Thursday, August 13, 2009

Devil in the Details and Gold...

FED fund rate on Wednesday was 0.13%, down 0.02% from Tuesday.

5 different maturity treasuries were auctioned up to Wednesday: 4-week, 3-month, 6-month, 3-year and 10-year. The pattern is still similar: T-bill maintains a bid/cover ratio above 3, whereas the T-note maintains a bid/cover ratio between 2-3 (3.41; 3.55; 3.49; 2.89 and 2.49 respectively at ascending length of maturity). Despite the seemingly lowered bid/cover ratio and the increasing yield, the money amount of T-bills and T-notes per each type was higher than last auction, say, 4-week at 4billion USD more; 3-month and 3-year each at 2billion USD more, and 10-year at 4billion USD more. The actual influence on bond market due to "recovery" notion cannot be simply decoupled from the "demand and supply" behavior. In general, the primary bond market does not experience a dead drop at the surge on stock market - possibly also a response to the extension of QE by FED, in addition to the conservative risk appetite.

The extension of QE for another month till October by FED, by speculation, can possibly be FED's reaction to the already pipelined short position for the coming September. The announcement about its re-adjusted economic foresight is another. However, given the so-called confidence, FED has still not dared to cease the QE as scheduled. It is more a signal of anxiety, or at least uncertainty, to the overall USA asset market.

Had the QE ceased, there could be two scenarios. The first one is that the market follows FED "optimisstic" expectation and pools money into equity, commodity and property market under the notion of recovery. Yet it will damage the bond market and further drive the yield rate up. It also means a financial burden on the USA government in the longer term: afterall its fiscal deficit will also run high to cope with higher interest payment. The flow of hot money, the collapse of fixed-income market, and the expansion of USA government balance sheet, points all but one word: inflation.

Another possible scenario is that due to the cease of QE (and hence lack of "easy-money"), the market loses the upward momentum and flats out or even drops to a certain level. Hot money will either leave USA equity market if they can find a replacement elsewhere or simply seek shelter on risk-protected asset. Although bond may seem to be a good choice, the cease of QE, a signal that FED will lower its profile on the money market, can also trigger the lost of confidence on USD. In turn, it will propagate to the bond market and also drive bond yield high. The asset depreciation and the weakening of USD will couple with each other and form a vicious cycle till a new lower equilibrium point. Deflation on asset and weak USD will result.

While each scenario starts from different causes and leads to two different results, one thing is common: the weakening of USD. Such weakening may mean a temporary surge on other currencies, be it EUR, GBP, AUD, etc. However, it is also apparent that such action will further dry up the potential recovery in those areas. No government can simply tolerate it longer, and corrective actions will be taken.

Under such circumstances, one of the major remaining options is apparent: gold. Perhaps it is the moment to pay more attention on it.

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