Oct 18. QE2 shows signs of failure before its start

 While Bernanke confirmed a new round of QE Friday, cracks in the plan are already appearing. “The dollar’s value against the basket of currencies has decreased by 7 percent since the U.S. Fed began talk of possible quantitative easing.” (ZH/China Daily) Likewise, interest rates declined sharply.  However, rates have since moved up, the curve is steepening (with 10/30 at new highs), and the dollar shows signs of reversal from the straight move down. Tens went below 2.4% on QE talk, but Friday were back to 2.57%, up around 20 bps from low.  Banking stocks finally succumb to the bad….really bad…news about mortgages.  Int rate vol not surprisingly bouncing higher.
–The trade now appears to be conditional curve steepener.  Almost have to do through options because there are too many uncertainties that could drive a treasury rally again, foremost on the list being another banking crisis. (Although I have to be outright buyer of EDM11/Z11 at 16).  What if QE2, which has likely been thoroughly priced, is swamped by the new MERS/banking foreclosure crisis?  Lack of clear title has already caused some people to quit paying mortgages.  If anyone has been on the fence, recent news would just about force them to quit paying.  There is a piece on ZH http://www.zerohedge.com/ outlining problems Conejo Capital had with just one property it had bought in foreclosure. Now imagine the extra cushion that buyers are going to want for foreclosed properties throughout the system.
–It’s not inflation the Fed wants, it just doesn’t want to see asset devaluation though deleveraging.  Any idiot can see inflation in commodity prices.  As a piece in China Daily points out (paraphrasing here) the US Gov’t transformed bad private debts into gov’t debt through aid programs, now the US wants to devalue to dollar so it can pay off the rest of the world in cheaper currency.  Will the rest of the world accept that plan?
–Interesting piece in NYT about Japan (Goes from Dynamic to Disheartened). http://www.nytimes.com/2010/10/17/world/asia/17japan.html  “Japanese leaders at first denied the severity of their nation’s problems and then spent heavily on job-creating public works projects that only postponed painful but necessary structural changes, economists say.” 
–It seems to me the US is also dead set against making structural changes.  To me it’s as simple as this:  US consumption as % of GDP used to be about 65-66%.  It rose to 71-72% on the orgy of mortgage lending and refi’s.  Even with recent deleveraging it’s still over 70%.  A reversion to mean, which is such a popular concept when applied to trading strategies, has ominous implications for growth going forward.

Posted on October 17, 2010 at 7:35 am by alexmanzara · Permalink
In: Eurodollar Options

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