Please, click here to read this article in pdf format: november-13-2009

After the close of yesterday’s session, commentators attributed the drop in equities (S&P500 closed at 1087.24 or -1.03%) to the Crude Inventory Report. Indeed, it was after the release of the report at 10:30am, that the sell-off was triggered. However, if the move had to come from that corner, we should have seen a better bid for the Treasuries auction at 1pm. The Treasury auctioned $16BN in 30-yrs. The auction was a bit soft vs. others in the past months, and awarded at 4.469% or at 2bps higher.

Thus, yesterday, even though the session started with the jobs data release coming better than expected (Initial jobless claims at 502,000 vs. 510,000 expected and 512,000 prior week), the market had made up its mind. Would it take profits and seek refuge in Treasury Bay? Not in my view. The market only wanted to money. The market preferred the USD, in my view.

My interpretation is in disagreement with the consensus view. The consensus view is that yesterday, as the USD strengthened, commodities had to sell off, which weakened energy stocks, dragging everything else. To me that was the symptom. My question to you is: Why did the USD strengthen? The answer to this question will be the real explanation. I am including below a chart of the Dollar Index (DXY). As you can see, the trend upwards was very solid all day long. Weakness after the jobs data release was bought. Strength after the Crude Inventory Report was not sold.

I will try now to explain why, in my view, the USD strengthened:

Since October, the yield curve has steepened. The Fed has finished its $300BN Treasury Purchase Program and the market is wondering who’s going to finance the obscene 2010 deficit + refinancings, next year. Recent data shows that it may not be foreign institutional accounts. Furthermore, the Treasury has announced its intention to increase the average maturity of its debt. In summary, while the US government insists in keeping or even increasing the current stimulus programs, the Fed is honoring its word that although it will not raise rates, it will not accommodate fiscal budgets either. The financial situation at the municipal level has not improved and consumer weakness is still out there. This is enough to understand that a steeper yield curve is very feasible, hurting credit, stocks and Treasuries, and strengthening the USD, ceteris paribus.

May this mean that we are set for some range-bound trading? What will decide a future gap higher or lower in risky assets? On the fiscal side, the situation looks very solid in favor of stable deficits. Therefore, what is the missing piece here? I suggest it is the actions other central banks may take.