As the S&P 500 Index (SPY; top chart) weakened through October, we saw the traditional flight to quality among 10-year Treasury notes, which hit a low yield of 3.4% on the 8th. Since that time, stocks have made harrowing new lows, but Treasury yields have soared, as investors have sold them off as well. Perhaps, amidst the glut of borrowing the U.S. will have to undertake and the state of the U.S. economy, Treasuries are losing their luster as a safe haven. That would not bode well for interest rates in general, including mortgage rates--and that would not be good for an economic rebound.
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6 comments:
Dr. Steenbarger,
Nice observation. This has been going on for a couple of weeks, but it's been more patently clear over the last few days.
On the other hand, the dollar (and short-term Treasuries) are doing just fine, which may be due to the unwinding of American investments abroad (and therefore, likely not to stand the test of time) or due to the perception that in a global crisis the American economy will prove itself more resilient than others (and should lead to a sustained upward trend for the dollar).
Notice also how gold has failed to gain any real traction, selling off nearly 10% from its highs today (way before the last hour rally in the S&P).
Certainly, it's hard to play by the book in these times. I honestly cannot read the markets at this speed of change, so for the moment I'm staying out (even though every day - in hindsight - I feel like a fool for not making a killing).
Best trading,
Jorge
Possibly the players that have to liquidate assets to meet margin calls or pay for CDS settlements just also happened to have some Ts, as well as commodity futures and equities, to sell ...
Doc,
Excellent post. You know, I too would interpret the unexpected behavior of the treasuries as a sign that people, especially foreign investors, aren't seeing treasuries as a safe haven right now. They are going to be buying their government bonds elsewhere.
Jorge,
We've got a bifurcated dollar here. The dollar is doing well relative to the euro, which comprises 57.6% of the $DXY basket, but it's getting crushed against the yen, which comprises 13.6% of the $DXY basket.
Two things seem to be happening right now. First, the carry trades between dollar/euro and yen are starting to unwind, and second, the European Union may or may not be on the verge of splitting apart at the seams.
Economically, it makes no sense for weak hands like Italy and Spain to share a currency with Germany. The strong currency has been killing the export-based economies, and if the euro stays strong, the weaker nations aren't going to be able to service their national debt. They need a weak currency to survive, and there are only two options here. Europe is either going to have to keep their interest rates artificially low to torpedo the currency, or they are going to have to let the weaker economies out of the arrangement.
I've seen this argument presented twice. Once in a pdf file that I can't find anywhere, and I have no idea who wrote it. And again, in a book that I just finished reading: A Roadmap to Troubling Times, by GaveKal. (Doc, you recommended that book. Thanks.)
In light of the new information that the market is giving us, I propose that we: 1) buy yen and yuan 2) short the euro. By the way, why aren't there any bilateral exchange rates on Middle Eastern currencies? And what do we do about oil and gold? You were right Doc: it looks like demand destruction is getting the better of inflation here. But are we going to see outright deflation? I'm not so sure.
I still think that our expanding money supply is going to cause inflation in the end, regardless of what happens to demand. Take a look at a money supply chart. It seems to me that gold will continue to do well. First, because people will want to own gold and nothing else during the height of this panic, and second, because it's going to continue to go up in value as we continue to inflate our money supply. As for what to do about oil, I don't know. I lost that hypothetical bet long ago because I would have already been stopped out of any oil position. And I have no idea what to make of it in the future. My gut feeling is that it will come back. But when? And how far will it go before it bottoms out?
Hope everyone is holding up okay. Jorge, it's not a bad idea to step aside right now. In these conditions, you're winning if you're not losing. Even as a trader. It is difficult to see the market down 20% on the week and your P&L unchanged. But if you don't have a good hand, does it matter that the pot is so big?
With love,
dgov
Bill, that's a great point. If it's been a simple case of distressed selling that we've witnessed in the past couple of weeks, then we should expect to find serial correlation everywhere we look, and perhaps we shouldn't read too much into it. Maybe the treasuries will bounce back after the liquidating is done.
Hi Dgov,
Thank you for the poker analogy, it helps!
Regarding Middle Eastern currencies, it depends on which specific countries you refer to, but you will find that many of them are pegged to the dollar (there was some discussion in several countries about removing or softening the peg due to rampant inflation, but the Saudis said no way).
As to Treasuries being down due to unwinding of positions (thank you, Bill), I considered that (also for gold's decline), but even if some players may have been long everything, IMHO the amount of selling is too much to come from just them - but again, in this environment, who knows?
Best trading to all,
Jorge
What I'm seeing is that no asset class has been spared - commodities like gold, oil, silver, corn, wheat; bonds of almost all sorts; carry trades unwinding; no equity groups, either country or industry, holding strength.
That is exceptional. That's what reinforces my belief it is forced selling on a massive scale.
The headline events clearly dictate that $400 billion of cash had to be raised last week (Lehman CDS).
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