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Carry Trades Turn Down As Fed Anticipation Turns To “Sell The Event” Sentiment

Financial market report for October 11, 2010

World shares, ACWI, closed up 0.07% and the S&P, SPY, closed up 0.10%, as CNBC reports: “A strong market belief that the Fed will implement another round of asset purchases has been at the root of a rally that has seen the Standard & Poor's 500 gain nearly 4 percent since Sept. 24 and more than 11 percent since September 1, 2010. Sentiment indicators, often contrarian signs, show nearly half the market players are bulls, or holding the belief that stocks will rise in the near term. The American Association of Individual Investors survey is at a 49 percent bullish rate, the second-highest this year; Investors Intelligence, which samples newsletters, is near 46 percent, the highest since mid-May. A big event, like next month's Fed meeting at which it is expected to spell out its intent, could spark a sell-the-news reaction. The term refers to investors' desire to buy ahead of major events, such as earnings or key economic reports, then sell once the news hits and take profits incurred during the run-up.”.

The interest rate on the 2 year US Treasury Note, $UST2Y, fell lower; while the interest rate on the 30 Year US Treasury Bond, $TYX, appears on the verge of going higher; this makes sense as the Fed heavily influences the interest rate on the short duration debt, while the market is more influential on the longer out debt and senses that the Fed’s QE 2 will be quite destructive to the 30 Year Bonds and the Zeroes.

The 2 Year US Treasury Notes, SHY, the PIMCO Enhanced Short Maturity Strategy Fund, MINT, and the PIMCO 1-5 year TIPS, STPZ, higher; while the Zeroes, ZROZ, broke down and fell from support in a head and shoulders pattern.

In light of QE 2 being widely recognized, and viewing the high level of the Yen, FXY, at yesterday’s close at 120.54, currency trades backed away from taking the Euro, FXE, higher today, letting it fall to close at 138.20.

The EUR/JPY fell from yesterday's close of 114.2 to trade at 113.9.  The fall of the euro yen carry trade can be seen in the chart of FXE:FXY  

Similarly the Canadian Dollar - Japanese Yen carry trade, FXC:FXY, fell lower.

Likewise, the Swedish Krona - Japanese Yen carry trade, FXS:FXY, did as well.

The Australian Dollar - Japanese Yen carry trade, FXA:FXY, traded unchanged.

The US Dollar, $USD, turned up; as did its 200% ETF, UUP.

The rise of of the small cap pure value shares, RZV, relative to the small cap pure growth shares, RZG, ...  RZV:RZG ... suggests that currency appreciation has reached its full expansion, and that debt deflation is ready to commence once again continuing its action that began April 26, 2010 when the currency traders sold the Euro against the Yen, as the European sovereign debt crisis broke out.  

Debt deflation is the contraction and crisis that follows credit expansion.  One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion.  The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

A number of stocks continued higher on the “QE 2 cool aid”, notably Blackrock, BLK,  Macy’s, M,  Petsmart, PETM, and Tiffany and Co., TIF,  the gaming ETF, BJK, Las Vegas Sands, LVS, America Movil, AMX, International Business Machine, IBM, Semiconductors, SMH, Exxon Mobil, XOM, Chicago Bridge and Iron, CBI, Jos. A. Bank Clothiers, JOSB, Credicorp, BAP, Chipotle Mexican Grill, CMG, Five Star Quality Care, FVE, Chipotle Mexican Grill, CMG , and, Companhia de Bebidas das Americas, ABB.  

Yet others questioned if the end of an anticipation rally might be at  hand. These included Blackrock Dividend Achievers, BDV, Brazil Small Caps, BRF, Copper Mining, CU, BHP Billiton Ltd, BHP, India, INP, Liberty Media, LCAPA, National Health Investors, NHI, Brookfield Properties, BPO, Chinese Real Estate, HAO, Retail Holders, RTH,, STMP, WD-40, WDFC, and the Russell 2000, IWM, and its 200% peer, URTY.

The close in volatility, VXX, at 15.11, man be a spike down low, and the rise in inverse volatility, XXV, to 28.81,  may be a rally high, if currency deflation commences.   

Gold, GLD, closed 0.48% higher.

In today’s news:

Charles Hugh Smith in Business Insider relates Here's Why Quantitative Easing 2 Will Fail Spectacularly

Re-SanFrancisco Real Estate reports: “In the month of September of this year in District 5 (Noe, Glen Park, Haight, Eureka Valley, Corona Heights) 16 Single Family Homes sold with a median sold price of $1,395,000 in 45 days.  In September 2009 23 houses sold median price $1,137,000 in 45 days.  In September 2008 26 houses sold for a median price of $1.3 million in 24 days.  In 2007 15 houses sold for a median price of $1.2 million in 22 days.  It looks like days on the market have definitely increased, and although number of homes sold is lower the median price has gone up.”

EuroIntelligence reports King Albert II of Belgium has charged Bart de Waver, the chief of the seperatist NVA, to launch a new round of negotiations for a government by October 18, after the breakdown of talks last week. De Waver said that the negotiations for the last three months had been in vain, but he was ready to go back to square one, and start all over again. As Le Monde pointed out, the issues under discussion are the role of the French-speaking minorities in the outer suburbs of Brussels, the budget of the capital city, the distribution of power between the centre and the regions, and the future budget.

Miguel Fernández Ordóñez, Governor of the Bank of Spain, provideed Testimony before the Parliamentary Budget Committee in relation to the draft State Budget for 2011, Madrid, 5 October 2010, courtesy of Daily Bail, he states: “The biggest risk to general government meeting its targets stems from the potential deviations that may arise at the regional and local government level. As known and reiterated on many occasions, the high decentralisation of public spending in Spain means that the collaboration of the regional and local governments is essential for achieving budgetary stability. At the end of this year it will be possible to make a full assessment of the consolidation drive made by the regional budgets, but my impression is that, as matters stand today, the measures announced by most regional and local governments far from respond to the reduction in public spending needed. I therefore believe formulas must be sought to strengthen regional and local government commitment to budgetary stability and to encourage compliance. In this respect, we should not rule out a revision and strengthening of the national budgetary framework, in particular in the case of regional and local governments, a framework that resides essentially on the Budgetary Stability Law. Such action would be in line with the recommendations recently made by the European Council for all European countries in the framework of the review of governance in Europe.” .... Chart of Spain, EWP.
I relate that the Dodd Frank legislation established a Federal Financial Regulator, that being the Treasury Secretary, and granted him wide discretionary power of the economy. From the Robert Wenzel, EconomicPolicy Journal article Secret SEC Meeting with Goldman Sachs and JP Morgan, I conclude that in the US, through an October 6, 2010, meeting of bankers, investment bankers and SEC officials, that an elite group of stakeholders has arisen to act as a “banking, lending, credit, and investment Regulatory Council”, supporting the Financial Regulator in overseeing the US economy.I believe that the Dodd Frank legislation, empowers the Federal Financial Regulator, to intervene in the foreclosure moratorium issue; and that at some point in the future he will provide a solution that integrates the banks with the Government in state corporate governance over housing and mortgage securitization. Perhaps, Annaly Capital Management, NLY, may have a role to play, given that it has done so well in the Government debt field.   
Tyler Durden writes that Karl Denninger, was on the Dylan Ratigan show, and not only provided one of the most comprehensive explanations of where we are in the mortgage foreclosure imbroglio, how we got here, and where we are going to date; but said in his concluding remarks: “What if we find that of these $6 trillion in securities that are out there, outstanding right now, half or more of them are defective. You put them back on the banks and they all blow up. You know what – we have a resolution authority under Frank-Dodd, how about if we use it?”

Irvine Renter in article Politicians Encourage Strategic Default with Foreclosure Moratoria writes  about the lack of falling real estate prices and about the FASB 157 entitlement of banks to mark  property at the managers best estimate rather than at market, and about the millions living payment free in mortgaged property stating:

“The announcement by BofA -- who was strongly encouraged by numerous government officials -- to suspend all foreclosures strongly encourages strategic default. Why would anyone pay their mortgage when they know they can stop paying and keep their house?”  BAC

“Why don't borrowers steal away? Why don't they keep the house and ignore the mortgage. With news like this, I really don't understand Why Struggling Homeowners Keep Paying Their Mortgages; after all Squatting is Becoming a Way of Life for Many Delinquent Borrowers, and now, the bank is stopping all foreclosures. Given these circumstances, isn't strategic default the most prudent course of action?

Not everyone will strategically default. Many borrowers really can afford their payments, and they rightfully figure the foreclosure moratorium will end; however, the struggling masses who are considering accelerating their defaults have just been given the green light to bail because they know the bank isn't going to foreclose on them.

It looks as if the government is going to delay the recovery [of real estate sales] by keeping a huge overhang of shadow inventory despite the inevitably lawsuits.”

Freddie Mac, an entity under government conservatorship and run by the Treasury department, asked major commercial banks to stop foreclosing on delinquent borrowers. This is one of two things: (1) It is a purely political act of desperate Democratic incumbents (Harry Reid and others) to make themselves look good going into next month's elections, or (2) the GSEs want to ramp up their own foreclosures while prices are still elevated and they don't want competition from the major banks (Government Expedites Foreclosures, Threatens Banking Cartel). I lean more toward political causes, but the economic issue cannot be dismissed.

Do we need to give squatters any more breaks? For those of you waiting for these squatters to move out of your future home, how do you feel about this? You are paying a subsidy to the people living in your future home while you continue to work, pay bills, and rent.”

And Irvine Renter provides the Dan Fitzpatrick, Damian Paletta and Robin Sidel Wall Street Journal article BofA Halts Foreclosures which communicates the growing likelihood of years of legal lawsuits:

"Calls for a blanket national moratorium on all foreclosures are a bad idea and would cause significant harm to communities at risk, the unstable housing market and the fragile economy," the industry letter said. Suspending foreclosures could end up forcing banks, which act as service companies for the loans, to spend billions of dollars to compensate investors who own the pools of mortgages they manage. And it could add to the losses at Fannie Mae and Freddie Mac, the two government-owned mortgage financiers. Pension funds and other investors in the pools of mortgage securities are worried that the big banks will get special treatment from Washington. "What's happened is a gross mishandling of paperwork and often times a misrepresentation of the transaction," said Chris Katopis, a spokesman for the Association of Mortgage Investors. "The banks have to have some responsibility and accountability for this."

Shevy comments on the Irvine Renter article: “They are setting us up for another round of money to go from responsible Americans to the banks through more modificaiton money etc. What’s sad is it’s unlikely to help anyone but the banks. Of course, they will pretend it’s absolutley necessary and that they are helping those underwater, current homeowners, and that it’s in everyone’s interest not to allow the banks to lose money on these deals. In reality they are creating indentured servants and only helping the banks. The American public has to wake up and realize that the only people benefiting are banks.”

Renting In Newport comments:  “These are amazing times we are living in.  There are so many potential ramifications of what is happening now that it boggles the mind.  I will admit that I am not an expert at these things, so it’s possible that my thoughts here are way off base.  But…
1.  Current non-defaulted, non-short sale sellers will have to provide verification to the new buyer that the title of the home can legitimately be transferred over.
2.  Buyers can potentially be buying homes and making payments to entities without proper title documentation.  In other words, what happens to the money they’ve been paying if they’ve been paying it to the wrong entity?
3.  Foreclosed buyers whose homes have already been sold to others might be able to make a claim that the forecloser was illegal and attempt to retake ownership of the homes that others have already bought.
4.  Banks may have been foreclosing and reselling homes when in reality, they no longer own the title to the home.  The title belongs to someone else, and they are reaping the money off of a second sale when that money really needs to be going to whoever now owns the title.
It is this fourth point that makes me think that BofA’s freezing of foreclosures may be necessary.  If they no longer own the title, we do not want them foreclosing and reselling homes only to find out later that they didn’t have the right to do that.”  

Disclosure: I am invested in gold bullion