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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Elroy Jetson who wrote (10073)	8/1/2004 12:21:46 AM
From: mishedlo	Respond to of 116555

Trouble at The Core. prudentbear.com Extreme mortgage Credit excess ensures an endless supply of mortgage paper to be financed. There is, however, some limit to the amount of Treasuries to sell (although borrowing and shorting securities increases the “float” in the marketplace) and, one would expect, speculative demand. And there is, as well, massive and growing interest-rate exposure to be hedged in the market, also entailing shorting Treasuries and other securities. Between the “carry trade” and hedging programs, the amount of Treasury shorting is truly massive. Derivative hedging strategies also dictate enormous trend-following trading, adding one more dimension to an uncertain market environment. And, to top it off, foreign central bank dollar support and Treasury purchases have become a major factor in the marketplace. In combination, this market has many dimensions with all the requisite characteristics for acute fragility. Inherent marketplace instability and vulnerability can remain dormant for years, only to be roused by sometimes subtle changes in the environment. Today, there is a confluence of developments that is more than subtle. First of all, market volatility that causes minimal hindrance when players are sporting solid returns and confidence turns increasingly disruptive and disconcerting when performance and confidence falter. Second, with Fed funds at 1.25%, the market must grapple on a daily basis with the reality that rates will likely be moving significantly higher. Third, the leveraged players have been stung by difficult conditions in various markets. And with surging industry inflows and a mushrooming number of funds, the leveraged speculating community as a whole is now vulnerable to the downside of Bubble dynamics. Fourth, mortgage finance excesses have gone to problematic “blow-off” extremes. Too much mortgage Credit of increasingly suspect quality must be financed by highly leveraged players and institutions, with the entire Bubble vulnerable to any moderation of lending or speculative leveraging. And, fifth, the global inflationary backdrop (and almost $44 crude!) is not necessarily the most comforting environment for holders of long-term bonds. There is today, however, little indication of heightened stress with regard to the Great Mortgage Spread Trade. Still, the environment is demonstrating many characteristics of NASDAQ 1999 – where runaway excesses and myriad distortions set the stage for the imminent bursting of the Bubble. Over the coming weeks, expect discernable indications of Trouble at the Core. But I also want to warn that I believe we have likely entered a period that will be marked by exceptional volatility in global equity, bond, currency and commodities markets. The leveraged players are on edge and markets should be expected to trade accordingly. Prices may, at times, be more determined by trading dynamics than fundamentals. Be careful out there.