The tough love fix for the Greek economy, as recommended by the IMF and administered by the ECB, has, as many had warned, harmed their economy. Slower growth, reduced tax receipts, and failure to reduce the cost of the bloated public sector have all contributed to the current debt spiral. Greek politicians, desperately trying to get the next tranche of euro's from Frankfurt's coffers, dance to the dictates of the central bankers as they assure them all will work out.
This Pollyanna approach may have fooled ECB President JC Trichet, as he aggressively added to his central banks portfolio of less than investment grade debt. The total ECB balance sheet has grown by €143B as Trichet has vainly tried to prop up failing banks and countries.
Others are quite dubious of the anticipated outcome. Last week, the German Juergen Stark, a member of the six-member executive board, resigned. Personal reasons were given, but suspected disagreement with the bond purchasing program could be a possible reason.
Credit markets have been signaling for quite some time that the end is near. While none of this is new, how much is already priced in the market?
Last week's COT report of futures and options at the CME for the period ending September 6th revealed there was an increase in the open interest, 44K contracts. The EURUSD closed that day at 1.3996, breaking the 1.40 handle for the first time since July 7th. The bulls tried to turn the market the next day but there was more selling to come, as the rally failed.
The next leg down came swiftly, under the 1.35 handle yesterday. On this leg down, again, the OI surged higher, about 44K, as there was more selling. Part of this is the aftermath of the the option expiration Friday the 9th. Holders of in the money options are now confronted with a choice of cash or futures, and their decisions give us increased volatility.
The big build in the OI tells us the market is aware of pending bad news. Can this be another "buy the rumor and sell the news" caper? Note the spinning top on August 29, and the possibility of one being formed today. Is this a high and a low?
Later this month rumors will begin to fly about the secret weapons in Bernanke's monetary tool kit. "Operation Twist" may be one of them. In this procedure, the Fed would sell the front end of the yield curve and buy the back end. The 2 year, yielding .18 would go up and the 30 year, yielding 3.22% would come down, flattening the yield curve.
Operation Twist, with the help of some unused TARP funds, would then offer lower rates to existing mortgage holders who convert to shorter term loans. Refinancing these loans may serve to diminish delinquencies, saving the government and the banks money. Convert a trillion or so of these loans and you have a whole lot of people with lower mortgage rates and perhaps money left over for consumption.
There will be lots of winners and losers if we proceed with such a program. It should give the economy a boost as we take money from those who have saved and give it to the big spenders. In a fashion, it is another form of 'social justice' currently in vogue.
We must remain alert for what the Fed is concocting. My guess is that rumors will cause buying in equities and commodities, but I am baffled how this will play out with the USD.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.