Oct 9. Yellen nomination should provide smooth 10 year auction today
Saw a man with the jinx in the third degree
From trying to deal with people–people you can’t see
Take away, take away, this house of mirrors
Give away, give away, all the souvenirs
We’re all in the same boat ready to float off the edge of the world
–LIFE IS A CARNIVAL by The Band
Oct 9. Reactions to reports that Obama will nominate Yellen as BB’s replacement include a small bounce in stocks and in fixed income. The dollar is also stronger this morning. It seems as if there is some chance of a short term debt limit extension, but when looking at the SPX, though we broke a trendline from last November’s low, we are still not through the lows set near the end of August when interest rates were on a tear higher. (DJIA did break slightly through Aug low). Seems as if continued Fed juicing is much more important to stocks than the gov’t shutdown.
–The market is becoming more attuned to the possibility of default with near t-bills jumping in yield and repo rates pressing higher. In euro$’s EDZ3 was the weakest contract, closing -3.5 at 9967.5. Implied vol in front exploded. For example, last week EDZ3 9937.5p were offered at 0.5 in size. Yesterday, 9862.5 puts trade small at 0.5…75 bp higher yield strike.
–Besides the pressure on repo rates associated with default, an article in the FT yesterday indicated that EU banks still reliant on ECB funding through LTRO would be penalized at upcoming stress tests. As the Bundesbank’s Weidmann has pointed out, it reveals a circular problem of the ECB providing cheap secure funding so that banks could buy (prop up) sovereign debt of dubious quality, leading to more risk in bank portfolios that could come back to further weaken sovereigns.
–In the US there is a similar circular conundrum, again related to cheap, secure and plentiful CB funding, but the beneficiary is financial assets, whose increased value was supposed to create confidence and escape velocity in the ‘real’ economy. Like a merry-go-round.
–But the immediate concern remains US gridlock and gov’t holiday. And the market reflection of dislocations is pressure on the front end and a bid in deferred contracts as growth prospects are jeopardized. While an extension agreement will cause reversion in some of these moves, what is still not being priced in my opinion is slower than expected growth. Markets revert quickly, longer term economic decisions don’t. Of course if there isn’t an extension, and the Treasury resorts to cheap chicanery like issuing ‘super premium bonds’ (from a UBS note), then the long end could run into a fresh set of problems.
