Liquidation & The Fed's New Found Sweet Spot

A: All commodities got destroyed the past two days in what appears to be a combination of liquidations, or the unwinding of speculative/hedged trades, PLUS the fed's new found methods of targeting the credit markets without the negative effects to the US dollar. Lets discuss.

YES, the fed cut its discount rate 100 bps and the funds rate 75 bps in the past week. But these are not normal times. In the past 9 days where we saw a bear get shot & killed, check out all the stimulus that the fed took to orchestrate an orderly liquidation and handover of BSC to JPM:

a) 3/4% point cut to Fed Funds Rate
b) 1% cut to discount window
c) $30B loan to JPM for the Bear handover that was NOT executed yet
d) $30B lending facility for primary dealers following the bear murder
e) $200B in a new TSLF, term securities lending facility, PLUS widening of allowable securities to be used as collateral

This is some serious action people! And it was targeted at the credit markets and maintaining an orderly financial marketplace as an 85 year old firm died out. In my opinion though, March 11th was the key date where the fed announced the TSLF that kicks in on March 27th.

Remember 9 days ago in my piece, "Fed Acts! Targets Freezup in the Credit Markets", when I stated:

"The fed pounced on what is working and announced today a new plan to lend up to $200 Billion in treasury securities to unfreeze the credit markets. The key element to the newly created TSLF, or Term Securities Lending Facility, is the 28-day hold period + the further widening of allowable collateral to be used. In addition, the fed has authorized increases in existing programs known as 'swap lines' with foreign central banks. All in all, a very targeted and effective move that is having an immediate effect.

The bigger picture here is that the fed seems to have found a tool that works, outside of traditional rate cut actions that have negative effects on the US dollar & commodity prices".

The money phrase is the last one: The bigger picture here is that the fed seems to have found a tool that works, outside of traditional rate cut actions that have negative effects on the US dollar & commodity prices.

Now, the fed did still cut rates afterwards, but not as much as the market was expecting and now we are seeing a reversal of trades that worked as the bet was on a weaker dollar. I must admit, I got caught up in the gold selloff and lost some nice profits in the past few days. But that is why you use STOP LOSSES on your positions, especially if you trade frequently. You may not hit the top, but you also won't get killed on the downside.

The point here is that the fed may not have to ease as hard as some thought, and that is why you are seeing the dollar trades unwinding. The fed is throwing everything but the kitchen sink at this credit crisis and time will tell how effective they are. At this point, future rate cuts to me are an indication of the severity of the recession! If the fed has to cut FFR down to below 1.25%, or another 100 bps, then the recession is expected to be much deeper than originally thought.

Dick Bove (story via Marketwatch.com) courageously announced this morning that, "...the financial crisis is over, economic crisis is not". The hidden gem in that statement was that the banks have realized the worst of the hit, and without the banks, we just won't have any sustainable market rally!

Now lets see if the fed's new found sweet spot can really allow them to navigate through this slowdown without cutting the FFR that much more! That in itself will help the US dollar and allow commodities to correct down as the speculative currency trade unwinds; bringing down with it expectations of pipeline commodity inflation.

ADD-ON @ 5:43PM: In the post 9 days ago I also stated, "I would also expect this to have a narrowing effect on credit spreads over coming days". I meant to put a chart of the CDX index via MARKIT. To the right you can see that a few days after the March 11th announcement, the CDX.NA.IG Series 9 spread did come in, so lets see if it continues! In a February 23rd post, I discussed what the CDX index tells us; but in case you didn't read that, here it is again:

WHAT CDX.NA.IG SERIES 9 MEANS (as I understand it from contacts I know in these markets): NA stands for North American. IG stands for Investment Grade. Every 6 months dealers are polled. They vote names into the new index. We're now up to series 9. To be eligible for a vote you must have contributed end of day marks for X% of days in the last 6 months on the names in the old index; X being a lot. There are a bunch of indices, but the two big ones are HY - high yield, and IG - investment grade. 100 names are in each. You take the 100 names and average the credit spreads to get the CDS spread on the overall index. Bigger spreads = worse credit in the index as a whole. If HY (high yield index) goes from 500bps to 1500bps and IG (investment grade index) goes from 50 to 70bps you know the HY index is getting a lot worse a lot faster than IG in terms of credit quality. Those numbers are just arbitrary to demonstrate a point.

PHOTO: Source

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