Please, click here to read this article in pdf format: august-17-2009

I thought it would be worthwhile to start the week describing how the last one ended. Today’s letter will be merely descriptive (vs. the typical analytical format) and full of charts, but I think that sometimes, there is value in induction.

With positive news out of Europe early Friday, it seemed it was going to be a good day across the Atlantic. The surprise came when, suddenly, the 30-yr Treasury rallied in early trading. With this rally, the yield curve was going to have an interesting flattening move by the end of the week (see charts below). However, early in the morning the USD was not appreciating, but the EUR/JPY was falling. Why would the USD not rally as well? Someone suggested it was a signal that the USD was becoming “the” carry currency, in line with what had happened to Japan. But if that was the case, we should have seen risk being bid (equities rising overseas, credit tightening), and that did not happen. In the meantime, crude (at around 8am ET) was holding its weight. One could still hope…until it just plunged. Obviously, volatility increased. Where is the inconsistency? As you can see, the 3-mo Libor-OIS spread kept making lower lows (did that liquidity end up in Treasuries?), while sovereign credit default swaps remain extremely cheap. Can this reversal lead us back to March/09 levels, if bad macro news keep coming and the Fed is really not going to monetize any more fiscal debt? I think this is only half of the problem. I think the other half is that the global coordination we saw in 2008 is loosing strength in 2009. The Bank of England led the way with its decision to increase its quantitative easing program. Others should follow, but are in denial mode. We should not ignore the VIX index, which is telling us correlation (systemic risk) is still alive.
(Source: Bloomberg)