Gary Tanashian's  Instablog

The story goes that our friends on Wall Street wink winked and nudge nudged with Alan Greenspan to cook up a massive bubble in credit and derived vehicles that eventually became malignant and spread toxic finance throughout the world. That is not a pretty picture.

Fast forward to summer, 2012 and we find Wall Street strategists wildly bullish on T bonds (in opposition to the Federal Reserve's desire to buy them) and seemingly standing in way of the great and powerful Fed's Twist operation. Are the Wall Street banks doing the public a service by showing the way to safety or are they simply holding up T bonds for the ransom of even higher prices than those denoted by today's record low interest rates?

Here is a picture of Wall Street strategists' alignment courtesy of Sentimentrader.com.

While I would love for us all to sing Kumbaya and integrate Wall Street's needs with those of Main Street, it appears that the boys and girls on 'the street' are simply holding up a buyer that has made the purchase of these bonds the central theme of its monetary policy; a buyer that has to buy.

The current Fed operation is to buy long dated maturities, keeping rates low for critical areas of the economy while funding these buys by selling shorter dated maturities to 'sanitize' the operation, i.e. to keep it from increasing the money supply. In other words, selling short term bonds allows the Fed to avoid printing new money into existence to fund its long term bond buying operation.

In this context the stance of the Wall Street dealers makes sense. They are holding an (in my opinion, over valued) asset that a big buyer states to be critical to its strategy, whether by Operation Twist or any coming QE operation in which the Fed wishes to make its inflationary intents widely known to 'promote' inflationary asset price appreciation. They hold this asset dear, with the buyer backed into a corner.

The timing of a 'QE' style inflation is unknown and complicated by the degree to which the public came to call for the Fed's head (so to speak) during the last inflationary cycle that ended a little over a year ago with T bond yields right at the boiling point (red arrow by our long term 30 year yield chart AKA the 'Continuum'):

As you can see, things are very different now, with bond dealers pushing another limit. In spring of 2011 bond king Bill Gross was short the long bond. Today big dealers are pressing longs. If this is a real deflation, look for the yield to drop to the unthinkable green dotted lower channel line. If it is a prelude to a coming inflation operation, expect the horizontal green support line to hold.

In recent newsletters we have been noting several anomalies and conflicting signals that can jam the radar of mere mortals (like this writer). Hence, the only sensible stance is to take what the market gives us and keep risk management in the forefront. July is seen as being a 'chop' month, after a healthy rally from the May bottom. The rally is intact with a series of higher highs and higher lows, but I would like to see some of the anomalies clear before pressing the bull case.

One of those anomalies is the amazing configuration currently in play in T bonds. Subscribe to the free (and spam free) eLetter, which highlights indicators going on beneath the market's surface like the T bond drama as well as standard TA and market commentary.

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