by Teeka Tiwari | February 10, 2010 9:45 am
While the bulls may be breathing a sigh of relief after Friday’s stunning end-of-day reversal, they might not be out of the woods yet.
Most of Friday’s trading action was dominated by follow-on selling from the previous day’s 268-point decline. But in the last hour of trading, the market rallied back as traders decided to cash in their short positions.
Late-day reprieve or not, the damage to the charts was already done. The break to 9,800 on the Dow Jones Industrial Average (DJI) was ugly.
The bulls are on their back feet here, but the bull case will require some really, really good news if the markets going to have a chance at propelling higher.
There are currently two big “meta” stories at work right now.
One is the very real possibility of a European sovereign debt default. The other is the possibility of a slowdown in growth in China, due to a combination of over-capacity from last year’s recession-fighting spending spree and a Chinese bank meltdown also caused by China’s massive stimulus spending efforts.
To make things even more interesting, we have the third story of the Fed and its exit from direct quantitative easing looming in March, which means it must extricate itself from hyper-low interest rates without crashing the market and the U.S. economy right along with it.
All of this uncertainty is starting to show up in different areas of the markets.
You want to pay special attention to Eurodollar deposit rates. (Eurodollar rates are the interest rate you receive on U.S. dollar deposits held outside of the United States.)
Other than a short blip up in Eurodollar rates when the Dubai debt story first broke, rates on Eurodollars have been steadily declining.
Over the last week or so, though, we’ve seen Eurodollar rates started inching higher while at the same time rates on Treasuries have started to decline.
This is the classic TED spread indicator at work. As the big money gets scared, it sells Eurodollars (that’s the “ED” in TED) and buy Treasuries.
Eurodollar deposits are not insured and are deemed to be riskier assets than Treasuries. The selling of Eurodollars pushes rates up and prices down on the Eurodollar futures contract.
The buying of Treasuries pushes Treasury prices higher, which, in turn, leads to lower yields. The difference (or spread) between the interest rate offered on short-term Treasuries and Eurodollar deposits is called the TED spread.
As that spread widens, it signifies a ratcheting up of institutional investor fear.
Along with a widening TED spread, we can’t forget the U.S. dollar. Institutional safe-haven buying has been defying dollar bears since December 2009.
So, what does this tell us?
It tells us that big money is moving into capital-preservation mode. The big money is seeing things it doesn’t like and is hedging its bets.
So, why isn’t gold rallying, what with all this uncertainty?
Isn’t gold supposed to be the ultimate hedge against global instability?
It used to be, but global wealth is now so massive that the gold market just isn’t liquid enough to house the world’s wealth.
If there was any time for gold to shine, it was during the 2008 financial crisis. And yet, the action in gold during 2008 was just meh.
We learned in 2008 that, during a period of global crisis, even with all of its flaws, the U.S. dollar is still the reserve currency of choice when the proverbial spaghetti hits the fan.
Remember, the play in gold was never a global uncertainty play. It’s always been (at least this go-around) a play on a bloated U.S. dollar collapsing under the weight of quantitative easing and deficit spending.
If the global economy is in for another roiling due to European sovereign debt defaults, there is no other financial bucket big enough to hold the world’s wealth outside of the U.S. dollar and U.S. Treasury market.
American markets act as a safe haven during periods of extreme uncertainty by virtue of their size.
It’s easy to forget that the U.S. economy is a gigantic money-making machine that throws off an enormous amount of annual cash flow in the form of taxes.
Do you know how irresponsible you have to be to outspend our annual tax receipts? Only politicians who do not feel the pinch of their profligate ways could be so wasteful. But I digress.
Even with all of our problems, our economy and our market are still head-and-shoulders above the rest of the world.
However, during normalized market volatility and calm business conditions, emerging markets will once again start to outperform U.S. dollar-denominated assets. But we’re not there yet.
The U.S. dollar and the U.S Treasury market will be bouncing up and down based off the most recent market sentiment surrounding the likelihood of a European sovereign debt default. But the ugly truth is that a sovereign bailout looks virtually unavoidable, and no amount of “massaging the media” will change that.
There still looks to be more global uncertainty ahead. And, at least for the short to intermediate term, U.S. Treasuries prices and the U.S. dollar should continue to move higher overall.
Tell us what you think here.
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