Good morning,

Yesterday’s action represented an opportunity to retest hypothesis No. 1: When the Fed injects liquidity, asset prices rise. When the Fed does not inject liquidity, asset prices fall. At 8:36am Bloomberg, was reporting Treasury Secretary T. Geithner saying TARP (Troubled Assets Relief Program) has enough funds for bank rescues. Later at 10:04am, Mr. Geithner indicated that most banks have more capital than needed. And at 11:00am, the Fed purchased $7bn of Treasuries (7 to 10 years)…Results are shown below (S&P500 in orange, 30-yr Treasury prices in white):

Treasuries sold-off. This is not surprising and is reflected by the Fed’s 25.4% participation in yesterday’s operation. The S&P500 ended at 850 pts (+2.1%), the VIX went back to 37.14 and the CDX IG12 index finished tighter, at 187.5/189bps. Deflationary market data, fundamentals, are irrelevant. Everybody knows it’s ugly out there. Pointing at all those bearish indicators will lead to meaningless conclusions. What matters is whether the Fed has the cheque book to pay for the party’s costs…or not.

Let’s now briefly review other events that I think are showing interesting trends in the make:

-Canada: The Bank of Canada (BOC) announced yesterday a reduction from 50bps to 25bps in its overnight rate. The market sold the CAD immediately (reaching 1.25 CAD/USD, settling back to 1.2360). The market views the BOC only taking a timid approach to monetary stimulus. If I had to guess why, I would say this opinion is based on the BOC announcing the extension of its Purchase-Resale Agreements from 1-3 months to 6-12 months (which means that liquidity in the market does not need to return back to the BOC anytime soon). I will take a stand here and say that what mattered yesterday was the sterilization transaction the BOC carried out before noon. At 11:00am, the BOC announced the purchase of C$750MM in private sector securities. At 11:42, the BOC announced that it lent C$226MM in Government bonds and Treasury bills. This, I believe (Readers’ feedback welcome) drove the CAD to the 1.2360 level by noon. Why is this relevant? It showed that in this world, there is one last strong central bank, with a balance sheet in shape to control its liabilities.

-Mexico: Last Friday, April 17th, the Bank of Mexico (Banxico) cut the overnight rate 75bps to 6.0%. Mexico’s consumer price index is at above 3.5% (down from 6.5% at the end of 2008). However….yesterday Banxico had to use $3.2BN of the USD swap line extended by the Fed. Although Mexico’s credit default swap has tightened significantly, from approx. 485bps in mid-March to approx. 305bps, I believe Mexico could be seeing the beginning of a run against the Peso, again. This is not good for emerging markets and emerging markets creditors. It is still too early to reach a conclusion. But those who focus their analysis on the health of the Mexican government’s finances are set to for a disappointment. It does not matter that Mexico’s public foreign debt is low. That is totally irrelevant. What matters is what can happen at the margin: How much worse can it get, if the government is faced with a spiraling situation, where they lower rates and reserves leave?