admittedly pick up as the economy continues to recover—could amplify the increase in yields we expect based on our macro forecasts.
Fed’s Bond Purchases Soon Drawing to an End
Through its asset purchase program (‘QE2’), the Fed has delivered a stimulus to the economy by-passing the nominal zero policy rate constraint and influencing directly longer-dated discount factors. In the December issue of our Fixed Income Monthly, we estimated the Fed had broadly succeeded in bringing intermediate and long Treasury yields close to a level consistent with negative policy rates as implied by a ‘Taylor Rule’.
As the purchase program draws to an end in June, we are frequently asked whether there will be an adverse impact on the bond market. We tackle this issue with an ad hoc regression analysis, cross-checking our findings through the suite of valuation tools we regularly employ in the formulation of bond strategy.
Our main conclusion is that the announcement of the total size of Treasury purchases, rather than their implementation, could have lowered intermediate maturity Treasury yields by as much as 40-50bp. As long as the Fed does not announce its intention to sell bonds back into the market any time soon (which continues to be our baseline case), this effect is likely to fade only gradually, assuming no intervening change in the macro landscape.
Our central forecasts, however, are consistent with a progressive increase in real bond yields over coming quarters. And, as the recovery takes hold, it is conceivable that market participants’ expectation of asset sales could increase, thus amplifying the sell-off in yields. With this in mind, we continue to recommend short positions in the 5-yr area of the Treasury curve, which looks to have been the most influenced by the Fed’s interventions.
The ‘Announcement Effect’
Assuming financial markets are liquid and forward-looking, bond prices should be affected by the announced total amount of purchases the central bank intends to conduct, rather than the subsequent flow of purchases. Chairman Bernanke has been among the proponents of this approach, which researchers often refer to as the ‘portfolio balance channel’ or the ‘stock view’.
If this theory is correct, when the flow of purchases is discontinued there should be little effect on yields provided expectations are that the Fed will not sell securities back into the market any time soon.
Empirical evidence appears to support the notion that the ‘stock’ effect dominates the ‘flow’. For example, 10-year US Treasury yields fell sharply following the surprise announcement of the ‘QE1’ program on November 25, 2008 and March 18, 2009. However, there is little evidence that yields increased following the termination of those purchases at the end of October 2009 (when the Fed stopped buying
Treasuries) and March 2010 (the end of the mortgage-backed security purchase program).
The chart at the bottom of the previous page compares actual 10-yr US Treasury yields with the ‘fair value’ implied by our Bond Sudoku model. The latter describes US bond yields as a function of 1-yr-ahead consensus expectations on short rates, real GDP growth and CPI inflation, both domestically and in the other major advanced economies. The effects of the asset purchase program (or shifts in the net supply of government bonds) are captured by the model only indirectly, i.e., to the extent that these influence expectations on the future course of the relevant macro factors.
As can be seen, ‘QE1’ led to a fairly rapid move in bond yields right on the announcement date. In the case of ‘QE2’, the effect largely preceded the FOMC meeting in which the decision was taken. This can be attributed to the fact that, in a number of speeches through the Summer, Fed officials had hinted at a resumption of bond purchases to stimulate the economy.
By the time the Fed announced the intention to further expand its balance sheet on November 3, 2010, 10-yr government bonds were already trading around 1 standard deviation (or roughly 40bp) below their macro equilibrium. Our GS Curve model—which links the term structure of constant maturity Treasury yields to consensus macro expectations at different horizons—indicates that around the same period bond yields in the 5-to-7-yr maturity range (the main target area of purchases) stood at very depressed levels relative to their historical relation with the 2-yr and 10-yr sectors (see chart below).
Once again, most of the effect precedes the actual decision to conduct asset purchases, but expectations of such an outcome had been building ahead of the FOMC meeting. A parallel can be drawn to the Fed’s decision to cut policy rates to 1% on June 25, 2003. Intermediate maturity bonds rallied strongly in the 3 months before the policy meeting, only to sell off aggressively after the event.
Fed Holdings Keep Bond Premium Lower
In order to test the empirical validity of the ‘stock view’ more formally, in previous research Jari Stehn ran a regression between the nominal 10-year US Treasury yield against four factors: the stock of announced purchases, the actual weekly flow of these purchases, a number of economic variables (including payrolls, the ISM survey and the University of Michigan/Reuters 5-10 year inflation expectations) and measures of the Fed’s other unconventional monetary policies (such as its guidance that it would keep interest rates “exceptionally low for an extended period”). The results, summarised in the first column of the table above, indicate that the effect of the announced stock of purchases is negative and statistically highly significant.
One issue with this simple specification is that the coefficient on the flow of purchases takes the ‘wrong’ sign, suggesting that the flow of purchases raised bond yields. This counterintuitive finding has a simple explanation: just about as the Fed started to purchase assets last November, bond yields rose sharply because growth expectations improved and, partly as a result of this, market participants revised down their expectations of further easing. But because the statistical exercise controls for the contemporaneous rather than the expected macroeconomic landscape, the increase in yields is attributed to the flow of QE2 purchases.
To address this shortcoming, rather than focusing just on the 10-year yield, we explore how the Fed’s purchase program has affected the yield curve across maturities. This allows a differentiation between the impact of economic factors (which affect the entire term structure) and the Fed purchases (which could differ by maturity bucket). Making use of the relative movement of yields at different maturities provides more information and should therefore provide better identification.
The Box above outlines the approach we have taken and the main results are summarised in the second column of the table on the previous page. Once again we find a significantly negative and economically meaningful effect from the stock of purchases on the 2-10-year part of the yield curve, while the coefficient associated with flows is now insignificant. Specifically, the estimates suggest that yields in the 2-10-year maturity range have been reduced by around half a basis point for each US$1bn of announced purchases. This suggests that the Fed’s Treasury holdings could be currently holding down 10-year yields to the tune of 40-50bp. This numerical result is clearly subject to the usual caveats applicable to the outcome of statistical analysis, but is reassuringly not far from what other studies have found. In addition, similar regression analysis on 10-year yields for the UK also found a significant and meaningful effect from the stock of purchases but not from the flow of purchases (for more details, see “A Modest Impact on Markets from the End of QE2” Global Economics Weekly 11/14).
To Sell, Or Not to Sell?
The empirical analysis reviewed so far allows us to draw the following conclusions for bond strategy:
- The starting point for 10-yr US Treasury yields is not far from a notion of ‘fair value’ consistent with the historical relationship to the current set of consensus expectations on macroeconomic factors. Going by this result, longer-dated US nominal bond yields are not abnormally low relative to where the average investor expects the economy to be heading. Rather, they do not incorporate the additional premium that is typically in place when the monetary policy stimulus is at full throttle.
- Expectations on what the Fed will do with its bond portfolio—hold on to securities until maturity or sell them beforehand—matters more than the distribution of flows. So, whether purchases are tapered off or ended on schedule should have little effect on bond yields. Put differently, no ‘cliff effect’ should be expected at the end of June.
- Our central view continues to be that the Fed will not announce asset sales for a long time to come. That said, even assuming the Fed’s bond holdings passively run off as securities mature, the term premium compression we have identified through our empirical work should gradually decay. Moreover, as the economy continues to expand along our baseline forecasts, it is plausible to think that investors’ expectations could shift towards assigning a larger probability to asset sales. This would amplify the underlying tendency for bond yields to rise.
- According to our GS-Curve calculations, the 5-yr sector of the Treasury curve has not completely realigned itself to its historical relationship with shorter- and longer-maturity bonds, conditional on consensus views on how the US economy will perform over different time horizons. In light of this observation, together with our forecast of above-trend growth in coming quarters and the idea that the compression of bond premium will decay as the Fed’s balance sheet (organically or voluntarily) shrinks, we think that short positions in 5-yr Treasuries remain attractive.
by Tyler Durden
Over the weekend, University of Texas made headlines after disclosing it was the first major institution to take delivery of $1 billion in gold, although still keeping it in the Comex system. Today, the CEO of the management company Bruce Zimmerman was on Strategy Session providing the rationale for his action to David Faber. First some prehistory: “We began buying gold in September of ’09 at about $950 an ounce. Our average price is at about $1,150. We’ve invested around $750 million in gold over that twelve months and it now has a value around $1 billion.” On what Texas thinks of gold (no surprise here): “The role gold plays in our portfolio is as a hedge against currencies. The concern is that we have excess monetary and fiscal stimulus. I noted a couple of days ago, i think there was a story out about Bernanke mentioning that while they may not increase quantitative easing, they may not necessarily reduce their exposure either. So i think that may be a signal that will continue to have a good deal of monetary stimulus. We read every day what’s going on in DC and across the states. We’ll see what fiscal policies look like. It remains a concern for us.” As to the specific reason for demanding delivery: “We had gotten to a size and our thought was that we probably will have our position for a longer as opposed to shorter term, although we could sell at any time. But rather than continuously roll the futures contracts, it became easier and more economical for us to take possession of the bullion.” So how long before many if not all other public fund managers decide the same logic should apply to them as well?
As to the question of where UofT is keeping their gold: “in an undisclosed location, underground in New York.” Somewhere just off Bryant Park perhaps.
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By: John Darsie of T3Live
The market had a constructive day Tuesday, edging cautiously higher after yesterday’s near debacle sparked by S&P’s warnings about a possible future downgrade of US debt. The ratings agency revised outlook on US sovereign debt from stable to negative while keeping its AAA rating intact, and Moody’s, for one, disagreed with the assessment. It seems the market is starting shrug off the warning as well and investors are showing a willingness to buy this dip.
While the market’s climb was slow and cautious, momentum stocks game to life today. Chinese Internet stocks like SINA Corporation (SINA), Sohu.com, Inc. (SOHU), Baidu.com and Youku.com, Inc. (YOKU) continued to lead the market, while a more laggard stock in the group E Commerce China DangDang Inc (DANG) played catchup. Apparel stocks Under Armour, Inc. (UA) and Lululemon Athletica, inc. (LULU) also continued to extend to new highs.
After the bell there were a number of big earnings reports. Here are some highlights:
Intel Corporation (INTC) Reports Q1 $0.59 (adj) v $0.46e, R$12.8B v $11.6Be
-Monster report, stock sharply higher (currently ~5%)
International Business Machines (IBM) Reports Q1 $2.31 v $2.30e, R$24.6B v $24Be
-Narrow beat, stock ticking higher
VMWare, Inc. (VMW) Reports Q1 $0.48 v $0.42e, R$844M v $815Me
-Strong beat, stock sharply higher (currently ~11%)
Wynn Resorts, Limited (WYNN) Reports Q1 $1.38(adj) v $0.74e, R$1.26B v $1.2Be; Doubles dividend to $0.50/share
-Monster report, stock trading higher (currently ~3.5%)
So far in 2011 the equities market has made some sizable whip saw type moves that even veteran traders have had difficulty being on the right side of the price action. The year started out with equities being very overbought and extended making is virtually impossible for a low risk trader to buy on pullbacks. This was primarily due to the fact that there were no real pullbacks other than for a day or two which was immediately followed by prices continuing to grind higher.
In March, we finally had the pullback everyone was waiting for which we caught 4% of the sell off using an inverse ETF. Then we saw the bottom a few days later and caught a 3% gain from near the lows during a rally higher. So as you can see there have been three trends in the SP500 so far this year and we are about to see another sizable move unfold in the coming week.
In the past 8 sessions we have seen the market pullback slightly and the big question everyone is asking is do we get long or do we short here? Below are my thoughts and analysis….
US Dollar Index – Daily Chart
The dollar is still in a very strong down trend. As long as it continues to fall we should see higher stock and commodity prices. I do feel as though there is more downside for the dollar but its nearing an end. Stepping back and looking at the longer term chart of the dollar is very clear that it is getting oversold and sizable bounce should take place. If we see the dollar breakout of this falling wedge and start to rally you will want to be short stocks and commodities.
SPY ETF (SP500 Index Fund) Daily Chart
When comparing the Dow Jones Industrial Average and the Russell 2K indexes it is rather obvious that both have performed well this year and have broken above the February highs. The DOW was strong because it has it is exposed to energy stocks and with oil rocketing higher, it has helped those energy based stocks lift the index higher. The Russell 2K consists of small cap stocks and with the general public still being so bullish on the equity markets and investors are buying volatile, high risk small cap stocks to help boost their gains.
Now, looking at the SP500 it has yet to break the February high and this is because it holds several large tech stocks and financial stocks which have been lagging the overall market so far this year. Tech stocks and financials tend to lead the market and the fact that they are not is of great concern to me.
So going back to the US Dollar, I feel as though it has a little more downward motion left which will help get the SP500 to a new yearly high. Once the dollar rally starts, it will crush stock and commodity prices for several months.
Weekend Trend Conclusion:
In short, I favor the long side for both stocks and commodities, but that can change on a dime once the dollar starts to rally. There are many negative factors coming together that give me a negative outlook on stocks and commodities for the next 2-4 months and they are:
1. Quantitative Easing is now done = rising dollar
2. Investor sentiment is at an extreme bullish level = typically a bearish sign for stocks
3. The Sell In May and Go Away is almost here…
4. Earning season is here and that is typically a time when stocks get sold into = lower stock prices
My final thought is to keep positions small and be ready to flip positions from long to short and vise versa depending on what you trade…
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Chris Vermeulen
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