Please, click here to read this article in pdf format: september-24-2009

Yesterday we had the announcement of the FOMC decision. Nobody was surprised, the target range for the federal funds rate was left where it was, and the extension in (and slowing down of) the mortgage-backed securities and agency-debt purchases to March 2010 had been expected. However, the intraday volatility was still there.
At 10:30am, the Dept. of Energy released crude oil inventory data. The consensus had been for a decrease of 1.4mm barrels. Instead, inventories grew by 2.9mm. This immediately triggered a sell off in crude and the typical flight-to-safety trade that appreciates the USD. Oil thus lost 3+ dollars, as it fell from $71.65 to $68.35.
The healing process in credit continues, with issuances coming to market in full fashion. Another positive sign yesterday was the weekly MBA Mortgage Applications index: +12.8%, from previous -8.6%. The refinancing wave keeps strong, but I still hold firm to my neutral stance on equities. It is neither bearish nor bullish. I am just neutral, with cash on the sidelines, waiting for things to crystallize before I make my next move.  As I wrote yesterday, the political action generates a volatility that makes me uncomfortable.

To make my point more graphic, I am including this morning a chart (see below left, source: Bloomberg) showing the reaction in the Treasuries (white line) market to the Fed’s decision of letting things the way they are. You would think continuity deserves indifference, but that was not the case. In fact, the S&P500 plunged at close, closing -1.01% at 1,060.87pts.

Naturally, I read the typical macro reports on what happened yesterday. I was surprised to see a huge divergence of opinions. Therefore, mine will contribute to the confusion. For instance, according to some analysts, volatility decreased. In my view, volatility ended higher, touching the swaps (see chart above, right, showing the last 10 days for the 2-yr swap and compare to what happened yesterday) and agency markets, as investors have to reinterpret the outlook with very limited information. The outlook is also seen from different angles. Some think that the fact that the programs are coming to an end signal that we are better off. To me (yes, I know, I am always a bit negative!), one can interpret the situation as follows: The fact that the Bank of England last week insinuated the probability of having lower bank deposits rates and yesterday the Fed announced the extension of its agency-debt purchase program until March 31, 2010 means that:

1. – It’s true, liquidity triggered a recovery, otherwise central banks would have already stopped injecting liquidity,

2. The recovery is still not self-sustainable, otherwise we would not be insinuating lower bank deposit rates or purchase program extensions. Another proof of that is the lack of details on an exit strategy. In fact, Bank of Canada Governor Mark Carney said last Tuesday that “…That growth that we are seeing is largely the result of policy: monetary policy, fiscal policy, the measures to stabilize the financial system….We have a ways to go before we are really going to see true growth, self- sustaining private sector growth.”. Thus, I rest my case! (A confesion de parte, relevo de prueba!)

This fragility, this weakness, led in my view to profit taking in the last hour yesterday. Now, to be fair, we should ask ourselves what is it that we would like to see, to convince ourselves that the recovery is in fact self sustainable. An exit strategy by central banks? No, in fact, I believe that it will only come after there is proof of such sustainability. What then? Capital expenditures! I will believe in this recovery the day I start seeing issuances in the bond markets not to refinance bank debt or other short-term debt, not to finance equity purchases, but to fund plain, old-fashioned capital expenditures.