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So yesterday the "news" was all about the long end of the Treasury curve rocketing higher (yield), which many people believe is about "risk acceptance" and The Fed (along with other central banks) cutting rates by 50 basis points.
Let's talk about what's really going on.
First, our rates. The EFF (Effective Fed Funds) rate has been trading at 1.5% now for a couple of weeks. Two percent schmoo percent; a target rate only in name is no target at all. In reality the 50 bips cut, even though it resulted in an instantaneous 40 handle rocket shot in the /ES futures Wednesday morning, was entirely a CONfidence game (with the emphasis on "Con"!)
The RTS (Russian Market) is down 87% YTD, and is closed until further notice. The Nikkei is trading below the DOW - that's not good. Indonesia's stock market was shuttered Wednesday and remains closed after tripping "lock limits" within 90 minutes of the opening bell. As of Thursday morning the RTS was closed again after Putin allegedly strong-armed a whole bunch of Russian wealthy to "stick it in" (to the stock market); this sort of v-fib in a market does horrifyingly bad things to ordinary investors who find themselves out just before the market rockets higher without underlying economic cause.
Iceland has essentially melted down. Their currency went straight into the toilet and two of the three largest banks were nationalized - all in the space of 24 hours. The culprit? Bad loans. Where have we seen this movie before?
Mexico's peso has fallen some 40% in days against the dollar. Great if you're traveling there as an American. Sucks severely if you're a Mexican. That alleged fence on our southern border is going to need reinforcements. Wednesday morning Britain and the EU zone all announced major bank rescue operations. Same deal - "throw money at it, paper it over."
The NY Fed announced plans to extend a further $39.6 billion credit line to AIG. The tab is now almost $120 billion dollars. Where did the other $80 billion go? Has it been vaporized trying to raise capital to pay down CDS contracts that have gone the wrong way on them?
Speaking of which, Thursday is D-Day - D standing for either "derivative" or, if things go sideways on people, "detonation."
See, this is the day that Lehman's CDS contracts are supposed to be resolved. Since Lehman's bonds are trading at ~20-30% recovery (horrible, on balance) the writers may have to fork up 60 to 70 cents on the dollar.
The $64,000 question is how many of those contracts net out. The real liability is what's left once everything is "balanced" (a long and short held by the same guy net to zero, assuming that both contracts are "money good", leaving the holder with no liability - and no asset)
This has the potential to be a big "nothingburger", a minor tremor, or a 250' high tsunami that washes over Lower Manhattan (and the City) tomorrow. There's no good way to know in advance which outcome will manifest, since nobody (at present) knows what the true netted-out open interest is. This is one of the problems with not having a public exchange; lack of knowledge.
The bright light of reality will shine tomorrow......
In the bond markets Treasury refunded some "off the run" bonds and got an ugly surprise - the market didn't want them. They had to pay a 40 bips "tail" to get them to go, which may be the start of a really troublesome trend. See, Treasury is now throwing over $100 billion a week into the market, and this only works on days when the market is crashing. THEN you can get people to suck up all you puke out, but the rest of the time you're going to have to pay up, and Treasury has had to do so - dearly.
This may be the start of the "bond market dislocation" that I have long feared. I hope and pray not, but if this trend continues Treasury is going to find that it cannot sell its debt into the market without slamming rates higher, especially on the long end of the curve, which means an instantaneous implosion of what's left in the housing market.
The ugly is that 3-month LIBOR widened today, as did the TED Spread. Both should have come in. They did not. LIBOR is essentially unsecured lending and the bad news is that a lot of corporate (and some personal) borrowing is indexed off it. If you are, you're screwed.
Why has LIBOR refused to come in despite these "coordinated" effort? Its simple: the underlying trust issue has not been addressed, and nobody is seriously proposing to do so.