Wednesday, 27 May 2009

Some seasoned market professionals are becoming "uncomfortable"

A number of seasoned professionals are becoming less and less comfortable about the state of play in the markets despite a spike in consumer confidence and plenty of chatter about green shoots (the one thing that Lord Lamont has to be proud of is popularizing those two words).

There is an excellent piece by Brett Steenbarger on the extent to which algorithmic trading is creating herding behavior in the equity markets with the TILT button currently in rally mode. But presumably the tilt bias could change to sell mode in a nano-second.

Perhaps more ominous is another specialist's view of the steepening of the yield curve and its possible ramifications.
The yield curve is losing its curve and is about to go perpendicular. The 2 year/30 year spread is closing the day at 356 basis points. I have recounted many times here that the widest level for that spread since man has walked erect was at 369 basis points in October 1992. The yields were 3.60 and 7.29 percent, respectively.

Look at the breakeven spread on the 10 year TIPS bond. That spread is currently 185 basis points. I do not believe that we have been that wide since the advent of the financial crisis in 2007. I think that investors are uttering a gigantic and collective nyet regarding the implementation of monetary policy and fiscal policy in the US.That is why the curve is steepening so dramatically.

Foreign central banks continue to intervene, buying dollars and selling their local currencies. The names most mentioned in that endeavor are Russia and Brazil. Sources tell me that the fruits of the intervention are parked in 2 year notes and 3 year notes. There is a dearth of central bank interest in the longer maturities.

Maybe the final climactic event is upon us. Maybe the final bubble to burst is the US Treasury market and maybe we are on the verge of a financial Krakatoa which will realign financial markets.

Whatever the case it feels like the calm before the storm and we are about to embark on another interesting expedition.

As I wrote earlier , it is my own view that we are entering an Extreme Hazard Zone, so be sure to bring your crash helmet.

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