I think there has been some pain with leverage. These are entities which are leveraged sometimes six, sometimes eight, sometimes ten times. It’s hard to imagine that all of them could be operating in good shape with interest rates on mortgage-backed securities having risen 140 basis points (1.4%) now from their low of the year that was set in the first quarter. Once you get a move of ten points on something that generally trades within a range of a couple of points, it’s hard to believe that there wouldn’t be some leveraged player that is feeling a great deal of pain. Those are the ones that end up with the involuntary redemptions and those could lead to the extension of the selloff. I think that’s partially what’s happened in the last several days.”

“It’s something of a liquidation cycle certainly. There’s a metaphor for what’s been happening in the last couple of weeks. It goes back to 1994, when the Fed under Greenspan raised the Fed Funds Rate by 25 basis points (0.25%). It didn’t seem like much of a move but it changed … people psychologically, and ultimately their behavior. This time, it’s not the Fed Funds Rate, it’s the statements about quantitative easing. What it did is we got people to alter their behavior and to invest more than they’re typically comfortable in investing – in stocks, in emerging market bonds, in high-yield bonds – in all financial asset classes. Indeed, that was the intent, wasn’t it? That was the intent, partially, of quantitative easing – was to alter behavior, and to get people to invest more than they typically would. Hold less cash, for example, than they typically would. Well, when people are holding less cash than they’re typically comfortable with, and markets start to move against them, not surprisingly they say, ‘Hey, I went to get back to home here and get back to my comfort position.’ which means liquidation. It’s a metaphor with what happened with Apple.
“What’s happening in the market is that a one-sided overinvestment leads to off-sides market. Therefore, it is something of a liquidation cycle.”


So for the moment the heat comes off of the Treasury market. Will they stabilise, has the Federal Reserve intervened? Who knows at the moment. This however is why stocks are currently having a little rally.

Go figure – the sell-off the Treasury market has seen since early May is actually already worse than what went down 20 years ago, as ISI’s Ed Hyman points out in a note to clients this week.

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The thing is, even if the Treasury market does stabilise, that does not mean that the stock market will stabilise. It could be in for a deeper correction yet.