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I wanted to inject a word of caution regarding the reverse repo market. Almost everyone has said that it is necessary for short term interest rates to rise once the Fed gets rid of Treasury bonds on their books by the method of the reverse repo market. I always get nervous when people say that this reverse repo selling by the Fed, in addition to the massive Treasury bond sales, will set up a slam dunk trade. That slam dunk is to short the Treasury bond market. Prices will go down as yields go up.

But what happens if this bond guy, Bernanke, decides to scare the sheeple into bonds? What happens if, in order to pull this repo trade off, Bernanke takes liquidity from stocks and people plough into the bond market for safety? These guys betting on higher interest rates will get stuffed!

And it appears that Bernanke can reverse repo and repo later, and I wonder what sort of manipulation that will impose upon both the bond and the stock markets? Cantor Fitzgerald trader George Goncalves stated that, “The Fed also happens to be exiting the Treasury market at a good time.”

Goncalves added:

Other markets, such as equities, which performed well due to the expansion of the Fed’s balance sheet are retreating and that will provide a backstop for the Treasury market.

While that statement was made in October these things move slowly. Uncle Ben's goal is

  1. low Treasury rates; and
  2. getting Treasuries sold

So, in order to meet these two goals, he will have to, and I repeat, have to crash the stock market.

Maybe he will have to crash the stock market multiple times, and the stubborn optimists may have to be crushed. The Cramer types may spin positive while Doug Cass shorts the world. If you are familiar with Cass's predictions for 2010, you are seeing that he sees a very strong dollar, good corporate profits but a market shock due to fears of a double dip, and the falling of Treasury yields.

Notice that all these predictions are exactly in line with what Ben Bernanke wants, i.e. low yields and massive purchases of Treasury bonds. Something to think about if you are on the other side of that trade! While this scenario may not come to pass, it could cause a lot of grief for the gold bugs, inflation bugs and all similar buggy investors.

Disclosure: no positions

Source: Getting Nervous About Reverse Repos