Inflate or Deflate

Fed raised the discount rate a quarter point and has begun what will be a pattern of rate increases to extend over the next several years. The dollar will benefit with this change in policy direction although the initial impact of the current move is primarily a psychological one. The curve between the 2 and 10 year, at a record yesterday, was not necessarily the issue for the Fed since it was responding to the structural elimination of some liquidity guarantees for banks which have already been closed down. The steepening yield curve move reflects a natural reaction to an almost organic insisting, that over time, inflation will be a problem. There is almost no other way the curve to go, it is reasoned, but as we know that does it make it a sure thing.

So many of the old trade tendencies may be tested as we deal with systemic complications created by the most recent collapse. Easy money during boom times historically leads to inflation. Easy money in an economic collapse limits but does not eliminate deflation. What is left is a trading industry trying to catch the next move, and since the last big war was against inflation, traders just cannot put there arms around a deflationary strategy. Not after all that stimulus. But if the velocity of money in the system is limited to providing liquidity to financial institutions and not to finance economic expansion through broad public use, jobs and asset growth will be limited. Inflation trades will implode.

Data Please

Barclays showed what asset sales and transaction revenue, (they call it proprietary trading), can do to in an environment where expectations are so low, down is up. They are quick to fire up the strategies which will go directly to the bottom line, and of coarse, selling things will always work. The trading side however is one where the game clock is running. Being able to continue to capture the latency factor on order and price data where opportunities exist in part by bank/brokerages own customers willingness to be hosed by the firm's proprietary trading desk.

"A technology arms race is under way in the equities and derivatives trading markets as traders – especially high-frequency traders – seek to get trades done as fast as possible. Colocation has emerged as a popular way to do this, with exchanges offering colocation and specialist data centre operators ......" Full Article

We must be near a top of sorts in this arms race since it is all one reads about. But this race is not new however and the chase to the data drough ramped up big time as far back as 2003. What is different now is reliance on it as a front running tool for brokerage/banks to generate transaction fees. As to whether it increases volatility is not quite clear. Last year the markets rallied continually in an orderly fashion with all the high frequency trading necessary to execute underlying demand and price change.

What is more important to volatility is the anticipation of higher prices and the eagerness to participate in the pursuit of what is perceived as real profitable opportunities. For 2010, you need, if possible, a clearer picture of the overall direction, which is somewhat cloudy considering the current price action of financial stocks. If it is the real deal, they will lead.

Gold Southbound

The current rationale to buy gold continues to be fueled in large part by an investment cycle where notions of value become intertwined with a macro view of trends. Gold unfortunately shares the bubble characteristics made possible by the enabling of an investment super highway funnelling dollars from the greater population into dubious upside expectations. While there is no doubt certain world events could raise the price of gold, most of them have not been thought of and the most feared would probably be a selling opportunity.

Gold's attractiveness as an alternative safe haven for economic preservation has some major problems. If it is merely a substitute for dollars, then a substantial rise in the value of the dollar, which I believe is underway, will be craps for the shiny stuff. But if it is more than a substitute for US currency and rather is a fundamental demand/scarcity play, good luck. Those notions have been played and there is not a commodity market on earth which, from its all time highs, has not suffered a retracement of at least 50%. The declines retrace a winding road and run over all those convinced of its investment power. Gold has started down that road.

Bernanke/CMEGroup/Debt

Bernanke clearly wants to get going on raising the discount rate to bring about the' beginning of the end' for intervention. Stimulus will remain but the controlling aspects of a hike will be the first time in a while the Fed can say it is leading and not reacting. Rates will rise ever so slowly even in the face of a sluggish economy.

CMEGroup worked out a deal with News Corp for the Dow Jones Index as a move to gain control of an important piece of trading content. Other than reducing license costs, controlling the underlying product is a strategic move to drive and protect the index and its derivatives from any and all competitors. All exchanges fear substitute possibilities, never knowing what may replace any of the current high volume derivatives in the future.

Sovereign debt will be a news game for the year with little chance of any real default but certainly enough bumbling among governments to make trading interesting.

Numbers

The unemployment rate fell to 9.7% but the announcement left confusion since January is the month to do the reset for many of the data components. Regardless, once the number came out the Bears had much of their day's anticipated thunder removed despite an intraday decline of about 150 in the DJIA.

Sovereign debt issue during the week was part of the debt is bad mantra with many concerned ultimately about the U.S. and Britain. The result will be zero rates to avoid defaults, modest economic gains for a long time, and eventual commodity melt downs as the big bets on inflation and China fizzle.

Financial reform has become a joke as there seems to be a Washington thing for big money. What a shock. Since the country seems about evenly divided on party loyalty, there is no one to sway. The Tea Party folks are simply the same end of the universe aliens who have been walking in the desert since Goldwater. They are convinced their meetings will make a difference. Better chance of a large volcano erupting in central Illinois.

Markets will continue volatile trade between false hope and over stated disasters, so the numbers will fly around, but here are a few numbers that do not matter;

1. The DJIA 10,000
2 Any 200 day moving average
3. Any appraised value of any home in the last 5 years.
4. Any economic data produced by the Chinese government.
5. The number of times anyone says 'it is not about the money.'

Volcker Rules

As President Obama announced the Volcker Rules last week, thousands of bank/hedge/equity linked individuals spit their coffee across office suites and began gagging. The V Rule or rules are two fold. One. If you are an institution that take federally insured deposits, you cannot speculate. Two. You will be limited to the amount of risk you can take and you will not be able to own, advise, or invest in hedge funds or private equity.

If you take deposits and cannot speculate, and you can speculate but cannot take deposits, how will these poor institutions survive?

Well the first V Rule can be taken care of simply giving up the Fed window deal. The second rule however is a bit trickier when trying to figure out how to get proprietary trading into the bottom line. Goldman and JP Morgan can go back to being strictly investment institutions but will have to scale back their business models that had recently included deposit nirvana. Growth will be a problem and growth by exponential dimensions has allowed them the ability to intertwine transactional volume together with speculative venues. Trading services is a wonderful thing since charging, not really trading is the game.

Volcker will testify on Tuesday in front of the Senate Banking Committee and then will be followed by Goldman and JPMorgan of Thursday as they try to modify the Volcker Rule with the Weasel Adjustments.

Save Us, Never Mind

Nervousness about the reappointment of Bernanke a bit over done on Friday. Democrats in the Senate got the red growing when several announced they would not vote for reconfirmation of Mr. B. This may have been a direct response to the election results in Massachusetts as Democrats came to realize they can play hardball too if all their health care efforts are to be undone. Being obstructionist, they reason, works both ways. Of coarse the Fed and especially Treasury have few friends as the tired public views the treatment of the same 'good old boys' and their financial workouts as only for those who are guilty of the greatest errors in fiduciary responsibility. Crying save us and then saying never mind after their rescue has the general public annoyed.

The 'worst is over' cheers suddenly got quiet as selling appeared late last week and may have made a dent into those who truly believe the market will gain in 2010 and their current long position. Those folks do not want to sell but do not want to leave all on the table again.

All this may be tied to a general realization that the nation's job creation engine will only idle in the coming years as everyone discovers the manufacturing of ring tones is not the lift the economy needs. No, a world of shrinking leverage opportunities will make it hard to employ those who came to rely on the broad uplifting effects of a climbing real estate market. Maybe congress should consider tax credits for families who take in lawyers, real estate agents, and mortgage dealers.

The paradox of is that there is plenty of money supply, but not enough supply of money to go around to the ever growing ranks of jobless Americans.

Mystery China Trade

Market's decline today partly blamed on China credit restrictions, but regardless, as mentioned here in September, the whole China story is going to end badly. The Google internet dilemma is hardly a surprise. Totalitarian forces will ultimately harm the entire China fantasy along with trades pushed by commodity and stock traders long on China but short on original thought. The China demand theory evolves from the same level of excitement which delivered trades based on bundles of weak scrutinized debt which the rating agencies stamped AAA. The design flaw in the China trade is not because there are not enough Chinese to lift demand, but because the underlying economic conditions and data are a mystery and lack transparency. Mysteries always lead to bad trades, always.

Why Up?

Markets on the defensive heading into the three day weekend. Even with today's decline, the usual chant for higher prices emanating from business news channels has reached an elevated level of confidence mainly as a result of the repeated bid side momentum carried forth from 2009. Puzzled financial blogs have written about the invisible hand behind the rally in stocks. Foreign purchases, Fed/Treasury manipulation, and other forces have been mentioned as suspects. But the answer is not so mysterious.

Back in the panic of late 2008 and early 2009, participants all became linked in a kind of financial Coriolis Effect, you know, the direction toilet water spins. Normal value schemes were diverted by the force of plunging asset prices including stocks, commodities, and real estate. Massive liquidations to offset remaining risk was gaining velocity and was quite unfriendly to any rational market theory, now known as the useless theory. As prices for broad based assets fell, the otherwise normal attitudes regarding purchase opportunities were replaced by a reluctance to place any bids which had the potential of becoming targets for liquidators. In March, the combination of Treasury and Fed intervention along with declining selling needs, put in place a price level not seen in twelve years and having wiped out generational asset growth. After such a decline, prices naturally began to retrace some of the ranges penetrated during the panic. This in itself provided enough energy to rally based on repricing against diminished selling.

So now what? An up January by some bullish thinkers is the indicator month for all those other months because, well, they really need to have an indicator early to rationalize January purchases. Waiting for February will not work. However, if January is a down month, the bulls use other indicators such as the Chinese Demand Indicator. This is done by counting all the Chinese and dividing by one, the answer or quotient is the number of IPhones that will be sold in the near future. Bullish.

Now this renewed confidence that the worst of all asset declines is over and that the long term bull trend started after the Great Depression has been put back on track, comes from the same basic understanding behind mood modification drugs, that even bad things can look good if you just think they are. But more importantly, good profit seeking efficient stewards of corporate banking and business have adjusted to the cleansed market place. Your cleansing not theirs naturally. Further, increased vigilance by congressional investigations, Federal Reserve preparedness, and Treasury oversight, will be sufficient for a new bull phase.

Well, that is the plan anyway.

Rates To Rise

Warning from FDIC yesterday in a letter sent to banks regarding prudent risk to be applied as rates about to reverse course.

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