Please, click here to read this article in pdf format: august-23-2010

The air is rarefied as we start the week and Summer enters its final phase. Somehow, the overall macro picture looks like a piece of clockwork, where we can all see where things are heading to (i.e. after (a) the Fed’s decision to have the size of its balance sheet driven by the unemployment rate and (b) finding out on Thursday, after the 500k jobless claim, that the trend on such rate is positive). The other episode in world’s history that comes to our mind, where chaos was so pre-announced, was the start of World War I: Alliances had been established, scenarios were well known and all that was necessary was a catalyst.

-Everybody knows that the liquidity trap we are in cannot be with us much longer and that on the margin, any increase in yields (in the US or elsewhere) is going to do horrible damage.

-Everybody knows that the financial system in Europe is broken and surviving on liquidity lines from the European Central Bank, and that the recovery in the Eurozone, if any, is uneven, which will trigger a jurisdictional arbitrage in capital flows. This arbitrage is nothing else but the other face of that coin called European monetary union.

-Everybody knows that nationalizing the housing Agencies in the US is one more desperate step to avoid the inevitable double dip in the housing sector, which will revert back to the financial sector and finally, the US Treasury.

-Everybody knows that all the financial regulation proposed so far has done nothing (and can do nothing) to guarantee a reduction in systemic risk. The latest intention to make bank debt holders share the cost of banks’ undercapitalization is as absurd as the mere idea that systemic risk can be mitigated in a world of central banking.

-Everybody knows that the US dollars leaving to Emerging Markets are fuelling an unstoppable rise in commodity prices and wages that will soon haunt the developed world back.

And yes, there are a few more “knowns”. All we need is “the” catalyst, and we will see gold wake up and the Ponzi scheme of currency swaps, which was first devised by the Bank of England in the ‘20s and is now abused by the Fed, be put to the test. If it doesn’t resist, the Treasuries market will collapse and we will all look at the drama of 2007-08 with a bit of nostalgia.

But we first need that catalyst…Will it be a deceptive sovereign Euro auction? A surprising jobless claim print? An Emerging Market challenging the status quo by refusing payment in USDs or by shifting central bank reserves elsewhere? An important turn by a G-10 central bank, just like Weber’s comments on Thursday, which left the Euro breaking the $1.273 resistance?

In the meantime, tight stop losses in curve and relative value trades seem to be the safest way to play. Anything else is to tempt the vengeance of the trading gods.

Martin Sibileau