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The Yield Curve Blasts Higher As Demand For The Ten Year Note Explodes Higher On A Continuing Euro Yen Carry Trade

I … Financial market report for August 6, 2010

The yield curve, $TYX:$TNX, has been steepening since early April, 2010, as concerns arose over the European Sovereign Debt Crisis and European investors took what is perceived to be safe haven investment in bonds, AGG, and in US Government Bonds, in particularly, the shorter duration US Ten Year Note, IEF.

The demand for the Ten Year Note over the 20 to 30 Year Bonds, has driven the interest rate down faster on the shorter duration Ten Year Note, than on its longer term peer. Thus the yield curve, $TYX:$TNX, has been rising.

With today’s explosive demand for the Ten Year Note, IEF, and only a limited demand for the 20 to 30 Year Bond, TLT, the yield curve, $TYX:$TNX, blasted higher; click on graph to enlarge.   

Chart shows the Ten Year Note, IEF, took off like a rocket from a launch pad; click on chart of IEF to enlarge.

Chart of IEF Weekly shows a rise since the Euro started to rise May 10, 2010 when the EFSF monetary authority was announced and the Euro rose in value. The rise in the US Government Note, IEF, like all debt is simply a flight to safety, underwritten by yen carry trade investing. When the Euro, FXE, falls, then all carry trades will fall, and bonds will tumble.   

The US Government Bonds, TLT, rose hitting resistance.

Government bonds, LQD, rocketed higher too. The monthly chart of LQD suggests that business credit could instantaneously be cut off as happened in mid 2008. 

Emerging market bonds, EMB, rose strongly. The monthly chart of emerging market bonds, EMB, suggests that funding for emerging market countries could disappear instantaneously.

Aggregate bonds, AGG, rose to a new high at 107.63

The euro yen carry trade, that is the EUR/JPY, jumped from an opening value 112.77, as the Euro FXE, gapped open higher value of 131.46. The Yen, FXY, gapped open higher from a value of 115.37: this was the driving force in sending the bonds mentioned above higher, as stocks, VT, sold off on the report that private employers added new workers at a weak pace for the third straight month, making it more likely economic growth will slow in the coming months, and as payrolls shrink by 131,000 and the unemployment remains at 9.5%, reports Christopher S. Rugaber of the Assoicated Press. The EURJPY closed at 113 .39

Today’s chart of FXE–FXY shows a gap open higher in the Yen; which was overcome during the day by those long the Euro, even though stocks were off sharply in the morning. The stocks recovered as the Euro rose and overcame the Yen. A high yen is the anti-thesis of investing long the markets.   

One can view the euro yen carry trade on, FXE:FXY, and one can use Yahoo Finance chart of the EUR/JPY too.

The chart of Monetary Inflation Index looks very similar to the Yahoo Finance chart of the euro yen carry trade, which leads me to believe that the dramatic rise in bonds between June 10, 2010 and August 6, 2010, is due to the rise of the Euro, specifically fed by yen carry trade investing.  

The Russell 2000, experiencing the greatest loss of value of US Stocks.

Kudos to McDonalds as it rose to an all time high of 71.74 manifesting a lollipop hanging man candlestick in its monthly and weekly charts. 

Europe, FEZ, fell, rejecting the euro yen stimulus, as did the European Financials, EUFN.

Asian, DNH, fell less than Europe.

In Europe, only the resource well endowed Nordic countries, GXF, were stimulated by the rising Euro; GXF closed 1.6% higher on the Euro, FXE, 0.6% rise.  

The Swiss Franc, FXF, rose more than the Euro, FXE, helping the Swiss shares, EWL, close 0.3% higher. 

Japan, EWJ, rose and the Japan Small Companies, JSC, rose to resistance.

Corey Rosenbloom reports in chart article that the S&P, $SPX, at 1,121, is at the apex of a broadening top pattern  at the 50% Fibonacci – or ‘halfway’ point for the absolute high and low trading range for the year with price peaked on April 26th at 1,119.80 and bottom on July 1st at 1,010.91.  

The fall of world stocks, VT, lower today, confirms an August 2, 2010 high of 43.55 as pivot point and stock rally high: stock deflation commenced August 2, 2010.

The fall of major currencies, DBV, lower today confirms an August 4, 2010 high of  23.37 as pivot point and rally high: currency deflation in the major currencies commenced August 4, 2010.

The rise of aggregate bonds, AGG, coming from demand for shorter duration US Treasuries, IEF, and corporate bonds, LQD, and emerging market bonds, EMB, makes a new high in aggregate bonds, AGG, today August 6, 2010 at 107.63.

This comes as emerging market currencies, CEW, rose to a new high today August 6, 2010 at 22.21.   

The Chart of Debt  from April 1, 2010 to August 6, 2010 shows that investors have steadily sought a safe haven from stocks by investing in bonds since April 1, 2010, much as others sought a safe haven by investing in gold.

The Chart of emerging market currencies, CEW, together with other currencies, FXE, XRU, BNZ, BZF, SCR, FXA, and Aggregate Bonds, AGG, shows that bonds have been underwritten by a tide of carry trade investing. 

II … Gold, GLD, broke out of a consolidation triangle, and rose 0.7%, as Base Metals, DBB,  moved 1.2% higher.

Commodities, DBC, fell to 200 day support, with Oil, USO, falling 1.4% lower. Natural Gas, UNG, fell 2.5% lower. Agriculture Commodities, DBA, fell 1.7%. Silver, SLV, rose 0.6% higher. Gold mining shares, GDX, rose 1.% to close at 50.17; slightly above their pivot point of 49.99. I believe that as stocks fall lower, gold mining shares will be progressively be pulled lower from 49.99.

Dian L. Chu writes an insightful article SeekingAlpha article Crude Outlook: U.S. Distillate Demand Falling Off a Cliff. I added UCO, which is the ProShares Ultra DJ-AIG Crude Oil ETF; it traded last at 10.74; as it’s price falls, short sellers will be rewarded

III … This week, the continuing euro yen carry trade, sustained other major currency trades and depressed the US Dollar

US Dollar, 1.4%  … Norwegian krone, 2.2% … Swedish krona, 1.8% … South Korean won, 1.8%  … Danish krone, 1.8% … Euro, 1.8%, … British pound sterling, 1.7%, … Australian dollar, 1.5%, … New Zealand dollar, 1.0% … South African Rand, 1.0% …. Russian Ruble, 0.7% … Swiss Franc,  0.8% … Japanese yen 1.2%   … Google Finance weekly chart for FXE, FXA, FXM, FXC, ICN, FXB, FXS, SZR, FXF, CYB, BZF, XRU, and BNZ.  Finviz Screener of the same.

IV …  Analysts provide comment on this week’s financial activity

Tyler Durden of ZeroHedge reports Euro Libor Jumps To One Year High, As Euribor Hits Fresh 2010 High: The most important story nobody talks about continues developing, with both Euro Libor and Euribor (3 Month) jumping to year highs. The much more popular funding rate, Euribor, just hit 0.905%, compared to 0.904% yesterday as tightness across the banking sector continues, on expectations that the ECB may cease providing constant backstops to everyone (1 week Euribor was 0.569%, 1 month: 0.649%). With the European policy rate at 1.0% the collapsing bank lending market may soon pressure banks to go exclusively to the ECB for overnight lending, in addition to all their other funding needs. And to think all this was supposed to be avoided with “successful” completion of the stess farce. And while Euribor has been on a non-stop tear higher, EUR Libor had recently dropped marginally. Well, no more. Market News reports, “The euro 3-month LIBOR rate was up 0.369 basis points on the day to stand at 0.8348%, edging nearer to the official 1% policy rate and at its highest level for almost a year. At the monthly press conference Thursday, European Central Bank head Jean Claude Trichet talked about normalisation of EONIA rates, and raised no concern about euro market rates moving higher. The euro LIBOR/OIS 3-month spread was almost 0.37 basis points wider on the day.”

Company Bond Risk Heads for 3rd Weekly Drop on Europe Optimism. Indexes measuring the cost of insuring against losses on European corporate bonds headed for a third week of declines as optimism the region’s economic recovery is accelerating fueled demand for risky assets. The Markit iTraxx Crossover Index of credit-default swaps linked to 50 companies with mostly high-yield credit ratings decreased 3 basis points to 468, according to JPMorgan Chase & Co. at 2:30 p.m. in London. The Markit iTraxx Financial Index linked to the senior debt of 25 banks and insurers rose 1 basis point to 116.5, little changed in the week and near a 3 1/2-month low, JPMorgan prices show.

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings was little changed at 102.25 basis points, and was 2.75 lower than a week ago, JPMorgan prices show. The Markit CDX North America Index rose 1.72 basis points to 145.3, Markit Group Ltd. prices show.

Bernanke: Many Ways to Replace Fannie, Freddie. It should be possible to create a U.S. housing finance system without the need for potentially risky entities like government-sponsored mortgage finance agencies Fannie Mae and Freddie Mac, Federal Reserve Chairman Ben Bernanke said. Bernanke, in a letter to Representative Marcy Kaptur that was released on Friday, said the housing finance system should ensure successful funding of mortgages and support a secondary mortgage market even during times of financial stress without creating firms that pose systemic risk. “There are a variety of organizational forms that might replace Fannie Mae and Freddie Mac that could likely provide mortgage credit without the systemic risks associated with these institutions in the past,” he said in the letter.

The Federal Debt Freight Train Is Coming at Mr. Market, Minyanville (David Stockman)

China Plans to Boost Existing Ties With Iran. (Chinese)

The average home price in China’s southern province of Hainan has fallen -42.9% to 8,000 yuan per square meter from 14,000 yuan, citing Cai Renjie, director of the provincial housing department. (Xinhua)

“Expedia… and International Business Machines… sold bonds with coupons at historic lows this week… Debt sales reached $35.9 billion this the week, the most since March 26.” August 6 – Bloomberg (Katie Evans)

“U.S. corporate bond sales in August may reach $100 billion, the most on record for the month, as companies benefit from falling borrowing costs and seek to raise debt before financial firms come to market in September, according to Aladdin Capital LLC.” Bloomberg (Tim Catts)

“Junk bonds are closing in on par for the second time this year as fixed-income investors bet recent signs of economic weakness won’t be enough to derail corporate profits and the ability of the neediest borrowers to repay debt.  High-yield bonds rose to 98.99 cents on the dollar yesterday after falling as low as 94.47 cents on May 25.  Investors are pouring money into bond funds at the fastest pace in 15 months.” Bloomberg (John Detrixhe)

“Relative yields on Europe’s junk bonds are poised to fall below their U.S. counterparts for the first time since June 2008 as concern the sovereign deficit crisis will derail the region’s economic recovery recedes.” Bloomberg (Bryan Keogh and Kate Haywood):

“The Federal Reserve Bank of New York may seek to require banks to buy back its holdings of faulty mortgages and other assets acquired through the rescues of Bear Stearns Cos. and American International Group…, a spokesman said.  ‘We are involved in multiple efforts related to exercising our rights as investors in non-agency RMBS or CDO securities,’ New York Fed spokesman Jack Gutt wrote…referring to residential mortgage-backed securities and collateralized debt obligations.  Steps include ‘those that require originators to repurchase ineligible loans,’ Gutt wrote… ‘These efforts support our primary goal of maximizing the value of these portfolios on behalf of the American taxpayer.’” Bloomberg (Dawn Kopecki and Jody Shenn)

“They are the elite among the elite at Goldman Sachs, high fliers who are the envy of Wall Street. But on Washington’s orders, Goldman is now considering a step that once would have been unthinkable: disbanding the corps of market wizards at the heart of its lucrative trading operation. Under the new Dodd-Frank financial regulation, Goldman must break up its principal strategies group, the wildly successful trading unit that has helped power the bank’s profits. Goldman is considering several options, including moving the traders to another division or shutting the unit altogether, according to people briefed on the matter. Across Wall Street, other financial giants are also embarking on the delicate task of complying with the new rules governing their trading and investments. New York Times (Graham Bowley and Eric Dash). 

V … Weekly and monthly bond analysis 

“For all the good the Federal Reserve’s $1.25 trillion of mortgage-bond purchases have done, they’ve also left part of the market broken.  By acquiring about a quarter of home-loan bonds with government-backed guarantees to bolster housing prices and the U.S. economy, the Fed helped make some securities so hard to find that Wall Street has been unable to complete an unprecedented amount of trades. Failures to deliver or receive mortgage debt totaled $1.34 trillion in the week ended July 21, compared with a weekly average of $150 billion in the five years through 2009.” Bloomberg (Caroline Salas and Jody Shenn) Chart of distressed securities mutual fund FAGIX, and IEF, LQD, JNK, MUB, EMB

IEF Daily has increased from 87 to 98.6 since April 1, 2010, when concern arose over European sovereign debt and gold broke out; the chart shows an ascending wedge with four cup and handle breakouts and a last trade on August 6, 2010 with a lollipop hanging man candlestick, a bearish signal.      

IEF Weekly has increased weekly for 16 weeks out of the middle of a broadening top pattern rising from 88 to 98.6, suggesting a fall can come any time. 

IEF Monthly has risen from 60 in 2002 to 98.6 on an ascending wedge manifesting three with soldiers during May, June and July, a reversal pattern suggesting that a top is in.

LQD Daily shows a strong rise from 103 to 110.4 which began on April 1, 2010 as investors sought a safe haven investment as concern arose over European sovereign debt. It was also in early April, 2010, that gold broke out. A review of the monthly chart of corporate bonds shows that the rise in corporate bonds began in 2003 with the Milton Friedman inspired policies of the czar of credit liquidity Alan Greenspan. The LQD monthly chart shows three white soldiers at the top of an ascending wedge on falling bottom. All I can say, is “lookout below”.

JNK Monthly shows a double top

MUB Daily shows a close at 105.3 in the middle of a triangular broadening top consolidation pattern.

EMB Monthly shows a rise from 100 on March 1, 2010 to 109.4 on August 6, 2010; this as emerging currencies, CEW Weekly, has risen to the middle of a broadening top pattern; and major currencies, DBV Weekly, has arisen to one as well.

The September and October 2008 fall in 10% in LQD and 30% in EMB shows the risk of a rapid fall in bond values. 

The rise in BND Weekly comes from a global carry trade investment in both emerging currencies, CEW,  and major currencies, DBV, which began June 10, 2010 when the EFSF monetary authority was announced. An unwinding of the euro yen carry trade, that is the EUR/JPY will cause a sharp sell off in bonds like that which occurred in September and October 2008. 

The Euro, FXE Monthly, shows a rise in the middle of a broadening top pattern to 132.45; next resistance levels are at 133 and 134.  

VI … Investment strategy for bear market investing

Personally I am invested in gold coins, it was a buy and hold decision made long ago.

I provide a list of 20 ETFs to sell short for a debt deflationary bear market.  The ETFs falling the most today, August 6, 2010 were:

BIB -1.8%, 200% Nasdaq Biotechnologies

LTL -1.7%, 200% Telecom

UBR -1.8% 200% Brazil

and UYG -1.2%, 200% Financials 

The ETFs rising the most were

URR, +2.5%, 200% the Euro

UBT +2.1%, 200% US Treasuries 

The gold ETF, GLD, broke out,  rising +0.7%, to close at 117.8 which is far above support levels at 116, 114, and 112.

Jesse in chart article covers the August 6, 2010 breakout in gold, $GOLD.

VII … How much higher will the Euro rise?

An inquiring mind asks why did the Euro, FXE, rise 0.75% on August 6, 2010, now that the European bank stress test is over, and now that Mr. Trichet gave a news conference yesterday August 5, 2010, with much self-congratulation that the ECB’s policies have been successful in restraining inflation.

Perhaps the higher Euro comes from credit tightness in the European banking system. Perhaps liquidity is evaporating, creating demand for Euro funding of Libor contracts. Perhaps the Euro moved higher as a competitive response to a higher Yen.

Edward Hugh in SeekingAlpha provides these facts and analysis: “We also have the recent surge in 3 month Euribor rates, which rose above the 0.9% threshold for the first time in over a year on Thursday. Twelve month Euribor is also on the rise, and stood at 1.373% in June, up from 1.281% in May. Still it remained 0.039% below the level of June 2009, but the rise seems relentless, and this is not without significance, since it is the benchmark from which over 85% of Spanish mortgages are set.”

“Are these movements, as some claim evidence that the market is finally functioning, and that demands for loans are on the rise? Or do they, as others claim, reflect continuing nervousness about the decisions the ECB will eventually take in connection with its short term liquidity provision to banks? Remember, borrowing by Spanish banks from the ECB shot up in June, and September will see the final bout of three-month tenders, which were introduced by the ECB in June to ease the pressure on Europe’s banks given the tensions in the interbank market. Seeing whether the level of dependency of Spain’s banks on the ECB can be substantially reduced will offer us one measure of the degree of success of the confidence raising exercise which lay behind the stress tests.”

“There can be no doubt about the consequence of this inching upwards in rates, the interest rate differential with the US Federal Reserve continues to rise, and with it the parity of the euro, which is now being valued at over 130 to the dollar, following hitting a low of 119 back in May.”

“At this point in time the differences in posture between the ECB and the Federal Reserve remain marked, and while the European bank left its main rate unchanged at the record low of 1 per cent for the 15th consecutive month, its President continued to emphasise the process of policy normalisation, resisting all questions which invited him to speculate about future decisions either on interest rates or on liquidity provision. The difference in tone with a US central bank manifestly concerned with perceived weaknesses in the recovery and the deflation danger could not be greater at this point.”

“Yet, as M Trichet acknowledged, while some of the worst of the financial crisis has now abated it is definitely far too soon to “cry victory” in the battle against Europe’s sovereign debt woes, and the second half of 2010 may well not be anything like as positive as the first half has been in terms of the real economy. Still, as Europe’s citizens lie outstretched on their beaches of preference, or search for the cooler climes of those mountain peaks, maybe it would be better for them to contemplate the recent performance of some of the continent’s key football teams, and leave the dreary task of preparing for their autumn “belt tightening” until their return to the fray in September. As I say at the start of this post, Jean Claude Trichet, for his part, informed us that after the meeting he was headed straight for Saint-Malo, and I wish him a very restful “time-out” there, recovering all that energy that he is most certainly going to need for the difficult decisions he will have to take in the months to come.”

VIII … When the Euro is sold, the Libor will rise quickly sending interest rates higher in all debt instruments globally. 

As the Euro is sold, the spigot of investment liquidity will be turned off. Lending liquidity will quickly disappear, credit will evaporate, bonds of every type will fall in price. A rising Euro since June 10, 2010, when the EFSF debt agency was announce has stimulated one of the most awesome waves of carry trade investments in emerging currencies, CEW, that has ever occurred, with emerging marke bonds, EMB, rising dramatically, and latin america countries like Brazil, EWZ, rising dramatically too.  As the Euro sells, this will introduce a wave of carry trade disinvestment, and CEW, EMB and especially EWZ will fall awesomely.

When the debt bubble bursts, the world will see “the end of credit” as it has traditionally been known, where credit comes from the seigniorage of sovereign nations issuing sovereign debt and financial institutions securitizing bonds, as well as currency traders bidding one currency higher against a low yielding currency. 

There will be no QE 2, there are no financial reserves left, the were all used in TARP and other Facilities. There many be monetization of debt by the US Federal Reserve.

Out of chaos, national leaders and finance ministers will waive national sovereignty and announce framework agreements which establish regional economic governance where ”credit bosses”, act as seigniors in public private partnerships, that is combines of business and government, to provide credit, which will be issued for the security needs of the homeland regions.        

In Europe, I see a new role for the President of the ECB.  I envision that in response to severe credit contraction and banking ill-liquidity, that he will be Credit Seignior, as he accepts sovereign and other debt and issues credit to Eurozone member banks thereby keeping some degree of money liquidity flowing.

Government leaders will become seignior, they will exercise seigniorage and become the first, last and only provider of credit. Then only food stamps and strategic needs will be financed.

A sell off of the Euro will stimulate a sell off of banking burdened Spain, EWP, Italy, EWI, and carry trade leveraged Austria, EWO, as well as the European Financials, EUFN, which in turn will stimulate a sell off of Financials, XLF, and the credit dependent Russell 2000, IWM. By looking at the chart of the European Financials, EUFN, I expect their fall to be substantially faster than the financials, XLF.

This tragedy will come shortly, and will be in advance of the September season when banks seek to roll over their debt and recapitalize.

Also because of the Dodd Frank Financial Regulations, investment bankers may be spinning off their trading divisions exasperating financial instability. And the shadow Landesbanken financialization system may not come through with its traditional financialization.

Today, August 7, 2010, the Yen, FXY, rose 0.51% and the Euro, FXE, rose 0.78%. A look at the daily chart of the Yen, shows the Yen gapped open higher than the Euro, but fell giving way to a higher Euro.  The net result was that the EUR/JPY rose from 113.1450 to 113.39. Today’s rise and stability in EURJPY maintained ”investment liquidity on”, bringing stocks back off from an early morning sell off that commenced due to the end of the bank stress rally in the European Financials and regular meeting of the ECB and reassuring news conference by the ECB chairman that inflation has been contained.    

Yet could it be that a European credit market seizure and liquidity crisis are being masked by melt-up in the Euro?.

How much longer a rise in the Euro can continue given that latin america and european stocks are oversold and want to sell off, is anyone’s guess.   In summary, the sell off will be spectacular in these ten ETFs, European Financials, EUFN, Spain, EWP, Austria, EWO, the US Zero Treasuries, ZROZ, the Russell 2000 value shares, IWO, Brazil, EWZ; and the 200% ETFs, Euro, ULE, US Treasury, UBT, Brazil, UBR, Russell 2000 Value, UVT …. chart of  EUFN, EWP, EWO, ZROZ, IWO, EWZ …. chart of ULE, UBT, UBR, UVT 

One can invest long with these six bear market ETFs: The 300% inverse US Treasuries ETF, TMV,  the 200% inverse Euro, EUO, Brazil, BZQ, Russell 2000 Value, SJH, EUO, BZQ, SJH, double long gold, DGP, and Volatility, VXX. Ultrashort Japan, EWV, and Ultrashort Biotechnology, BIS, will provide good results also, but not as good as the others. 

When the Euro eventually turns down, then gold will emerge as the sovereign global currency. 

Disclosure: I am invested in gold coins