Pull My Finger
You know the old gag. Someone walks up to you, extends a forefinger, and insists that you pull their finger. Upon doing so, they emit a noxious odor accompanied by the sound of a tired bugle. You know the gag. You know the result. It's annoying and you really don't want to play. Yet, whether or not you pull the finger, you still get the stink.
A week ago on Friday the market was all in a dither about a fund in Dubai asking for a six month extension on a debt payment. Money supposedly rushed to the US dollar for safety and when the dollar rises, the stock market falls. Is the world so confident in the dollar that is printed night and day by a government tens of trillions in debt? No, it's about liquidity. The market is all about liquidity these days and the Dow is the ripple effect of this liquidity.
I give you two charts to review this week. The first one is a 33 month weekly look at the IEF (iShares 7 to 10 year bond ETF fund) in blue and the US dollar in green. As you can see in late 2008, the dollar appreciated and the bond ETF sank. This continued until March of 2009 and following the Fed's master plan, the dollar resumed its descent and bonds rallied. This is the Fed at work. To save the big banks, they went zero with interest rates. Temporarily, this results in a renewed bond interest since bonds were still paying something. The real meaning is money is worthless if it bears no interest coupon. Investors are therefore willing to hold almost anything other than the dollar. It's like the Fed saying, "We can fix everything if you will just pull my finger." But in general, the bond ETF and the currency are trending in the same direction - down.
33 month - TNX in blue, USD in green
Chart courtesy StockCharts.com
The stink then begins to waif through the air when investors realize the dollar destruction also destroys everything around it. You would think that a falling dollar would instigate inflation and bonds would sell off as the dollar falls. When we look closer at a 6 month chart of the same two contestants, we see this is true. The market is trying to find balance but the Fed just won't let it. They continue to manipulate the bond market in an effort to tamp down the natural tendency of interest rates to rise in a falling dollar era. This is due to monetary inflation. Of course, our pitiful government cannot admit to inflation. They leave that for each of us to discover at the grocery store, the post office, Fed Ex shipments, taxes, and virtually every monetary exchange point as we know a Federal Reserve Note buys less and less. But, no inflation means no cost of living adjustments to social security recipients. And of course, Obama's boys know a measly $250 appeasement check will quell the senior anger. This is mearly another link in the shackle of ignorance that has incarcerated America's cognition. Many of them are still infatuated with slayer of capitalism. In fairness, the last White House occupant was doing the same thing so we can all be confident that the government is now only a government for the banks and not the people. Anyway, the next chart shows the relationship of bonds and currency. The key point for investors is that we must all remember that foreigners own us now. They own trillions of dollars worth of our debt and they get nervous when bonds sell off violently thus driving up interest rates and drawing down their treasury portfolios.
So a week has passed and Dubai is in our rear view mirror. They played the derivative trump card and central banks no doubt pledged rescue efforts with worthless money. To keep the party going, the US government claimed job losses to the US economy drew down to only 11,000. Unemployment fell to 10%. The markets rallied. The dollar strengthened. Okay kids, what did I say happens when the dollar rallies? That's right, the Dow falls. Besides, no one really believed the numbers. The rally caved in. Certainly the Fed stepped in late in the afternoon to put the market back in the black. In fact, the volume in the IEF was 756,604 for the day. It traded a bit over 100,000 shares in the final thirty minutes of trading as the price surged on Friday afternoon. This of course should serve to lower the Treasury yield which soared over 3% on the day to 3.84%. Of course, IEF is an ETF and it traded up until 4 o'clock. Treasuries shut down at 3. As you know, a 10-year Treasury yield at 3.5% is what I call the 'Asian Phone Call' pattern. This is when Bernanke and the Fed buy the yield down to appease our Asian creditors. Now, who would buy such a large block of bonds at the very end of the day? Who would buy so many bonds late on Friday afternoon knowing that the Treasury is flooding the market with supply next week to the tune of $74 billion? Pull my finger.