Snoopy-Typing-Away-1-CVV14J0D95-1024x768

This is a court of law, young man, not a court of justice.

Oliver Wendell Holmes

And so it seemed with the Federal Reserve policy announcement last week, followed very closely by Bernanke’s interview. The Fed statement reiterated the same policy that they had churned out over the previous meetings.

Bernanke however changed the rules. Instead of 6.5% unemployment, now 7% was going to be close enough. Well the markets were less than impressed, and puked up pretty much everything.

Bonds continued to rise into Friday. The stock market had a little short covering rally, with sellers taking profits, but it was not the bulls stepping up to the line…they already got steamrollered at $160 on the SPY

Well the COT traders I’m guessing, bought last week in anticipation of a benign Fed statement. Indeed they got it. The Fed Futures had accurately predicted nothing much until towards the end of next year, again, policy wise, that is what they got. Then Ben opened his mouth.

This week the COT traders are still buying. They are at +22.5% on the index. Do they know something that the rest of the market doesn’t? At this point, I doubt it. I continue to monitor, but I am not trading their prediction.

There is a general feeling that increasing yields help the financials. The FT is not so sure. What then might be the risk?

Banks borrow short and lend long. In a rising rate environment the loans lose value more quickly than the short end. Held to maturity, with quality credit risk, this can work out fine.

With questionable credit risk, and/or leverage that creates a margin call, this strategy kills banks. We saw it most recently in 2008. Would banks be stupid enough to do it again? So soon? Of course. Bank CEO’s are some of the most stupid out there.

Therefore with a surprise from the Federal Reserve from their policy statement, yields are rising and rising fast. The speed of the rise could well create margin calls. With the excess reserves held at the Fed, this [you would think] should not be a problem…unless the leverage is too high again.

Earnings season will identify the bad banks [if there are any again] as those in the know, and holding common stock get out. There could be some earning’s surprises in store coming up.

For this week however it means that the uncertainty in the markets will remain. Nothing really was sorted out with last week’s Fed policy, and the technical damage done to all markets was significant.

This break of technical levels will not quickly resolve. It will take some time to test various technical levels and if the bulls are to prevail, re-establish confidence. At the moment, the bulls have lost the initiative as their credo, the Bernanke Put, has been washed away.

Remaining market neutral is the sensible option. Profit is available in either direction of trending market movement.

The trade this week only extends out to November. I would have preferred a longer expiry date, longer is always better in a credit spread. This is the risk with the position.

Advertisements