They whispered…..

“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth. In recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen. These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows and technical factors related to the hedging of mortgage holdings” Ben Bernanke testifies before the House of Representatives

“Today, I pledge to cut the deficit we inherited in half by the end of my first term in office” President Obama setting himself a very ambitious target (24/02/09)

“What other central banks have been doing must be reversed. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe. Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds. We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time” Angela Merkel being uncharacteristically critical towards central banks in Berlin

“What we did with all these bailout billions is that we bought ourselves a rally” Rick ‘Chicago Tea Party’ Santelli

CapitalWhispers

The US budget deficit this year is projected to reach $1.85trillion, that is 13% of the economy. This gigantic -not just in percentage but also in dollar terms- figure, in conjunction with the anything-but-benign macro-economic environment gives President Obama’s pledge Herculean dimensions

What is more -and probably for the first time since the crisis began- Mr Bernanke is shifting his focus to fiscal discipline. The glut of Treasuries issued to fund the deficit are starting to: (1) spook investors (Mr Geithner travelling to China this week to appease the -very serious (in both meanings of the word)- Chinese investors), (2) raise creditworthiness fears -especially since the UK’s outlook has been downgraded to negative and (3) spoils the effort of kick-starting the economy by bringing down the long-end of the yield curve -traders are pushing the 10y+ higher and the curve keeps steepening (not very helpful for mortgages & lending in general)

The past couple of months have produced a spectacular, logic-defying rally that has spilled over almost all asset classes. Credit is rallying ruthlessly, enhanced by the predictable herd capitulation, and now implies defaulkt probabilities in line with historical recession levels (but not fully realised yet – watch this space in the next 12 months). Oil & the basic metals are rallying, aided by a seemingly unstoppable China and macro-indicators showing a distinct improvement from a few months back. In fact oil and dry freights (Baltic Xchange) have doubled from their lows and it feels like the rollercoaster has started again. Equities..the the rally momentum has been almost unprecedented in its smoothness and strength. Many -CW included- have been waiting for the downward correction that never comes (to ride the next wave).

We are increasingly of the view that the rally has nearly exhausted itself (in equities more so, with credit possibly having another 10-20% to go). That said, we believe that revisitng the lows will be rather improbable; instead, we expect a long +-5/10% range-bound market for the next 6-12 months. (Still, when the long overdue correction comes, there should be a brief spike given that so many investors are waiting to jump in).

Keep your ears open, do not follow the herd … and let’s hope that we won’t get overly spooked by the default (personal & corporate) wave that is swelling.

nikosgi