Barking At Consensus

"One dog barks because it sees something; a hundred dogs bark because they heard the first dog bark."
-Chinese Proverb
 
I was in New York meeting with investors last Wednesday. When I started going through the second derivative effects of a US Dollar moving into crisis mode, and walked through how this story ends (with the US Federal Reserve eventually being forced to raise rates), I had some interesting looks at me from across the table.
 
On Thursday morning, Bloomberg TV's Erik Shatzker and I walked through the implications of what Bernanke had to say about quantitative easing (reigning it in) combined with the yield curve being at an all time peak. I said current US monetary policy was unsustainable, and that the next Fed move would be up.
 
This morning, a top 3 story on the Bloomberg box reads "Treasuries Fall as Traders Bet on Higher Fed Rate; Stocks Drop"...
 
I'll stop barking now.
 
On a percentage basis, Friday's move on the short end of the US Treasury curve was one of the most explosive one-day moves we have ever seen. Two-year treasury yields remain elevated at 1.34% this morning - that's a full +41 basis points above where they were at this hour of the morning last Monday when I was writing credit market factors down in my notebook.
 
As a result of the short end exploding to the upside, the yield curve (the spread between 10 and 2-year US Treasury interest rates) has come in from its all time highs. When I was talking about last week's "peak in the yield curve", I meant that the spread between 10's and 2's was +277 basis points wide - that was a PEAK, as in the widest the yield curve has been, EVER...
 
Ever, is a long time. For a risk manager, EVER is where we look for things to change on the margin. This morning that, thankfully, has. The spread between the 10 and 2-year yield has come in by a full +26 basis points to +251 basis points wide. Yes, in the land of rates and spreads, these are huge moves in compressed periods of time.
 
So what does it mean? It means that the Piggy Bankers will have less of a spread to chow down on as we move into Q3. Apart from a nauseating calendar of investment banking secondary issuance in Q2, another point that we made last week was that the bankers are having a blockbuster Q2 on that yield curve.
 
The way that this works is that the Goldmans and Morgans scare the living daylights out of Washington into believing that we are going into a Great Depression - then they borrow American moneys for free and lend it out to America's commoners for a piggish spread. I know - isn't that an America we can all trust!
 
The New Reality remains - as the US Dollar continues to trade in the crisis zone, the Three Little Pigs are getting paid: Bankers, Debtors, and Politicians. Since 53% of the world's foreign currency denominated debt is in Dollars, collapsing its value reduces debt obligations and allows Timmy Geithner to tell the Chinese that all has been corrected in the land of Wall Street Oz.
 
Obviously this is a joke, and that's why the Chinese laughed at tiny Tim. But make no mistake folks - the other side of 2-year rates shooting higher is that holders of those bonds (China and Japan) get smoked.
 
The other somewhat meaningful constituency who cares about this thing called cost of capital is the American public. If they weren't getting paid ZERO on their savings accounts in order to facilitate this pigging out on the trough of their yield curve, they might actually believe CNBC's narrative on this too... but, once again, betting that the hard working people of America are stupid, is a bet reserved for Washington and Wall Street.
 
Main Street pays for Bernstein to upgrade Goldman ahead of the quarter alright - they pay for it via higher mortgage rates and at the pump.
 
Pumps matter, especially when they start to feel like pump and dump. I know, I'm barking again.
 
Best of luck out there this week,
KM
 

LONG ETFS

EWC - iShares Canada- We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.   

XLE - SPDR Energy- We bought Energy on 6/05. We think it works higher if the Buck breaks down.  Bullish TRADE and TREND remain.

CAF - Morgan Stanley China Fund- A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

GLD - SPDR GOLD -We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.
 

SHORT ETFS
 
UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the greenback.

XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser.

EWW - iShares Mexico- We're short Mexico due in part to the repercussions of the media's manic Swine flu fear.  The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.



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