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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: basho who wrote (41260)	9/10/2005 9:37:47 AM
From: russwinter	Read Replies (1) \| Respond to of 110194

Could FCB funds be finding their way into this category through large deposits in the banking system?> I'm not sure how to analyze this aspect. I think the primary impact of this more recent FCB activity is to take agency holdings off the balance sheet of the GSEs, and put them into the hands of central banks. The GSE balance sheet in theory shrinks, but the net effect is a wash, just shifting the deck chairs on the Titanic. As noted, $125 billion of the $176 billion yoy FCB adds are agencies. Over the last four weeks though, the FCBs have not been active there. The question I would ask you: as you've tracked the lessening activity of the FCBs, do you sense it having an effect on taking interest rates higher? My theory is that over the intermediate term US interest rates are largely correlated to FCB custodial holdings (A) + Fed monetization (B)(the elephants) divided into twin deficit financing (C)needs. What we have witnessed so far this year is a gradual pullback from the FCBs, somewhat offset by temporary stabilization in the twin deficit. This combination has resulted in a slow but steady increase in rates. But now with the twin deficits (C)set to potentially explode, A and/or B will have to keep pace. If the FCB only show up to the tune of $3 billion a week, then the Fed will have to really run the printing presses, or rates will take off. And if they do that, then they risk a market panic, although so far the market doesn't seem to care how many little children Uncle Ernie abuses. Then there are shorter term indicators on top of that which is the repo or dealer activity (D). Finally there is what I call the Pig Man squeeze factor (E). Just like in the stock market, there is an aggressive speculative pool (the Boyz) of money that has regularly made big offside bets (shorting ED, notes and bonds) on higher interest rates (Pavlov Dog betting on measured rate increases) or are using these instruments to carrytrade into riskier credit. These have been exploited by the Wizards (Fed) and prop trading desks (Pig Men) as squeeze gambits, to keep bond and ED rates compressed. We've seen two of these operations so far this year, including the Katrina squeeze. They've worked pretty well, because up to now twin deficit financing needs have been more stable. That's changing post-Katrina. I also feel Boyz are shorting (carry trading) Euro (this may have unwound in the last month?), and Yen instruments to raise funds for a wide variety of speculation, including flucht in die sachwerte trades like energy. This should not be overlooked, especially now, as there is potential for a big unwinding.