Do you want to stay young? Bill to Ben After being a monk for less than a hour over the weekend, i.e., reading, praying and lunching in one of the biggest Buddhist temple here on West Coast, I returned to my pursuit in the mundane world outside of the temple, like other visitors. Life is all about pursuit, even for monks, with many of them had similar pursuits like ours, before becoming monks and started a totally different pursuit. Bill Gross of PIMCO, now in his 60âs, is one of those heavy-weight bond guys in US and perhaps in world as well. He is a great thinker and writer as well, and I always enjoyed his writing. Does Gross want to change his pursuit in bond world to that in Buddhism? Not likely. âThe early 1940s generation may not have been the greatest one but it could have been the luckiest â although to be honest, I would trade it in for a crack at being a Xâer or a Yâer if I could take my wife Sue with me. Youth is a most precious commodity.â Gross is kind of Benâs counterpart in financial market. Bond is the so-called the mind of market, if simply due to its size: Daily trading volume of Treasuries by primary dealers. averaged $501B in 2004, while the combined daily trading volume of NYSE and Nasdaq together is about $70B. (data source in my previous post). Of course, Gross is not going to ask Ben if the Chairman also wants to âtrade it in for a crack at being a Xâer or a Yâerâ, âitâ being anything else. What Gross cares about as a big bond guy is not the subjective value of âbeing a Xâer or a Yâerâ for Ben, but the value of his huge bet on the front-end of the yield curve. Per Bloomberg.com âGross, who predicts the Fed will cut rates to 4.25 percent this year, has raised his holdings of cash-equivalent securities to the highest level in almost two years.â Central in Grossâs prediction of the Fed rate cut (since 012006) is few things: 1. Fed has in past tightened long enough for US GDP growth slow to 2% or lower (real rate) Back in 082006, Gross wrote: âWhy then should the Fed be stopping and the bond market have bottomed in early July? The overarching reason is that 425 basis points of short-term hikes and the concomitant tightening of the yield curve in the past several years has been more than enough to slow economic growth and contain inflation. Thatâs a bold statement to make in the face of an apparently still strong domestic economy, a booming global environment, and accelerating core CPI numbers, but PIMCOâs cyclical analysis would suggest that it is justified. No doubt, Asian and Euroland growth is acting as a strong magnet for U.S. exports but the tightening cycle in the U.S. seems to have run its course, primarily because of its effect on housing and related repercussions on consumer spending and economic activity. 072006 and later, Fed stopped but did not cut the rate as Gross had hoped. Consequently and reportedly, Gross got burned. 2. Gross to Ben: You got to let Joe to pay his mortgage and me to make my proft, and we canât make it with 5.25% Fed rate In making his point, Gross said he has been patient for those not in bond trading rooms (whatâs the other room, dining hall or preying hall?) Gross wrote: âImagine, if you will, purchasing (receiving) a 5-year interest rate swap at some time over the past few years. For those of you who donât spend 12 hours a day in bond trading rooms, that means owning a 5-year fixed rate bond and financing it (paying) with 3-month Libor which increases in yield every time the Fed raises its benchmark. Instead of mark to market changes in the 5-year swap price, what I would like to promote here is the concept of an increasingly more expensive "cost" to owning this 5-year swap as its financing rate (3-month Libor) increases. A 5-year swap purchased when short rates were much lower and the yield curve more positive, produced positive carry and therefore generated "profits" for anyone holding this longer dated maturity when viewed from an income statement perspective. But if you narrow or eliminate that carry via higher short rates (and a flat yield curve) those "profits" disappear. This 5-year swap concept is important because the U.S. economy operates in much the same way. With close to a 5-year average life, the entire U.S. bond market can be compared to a 5-year fixed swap. That means that companies, homeowners, and consumers that have borrowed money in recent years - (and purchased assets such as a home that are akin in my example to a 5-year swap) - are now being squeezed in a flat yield curve environment. Visualize a real life example in which you have "financed" a home with an adjustable rate mortgage (in my example you finance a 5-year swap with floating 3-month Libor). As the cost of the ARM increases with higher short rates, your excess income available to spend on discretionary items begins to shrink. If that ARM rate goes too high, you hunker down even more by not eating out, going to movies, or taking a vacation to exotic destinations. The economy in other words slows down.â Thatâs for Joe and those who have mortgages. As for WS, Gross wrote: âIt is my contention, in fact, that 21st century capitalism depends upon a positive yield curve which provides the âvigâ of short rate/intermediate rate arbitrage that banks, unregulated banks (hedge funds), and a host of financial institutions utilize to make structural profitsâ. Bottom line: WS canât buy low and sell high with 5.25% fed rate, and that, by the way, would also make Joe and his employerâs life even harder Showdown time, between Gross and Ben: Fed may be just as tough as Gross and his alike. Fed, I guess, has actually two things in its mind in trying not to ease, as long as economy permits: 1. further draining out of the excess liquidity produced partially by their last ease, the more the better; 2. Inflation: CPI 2.7% is still obviously above Fedâs comfort zone; As about potential inflation threat: âOverall capacity utilization in February increased to 82.0 percent from 81.4 percent in January. The consensus had forecast that capacity utilization would rise 81.3 percent from the initial estimate of 81.2 percent for January. For manufacturing, capacity utilization stood at 80.1 percent in February, compared to 79.9 percent in Januaryâ. âThe capacity utilization rate reflects the limits to operating the nation's factories, mines and utilities. In the past, supply bottlenecks created inflationary pressures as the utilization rate hit 84 to 85 percent.â (barrons.com) Whatâs Fed comfort zone on capacity utilization rate? I donât know but guess itâs below 82%. Rate of unemployment minus the rate of nominal annual wage growth: I donât have data, but if it is greater than 50 base points, it will be out of Fedâs âcomfort gapâ. So, unless US economy GDP falters under Fedâs target rate (what it is?), Fed is not going to ease. Last summer, Fed stopped and but did not ease, and reportedly burned Gross and his alike, with goldilocks economy just doing fine until recently. On Feb 28, 2007, Ben said that the US economy could strengthen by mid-year if housing and manufacturing stabilize. That was then, and it is now. March 19 (Bloomberg) -- Options traders are starting to say the Federal Reserve may cut interest rates three times this year as the housing slump threatens the economy's growth. âTraders in options anticipate lower borrowing costs than economists or futures contracts, the most widely used barometer of Fed policy, amid increasing concerns about mortgage defaults. Futures show rates will fall to 4.75 percent by year-end and economists expect 5 percent, according to the median in a Bloomberg survey 73 forecasters from March 1 to March 7.â Is subprimeâs spread out of control a real thing or just another piece of the emperorâs new cloth? Itâs hard to tell now, and Fed has to tell market what is Fedâs thought on this next week. Will Gross and his alike keep shorting stocks and longing bonds until they get Fed to say, âok, babies, I will give you guys a few drop of milkâ?
âFA: guessing into mind of âanimalsâ and Fedâ âIn short term, there are no fundamentalsâ, and TA would love a trading session like today. With basically no new input from data, information and FA side, what dominates todayâs market movement is last nightâs sunny Orient and M&A this morning. Obviously âanimal spiritsâ are going around with some steam, inducing a lot of short-covering I guess, particularly for those shorted since 031307. 10Y T yield index at 4.57%, kind of recovered back above its 031207 level of 4.53%, turning a lot of Grossâs bond followers into red, at least for now. Dowâs volume is about on average, and the index gain is far below 1.7%, required by IBD for a valid âfollow throughâ. Where Dow would go from here? TA would point at next resistance or support, and next after next. IBD will tell you to wait on the sideline, until you see a valid âfollowing throughâ. They are all very honest: thatâs as much as they know and can tell you. How about FA? FA is still a guess, like TA. Instead of guessing on greed and fear, FA guesses financial/economic data and information about a company, an industry, an economy, and many economies, thanks to the arising of Chinese-style capitalist economy and itâs alike. Speaking of Chinese-style capitalist economy, I somehow feel more bullish about it and recommend CAF, one of my long-term holdings. If nothing else, my bullishness is kind of justified by FA, which by the way, can guesses a lot of better about Chinese capitalist economy as managed by CCP, in its current context. FA is lot of limited in its value when guessing about US economy, scarstically. Keynesianismâs description of US or Western capitalist economy is right on money: it is a combination of animal spirits, âLaissez Faireâ market, and state intervention. So, âFA: guessing into mind of âanimalsâ and Fedâ is my short description of FA, âanimalâ being market participants as named by Keynes, of both bears and bulls. Now letâs peek into their minds. US GDP growth this year Bulls: 2.4 percent annual rate this quarter, and accelerate to 3 percent by year's end (Bloomberg.com) Bears: Pimco thinks US GDP will slow to 2.0% this year. Inflation Bears and bulls seem not too far away from each other, CPI around 2.7%. Subprime Bulls: 5% of subprime may fall delinquent, not much spreading out into other parts of economy Bears 20% of subprime may fall delinquent and the problem will spread into other parts of economy. Earnings Bulls Briefings.com and reuters.com Earnings estimates for the first quarter have drifted down from 8% two months ago, to 6% one month ago, to 5% or less today. Second and third quarter estimates have dropped from an average 7% for the two quarters to 5% over the same time period. âFor the first time in 14 quarters, we could see year-over-year percentage profit growth rate for the S&P 500 universe in the range of 5 to 7 percent. Overall Bulls think goldilocks is still in the cards, with Stocks in the S&P 500 index traded at an average 16.9 times current earnings. below the average price-earnings ratio of 21.9 since the four-year rally began in October 2002. Bears think more of a recession if not a stagnation, with a Fed rate cut quite possible but may not helpful, and they like front end of the yield curve for now. Fed I guess Fed is somehow confident and comfortable with US GDP growth, but still very uncomfortable with inflation and excess liquidity in the system. GDP No data about Fedâs comfort zone. Inflation CPI of 2.7%, above Fedâs 1-2% presumed comfort zone Inflation potentials Capacity utilization rate Overall capacity utilization in February increased to 82.0 percent from 81.4 percent in January, with historical average being 81%. Rate of unemployment minus the rate of nominal annual wage growth: if it is not greater than 50 base points, it will be out of Fedâs âcomfort gapâ. Unemployment rate as of 022007: 4.5% Hourly earnings rose 0.4% in February. That is a bit stronger than expected, and puts the year-over-year increase at 4.1%. So, either too many Joes are at work or Joes earns too much, in terms of inflation potential threat. Productivity growth Productivity growth, slowed to 2.1% over 2005 and 1.4% over 2006, although possibly due to cyclical factors, while trend productivity growth is roughly 2½%. The productivity deceleration has contributed to acceleration in unit labour costs of 3.4% over the past year. (Morgan Stanley) Excess liquidity Still too much left in the system from last Fedâs ease, and âanimalsâ particularly bulls have drunken too much of it. Fed wants to keep substantial amount of âcrackâ in Fedâs hand and away from somehow already overdosed animals, in case Fed has to really âhelicopterâ crack out from sky when âJapanese Deflationâ invades (marketreflections.com). With US economy cruising in a social-economic structure totally different from that of Chinese-style capitalist economy, Fed has to co-pilot the ship with a bunch of âanimalsâ in bond, equity, and commodity and currency market. To make things worse, both of the two pilots have to guess each otherâs guesses on the economy, and communicate in a non-communicative way. So, what FA can do except guessing all these guesses?
âIn short term, there are no fundamentalsâ As a day trader, I always try to close my trades a couple of hours before market close. Later session trading is always harder for me, I guess one of the reasons is that market participants tend to be less emotional than earlier, having less âanimal spiritsâ, as they process and digest data and information further and further, and therefore market tends to be more âefficientâ as it goes into close, creating less opportunities for day traders. Thanks to -j4âs post, I read two articles about âRandom Walk Processâ and âEfficient Capital Market Hypothesis-ECMHâ, and feel I had better understanding by reading in Chinese. Both theories emphasize that, data and information and their processing by market participants, play the most important roles in determining prices in financial market( Marketreflections.com). I always think that if todayâs academics could learn from Keynes and actually participate in financial market, not only as an investor but also as a trader, they could probably understand market a lot of better Being an active investor and trader himself, Keynes emphasizes the importance of âexpectationâ/âanticipationâ in stock market. âExpectationâ/âanticipationâ and their formation are a lot of more subjective and emotionally driven than data and information themselves, which are basically objective. I am not sure whether Keynes talked about âanimal spiritsâ in stock market, âanimal spiritsâ being greed and fear, although more of the former. âAnimal spiritsâ is very often more emotional than rational. TA studies and measures âanimal spiritsâ in financial market, based on two assumptions: 1. Human market participants always have âgreed and fearâ; 2. âGreed and fearâ work in certain behavioral patterns. TA, although never achieved similar academic fame as âRandom Walk Processâ and âEfficient Capital Market Hypothesis-ECMHâdid, actually is one of traderâs best tools, probably more important than the more famed âRandom Walk Processâ and âEfficient Capital Market Hypothesis-ECMHâ. âIn short term, there are no fundamentalsâ, is my short explanation of TA, although I really mean that in short-term, such as one day session, input from fundamentals or FA is approximately a fixed amount of information. This assumption is of course itself an âapproximationâ. With this approximation, traders resort to TA to formulate a trading plan for the day.
No data, no volume Today is almost a repeat of Monday: last nightâs sunny Orient and more M&A chased short-coverers to push Dow to as high as 12290, almost back to the level of pre 031307âs slide. I could almost feel the âbidsâ from short-covering, particularly in PM session. Once I got my trades closed, I stayed aside, watching them scramble over each other in biding for shares, and there were almost no testing of lower ends for index today. Index gains seemed not driven by institutional buys, as indicated by lighter volumes. âTrading was moderate on the NYSE, with about 1.45 billion shares changing hands, below last year's estimated daily average of 1.84 billion, while on Nasdaq, about 1.71 billion shares traded, below last year's daily average of 2.02 billion.â (reuters.com) Mondayâs volume was light, and todayâs is lighter. IBDâs comment on Monday: âStocks rallied Monday, but sharply lighter volume took the juice out of the session's gains. The Nasdaq picked up 0.9%. The S&P 500 climbed 1.1%, the Dow industrials 1%. The small-cap S&P 600 also tacked on 1%. But volume receded 19% on the Nasdaq and nearly 30% on the NYSE. Two factors weighed on Monday's volume. The lack of option-fueled trading certainly played a part. Big investors also were reluctant to trade heavily ahead of the two-day Federal Open Market Committee meeting that begins Tuesday. Still, Monday's trading level came in below Thursday's tally, and was the second-lowest total since the last week of 2006, when traders stayed home for the holidays.â There are possibly two reasons why âBig investors also were reluctant to trade heavilyâ 1. Fedâs meeting 2. FA side: In a correction like this, bulls are on trial and burdens are on bulls to get the data to prove goldilocks are still in cards, and stocks are still worth âcarryâ at current level. (marketreflections.com) Consensus is that GDP will slow below 3%, but by how much? Earningâs growth will slow from double digit into single digit, but what is single digit, 5-7% or even lower? Where would yield curve stay, shorter and long ends? Bulls, just like Fed, are data dependent. Before there is substantial bullish data coming out as a real buy signal, I guess bulls would not stick out their heads attempting any significant rally.
Fed and three representations Major indexes all moved substantially higher with substantial volumes improvements. Yes, Dowâs 1.3% gain is still below IBDâs 1.7%, so what? Benchmarks, even though often based on historical data, are still subjectively made. Bench marked on its presumed comfort zone of CPI 1-2%, Fed is not comfortable with CPI of 2.7%, but it just have to deal with it. Keeping interest rates unchanged, Fed today âomitted a crucial sentence from its accompanying statement that suggests it is dropping its tightening biasâ(marketwatch.com). Fedâs softening in its long-standing tightening bias is definitely a new piece of bullish FA information. With that, market rallied. 10Y T yield dropped about 7 base points to 4.518%, kind of lowest YTD. Bill Gross must be smiling. Speaking of Bill Gross and the gang of bonds, I thought about CCPâs famous âthree representationsâ in Jiangâs time. Similarly, Fed has its own version of âthree representationsâ. The first two are well known, being Fedâs employment objective and inflation control, its dual mandate empowered by congress. The third one is bond market, as I thought. Since US monetary system was debased from gold standard, US governmentâs âcontrolâ (for lack of a better word) of banks, and banks control of economy, is basically based on treasury bonds, with Fedâs policy implemented via the purchase and sale of T bonds among Treasury, Fed, banks, and the rest of bond market such as PIMCO, with an average daily volume of $501B, 7 times of that of US stock market. So, when Bill Gross and his alike claimed that they cannot make âstructural profitsâ under current yield curve and economy needs a rate cut, Fed listens. Once on âthree representationsâ, we have to talk about CCP and its âthree representationsâ. Although always seemingly formidable and infallible, CCP faces an equally daunting challenge when trying to make their âthree representationsâ. âAs of July 2006, the Chinese population was 1.3 billion, which is more than four times as large as the U.S. population of 298 million. In terms of total production, measured in dollars at purchasing power parity, the Chinese economy is the worldâs second largest economy, trailing only the United States. In 2005, the Chinese GDP exceeded $8 trillion, which was roughly two-thirds the U.S. GDP.â (marketreflections.com) Because of this and other reasons, CCP and US have to work very closely with each other in many areas where both of them are âstakeholdersâ, such as purchase and sale of US T bonds, some kind of âorderâ for US dollars, some kind of USD-pegged currency system in Asia, and of course, Iran, N. Korea, etc. Interestingly, when stock market corrected last year, all gold bugs and dollar bears came out crying, as if the end of world was coming. This time, they all seem unusually quite. I guess they somehow figured out, that with Comrade CCP and Uncle Sam in alliance, there is a thick resistance line atop of Iran, N. Korea, and may be gold as well.
Although sometimes amused by things like âthree representationsâ, I as a day trader actually start everyday with âtwo representationsâ: I have to try to listen to both bears and bulls, and see if I can get a few work-orders from each of them, short or long. To do my job well and to have my rice bowl filled at the end of day, I better not to be biased, and not to have any "gaps" (marketreflections.com). Todayâs Fed statement is indeed a bullish FA piece for bulls, but just how bullish? Yes, Fed seemed to have switched to neutral from a âtightening biasâ, after acknowledging that "Recent indicators have been mixed and the adjustment in the housing sector is ongoing." From bearâs point of view: 1. Fed is just acknowledging that housing slowing down is âongoingâ, and where is bottom? 2. With a slowing housing, GDP and earning growth are going to slow down. How much slowing down has to be seen by Fed to ease, and if easing, how many cuts? Before that, why âcarryâ stocks? Today, after Fedâs statement, âThe yield on two-year notes, more sensitive to changes in interest-rate policy than longer-maturity debt, fell below 10- year note yields for the first time since August as speculation increased the central bank is more willing to cut interest rates as housing slows economic growth.â (Bloomberg.com) So, there is still a lot of money going to Treasuries, particularly the short end, and I would think most of them would be institutional money. Not only that, Fedâs today statement even sounds familiar. 072006 âBernanke's testimony indicated that the Fed expects inflation to cool in the months ahead and that the core PCE is better inflation measure and thus a more important policy determinant. Apparently, the Fed is concerned about the economic slowdown and will not move aggressively in response to short-term inflation data. This is very good news for the stock market.â(Bloomberg.com). Except that there was no housing issue back then. Speaking of housing, Greenie not long ago said âthe worstâ is over, he just has not found the âconfirmationâ anywhere in the chart, and now he is saying that subprime may spread out. I think Greenie has been honest. More difference: that time there was no CAF for me to âsafe heavenâ into, and there is CAF now, and HSI and N225 seem in steps more with Shanghai Index than with Dow. Also, less cries from Iran, gold burgs, dollar bears, and Stephan Roach of âglobal imbalanceâ. Letâs see Existing Home Sales 10AM the coming Friday.
Chewing âcrackâ and dancing with MM from marketreflections.com Day trading is addictive: you have to trade to live and enjoy, that is what you do and who you are. In that sense, trading is âcrackâ. âCrackâ shall not be overdosed, particularly when dancing with MM. I am done for the day. Today my MM is citi group, and others. These days MM very often is just part of a big group, which does asset mgmt, hedge fund, advisory and technical service for institutional clients. There are some kind of regulations I guess, but âloopholesâ and âfavorsâ are always there. Their favors are very often otherâs cost, particularly small and retail traders. Can MM manipulate index? I canât find any data to TA with and therefore can not trade âitâ. The manipulation of individual stock with a day session or over a few days can be âfeltâ everyday by a day trader. MM is formidable but not infallible. Market force, or âtrendâ if you will, dominates every trading session. In front of a trend, MM is just as week as an average day trader. In front of market trend, big or small, everybody is equal. In front of knowledge, skills, experience, patience, endurance, guts, everybody is not equal. To be better is to learn from others, including MM. 19th century British moral philosopher John Stuart Mill wrote in his "Essay on Coleridge.": "Lord, enlighten thou our enemies", "Sharpen their wits, give acuteness to their perceptions, and consecutiveness and clearness to their reasoning powers. We are in danger from their folly, not from their wisdom: their weakness is what fills us with apprehension, not their strength." Todayâs market is not a surprise, there seems no follow through.
Chewing âcrackâ and dancing with MM Day trading is addictive: you have to trade to live and enjoy, that is what you do and who you are. In that sense, trading is âcrackâ. âCrackâ shall not be overdosed, particularly when dancing with MM. I am done for the day Today my MM is citi group, and others. These days MM very often is just part of a big group, which does asset mgmt, hedge fund, advisory and technical service for institutional clients. There are some kind of regulations I guess, but âloopholesâ and âfavorsâ are always there. Their favors are very often otherâs cost, particularly small and retail traders. http://marketreflections.com/ Can MM manipulate index? I canât find any data to TA with and therefore can not trade âitâ. The manipulation of individual stock with a day session or over a few days can be âfeltâ everyday by a day trader. MM is formidable but not infallible. Market force, or âtrendâ if you will, dominates every trading session. In front of a trend, MM is just as week as an average day trader. In front of market trend, big or small, everybody is equal. In front of knowledge, skills, experience, patience, endurance, guts, everybody is not equal. To be better is to learn from others, including MM. 19th century British moral philosopher John Stuart Mill wrote in his "Essay on Coleridge.": "Lord, enlighten thou our enemies", "Sharpen their wits, give acuteness to their perceptions, and consecutiveness and clearness to their reasoning powers. We are in danger from their folly, not from their wisdom: their weakness is what fills us with apprehension, not their strength."
Is the current correction over? The Standard & Poor's 500 index, a benchmark of corporate America's equity, dropped 75 point from 1449 Feb 27, 2007 to 1374 March 5, 2007, a 5.2% correction so far, triggered by a slide in Chinese shares and warnings by Greenspan that the U.S. economy was vulnerable to a slowdown. http://marketreflections.com/ S&P closed at 1436, As of March 23, 2007, just 13 points short of its open on Feb 27, 2007, retracing 82.6% of its loss since the current correction started. Is the current correction over? I would probably say yes, in the sense that the bottoms may have been found on 030507 for S&P, Dow and Nasdaq, So, just about 5.2% correction this time? Probably yes. The indexes may test the 030507 low again, but it is very difficult for the indexes to go a lot of lower than 030507. I doubt S&P will make it to 200MA of 1354, about 20 points lower than 030507âs close. The strong headwind against bears are from FA and PA, PA being political analysis. Letâs start with Fed. Fed, being US central bank, is also a political institution, a part of US government. In my âFed and three representationsâ, I talked about Fedâs dual mandate instituted by Congress: employment and inflation objectives. Thatâs politics right there. For simplicity, inflation objective is more important for bond holders. As bond holders, higher than expected inflation is bad, with default being the worst. Thatâs why on the long-end of yield curve, inflation risk has to be priced. If the inflation turns out to be higher than expected, your bond would depreciate, other things being equal. So bond market participants like Bill Gross cares big deal about Fedâs control of inflation. Employment objective is more important for workers like average Joe, again for simplicity. For Joe, with a big mortgage and credit card balance outstanding, he probably doesnât care much about inflation, and theoretically he could even benefit from it as a debtor: creditorâs loss is always debtorâs gain. But Joe needs a job, and for every Bill Gross, there have to be many Joes, ratio unknown. So, there have to be many jobs around. Politics is called âbalance of power/interestâ sometimes. I guess thatâs one of the reasons, House Financial Services Committee Chair Barney Frank told Fed chief Ben bluntly early this year that he opposes a specific numerical inflation objective because it might conflict with the Fedâs employment objective as part of its dual mandate. Ben, being an âdata dependentâ professor and supposedly one of enthusiasts for numerical inflation objective (ECBâs present target is to keep inflation below, but close to, 2%.) , must be disappointed a little bit. But I think Ben understands the message very well, being an inventor of âBenâs helicopterâ himself. A government in a capitalist economy would use its power to provide certain level of employment to the working class. Marx had a gap in his capitalism theory on this issue. He thought the working class in England of his time would have to launch a revolution just to survive. To make accomplishing its employment objective easier, US government debased US financial system from gold standard long time ago, and has since then practically put US financial system on a âbond standardâ. With Fedâs treasury operation, government can manage liquidity in the system according to its policy purpose. Why tie up yourself to a piece of metal like gold or silver? Why tie up yourself to a particular value of CPI such as 2%? Fedâs statement on March 21, 2007 was interpreted by market basically as a Ben Put: âAt the very least, many take comfort that U.S. Fed Chairman Ben Bernanke appears, like his predecessor Alan Greenspan, to be ready to help with easier money if things get rough or in the event of nasty shocks, like this year's subprime mortgage jolt.â (marketreflections.com) As to inflation, if CPI 1-2% is presumed to be Fedâs comfort zone, why 2.7% cannot be presumed? Deng Xiaoping proves to be the master of politics, just like his other CCP comrades. â A cat is a good cat as long as it can catch a mice, color of cat doesnât really matter, black or whiteâ. Bond market Through bond market, Fed âcontrolsâ (lack of a better word) banks and banks control economy. Average daily trading volume of Treasuries is about $500B, 7 times of that of NYSE and Nasdaq. The weekly average of corporate debt sales of 2007 is $24.6 billion, or $100B per month, according to data compiled by Bloomberg. So, it is important for bond market and Fed to understand each other, and to keep economy going, so Joe has a job and pays his bill, and Gross makes his profit. It seems they do understand each other well. Corporate bonds: âCorporate debt sales totaled $34.8 billion in the week ended March 9, more than double the previous week's total of $14.9 billion, when investors fled all but the safest assetsâ (Bloomberg.com) âThe perceived risk of owning corporate bonds has fallen from a five-month high, and an index of derivatives tied to subprime mortgage bonds has gained about 14 percent in the past three weeks. Even emerging market bonds, among the riskiest assets, are rallying.â The CDS (credit default swap) index I followed: iTraxx Crossover 10 Y was 319.33 on 032307, down from 340.88 on 030507 DJCDXNI is currently at 34.73, down from about 40 on 030507. Mortgage bonds: âAn index of credit-default swaps on 20 mortgage securities rated BBB- and created in the second half of 2006 fell 36 percent from Jan. 18 to Feb. 27 when it reached a low of 62.25, indicating deteriorating confidence. Since then, the index has recovered, climbing 13.75 percent to 70.81, according to London- based Markit Group Ltd., which administers the ABX-HE-BBB- 07-1. The index traded as high as 97.47 on Jan. 19.â(Bloomberg.com) Hedge Fund is never behind anybody âAhead of curveâ is the slogan of Citadelâs founder, billionaire trader Kenneth C. Griffin. Citadel bought bankrupt ResMae Mortgage Corp. two weeks ago, and took a 4.5 percent stake in Accredited (Bloomberg.com). So, Citadel, one of my MMs, even acted long before Fedâs statement on 032107. Farallon Capital Management LLC, a San Francisco hedge fund that invests in companies facing cash shortfalls or bankruptcy, said this week it held talks to buy San Diego-based Accredited Home Lenders Holding Co. before agreeing to lend it $200 million. Conclusion Subprime is a big problem without Ben Put, and a manageable problem with Ben Put. Is that the bond market and Hedge fundâs interpretation of Fedâs statement? They are probably right, and consequently we probably have seen lows for major stock indexes on March 05, 2007. Caution is always advised for traders. As one of big the volume guys in treasuries trading (031207 âWhat would you do if you are Citadel?â Marketref;ections.com), I suspect Citadel probably sold a lot of treasuries last Friday. âSelling on newsâ in Treasuries last Friday pushed down price across the entire yield curve, raising up 10Y and 30Y yield indexes back to the level on or before Feb 27, 2007.