6/10/09 (Will the Dollar Break?)

Traders,

Yesterday was a mixed market across the board, we saw the dollar start to weaken, commodities rally, and the a mix session in the bond market. The market tested those resistances and we have been in a momentum rally (rather than a fundamental) for the most part. There had been some expectations that Bernanke (and the FED) would raise rates - but that debate cuts both ways, policy and politically he will not raise rates, but fundamentally he may have to. Who is to say - but if that were the case it would be damaging to the consumer recovery as the very little credit available will become more expensive, which would put a clamp on home sales.

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Policy News

Summertime is usually a low in stock and sector news, with market news driven by policy or world events.

The Supreme Court passed on taking a go at the Chrysler decision and it looks like the sale will go through – giving some concern to the corporate bond market.

The administration is looking to expand the SEC powers to include executive pay oversight, which will certainly get push back and create some concerns in the banking industry.

US Debt and Dollar risk continues to be a concern, Russia announces it will switch out of U.S. Treasuries and into IMF DEBT (others may follow).

The Stimulus is seeing its way into the market, but consumers are still strapped for spending power.

Trade deficit widens – as exports drop - reducing hopes of a recovery soon.

Certainly we will get some good and bad news and it the market will take it in stride.

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Dollar and U.S. Debt

The story that just will not die. For the last several months we hear concern about deflation, I had said that was a very short sighted view and while it may “seem” like deflation it was really a by-product of the credit crunch than actual deflation (in my book) – my concern was coming inflation and mounting U.S. debt. But as I mentioned earlier the concern seems to be a two way street. Certainly we are seeing inflation – you can’t deny that – just look at commodity prices or go to the gas pump or pay attention the next time you are buying food. Prices are going up.

As Bernanke took interest rates to zero, the only reason people bought U.S. treasuries was their concern about RISK, they certainly were NOT making any money with close to ZERO rates. But now, after the market has made a significant rally, people are coming out of there caves and seem to have an appetite for risk – (selling their U.S. treasuries and buying stocks and equities). That is one primary force in the market (that is driving up the equity momentum rally and down U.S treasuries), but there is another force.

While retail and investors are selling treasuries because they are looking for better returns elsewhere, the foreign players (and considerably bigger) are reducing their longer-term U.S. treasuries for a different reason – FEAR of the mounting U.S. debt and deficit, coupled with the massive printing of money. While we have seen many foreign players continue to purchase U.S. treasuries, they have significantly changed their game plan. What had traditionally been a mixed basket between 30 day, 2 year, 5 year, 10 year, - we are now see them move more and more into the short-term paper and significantly less in the 5 and 10 year (forget 30 year). The answer is simple – the shorter time frame, the quicker they expire, the quicker they are out. This gives them time to figure out where to go to next. We have heard their concerns and calling for a NEW reserve currency, but so far they have continued to buy (and hold) U.S. treasuries – until now. Russia announced it may be the first to cut the cord and switch out of U.S. treasuries into IMF Debt. While Russia is not the biggest player – it could be the domino that creates a wave of others to follow.
http://www.bloomberg.com/apps/news?pid=20601087&sid=ahoIPyEdpHUI

What does this mean – well it means that we could see Treasuries fall dramatically (they are already going down), that means yields will go up fast. This has many very negative consequences.

1. It can create a very weak dollar as others rush to get out of U.S. dollar holdings
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2. It will significantly hurt the U.S. deficit and debt – as Obama needs to finance MORE of the deficit and sell 100s of billions more in treasuries – with no buyers the yields go up that means the U.S. government paying VERY high interest payments – which could be a back breaker.

3. Consumer credit will become very expensive – forget those low mortgage rates (banks have to borrow money and it will be expensive).

4. Bankrupt Fed? The Fed is rumored to have over 9 trillion in off balance sheet risk (Bloomberg law suit), they have doubled their reported balance sheet, and are buying more and more treasuries (with printed money) because the government’s spending is so massive there is not enough investors in the world to finance it. If nations stop buying (or worst start selling) their holdings – that means the amount the Fed has to print to make up for the short fall is passing the tipping point.


If Russia moves in this direction and others follow – would could get ugly fast.

We are beyond the math models of inflation, deflation, stagflation. This can no longer be measured in any velocity of money or M1, M2, M3, etc. We have moved into the realm of FAITH. If nations lose faith in the U.S. dollar no amount of printing, policies, speeches, or even math can make up any difference. A move to a new reserve currency tells the U.S. that the world has lost faith in the U.S.’s ability to manage debt and their printing has gotten out of control.

While I might sound like an alarmist – I am not alone, wiser and more knowledgeable men than I have voiced similar concerns (Buffet, Rogers, Faber, Gross, and many others). We can only “HOPE” that Congress and the administration can get in front of this. When Bernanke the other day WARNS Congress they must stop spending – shouldn’t that be warning enough. The FED is printing billions daily to keep up – it just has to stop.

What is the breaking point? How much more money do you have to print to finance the U.S. Debt (treasuries) before it becomes a joke (or worthless)? Nations, Bernanke, and others are saying we are very close to that tipping point.

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Futures Pre-market

We are getting a pop in the futures pre-market which just seems to be a following of the Europe and Asian markets – rather than any fundamental information.

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Support / Resistance

We are right there and the futures look to break through those resistance points – watch the close for confirmation.

INDU 8750 (We are right there – with the INDU pretty much unchanged – the futures are pointing to a higher opening. But will that hold into the close?)

NDX 1500 (Again – closed almost right on the money – future pointing higher.)

SPX 940-950 (Right in the resistance wheel house.)

RUT 540-550 (Just below – but close)

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Conclusion

The big question for the economy and future stability is twofold, IF Russia makes this move out of the dollar and IF others follow. I think this should be the primary economic story of the day – not just the brief headline that I saw on Bloomberg. Of course the media reports after it happens, maybe we should look at this as a warning shot. So far it has just been saber rattling requesting a new reserve currency and their increase in short-term vs. long-term. However, a move out and if others follow could send yields spiking fast and hard when we least expect it.

I don’t know how the administration is going to smooth the relationships with our largest creditors. Obama and Geithner had initially shot themselves in the foot when they had said that China had “manipulated” their currency. Now they are retracting that and Geithner went on a road show to China to ease their concerns. You can’t piss off our biggest creditor when the economy looks this bad, we NEED China more than they need us. We NEED them to buy more treasuries! Bernanke is at a breaking point, he can’t keep printing money to make up the difference which is increasing.
Everyone is running out of the dollar (U.S. treasuries) – small and big investors as their appetite for risk increases and they don’t want to miss the boat on the equity rally and the foreign nations that think the U.S. debt and spending is out of control. As everyone rushes out, how are we to fund (borrow) to cover our deficit, pay down the debt, or just pay off the interest on our debt.

I got sick this morning when I heard on NPR about the new Health Care plan that is expected to cost $1.5 TRILLION – yeah how are we going to pay for that?