Sell US Treasuries? Probably Not

Newedge - Morning Porridge August 1st 2011

By Bill Blain, senior director, special situations, Newedge

Bill.blain@newedgecom

“Ah, thank the Lord for a week at work to recover from the weekend..”

Dollar up. Oil Up. US markets up. CHF and Yen down. Praise the Lord, Hallelujah and apple pie…we are saved. (Loud Sarcasm Alert…).

Last night’s stroke of midnight US debt ‘deal’ shouldn't surprise anyone - last minute agreement always looked to be on the cards. Our suggested trade ‘of the day’ on Friday was buy US Treasuries and sell into this morning's relief rally. Whee-hee if you did!

How long-lived will the rally be? Limited. ‘Reduce the deficit and avoid default’ seems a little empty to be a road map for future deficit reduction. $917bn in cuts over 10 years looks like a limited ambition. Politically, the agreement is, at best, a fudge up. Its agreement for agreement's sake – pleasing no one by neither cutting spending or raising taxes enough. In that nothing is solved, it’s just like every ‘full and final’ settlement to the debt crisis Europe has announced in recent months.

If anything, the right wing won this battle by a nose – but might have made themselves unelectable! Mightily have they smote the spendthrifts of Capitol Hill – yada yada… The Tea-Party’s intransigence is a fascinating insight: the libertarian US caucus adopted Bolshevik stone-walling as its prime negotiating tactic! This morning we'll get lots of talk and analysis about the bones of the new agreement, and what likely issues will remain on the discussion table. There is a whole new career of ‘budget-watching’ beckoning to challenge-starved financial analysts.

Regular US budget crisis look likely to become an ongoing market feature. However, the market focus cares little for political posturing. The debate is now about the likely US downgrade - which looks more nailed on than ever.

Not only has the long-term US deficit problem not been addressed, but the fudge-up leaves the economy vulnerable to repeated dislocation from the flawed political process. There is nothing immediately obvious in the package that will stop a ratings analyst from pronouncing US national debt remains a major future concern - which means a downgrade is inevitable.

But should you be selling Treasuries? Probably not. What's the alternative? There isn't one that offers the same liquidity, (as yet) remains front and centre to the global economy, and retains access to the printing presses. Some may see Germany as the global safe haven - but it's mired in the European crisis. Even though Germany is the core of Europe, on a individual country basis it has surrendered its' freedom of economic action and financial  independence as conclusively as Greece, Ireland or Portugal. If/when crisis strikes Germany, its freedom of action will be massively constrained - making the consequences so much more painful.

And of course, downgraded or not, the US is likely to repay its debt. The debt burden will fall. Come growth, the US remains far better placed to accelerate out of recession and swifter to repay than mired Europe.

So I reckon the next few days are about relief rally a budget agreement was secured, even though it fools nobody, and then the slide into downgrade. Play your chips accordingly.

Banks, Banks and Banks..

This week's slew of bank results should open our eyes to global banking weakness. Sunday headlines were about 10,000 jobs to go at HSBC, the collapse of the investment banking crutch at RBS, 5,000 jobs lost somewhere else, and 2,000 to go at another place. It’s all horribly predictable and familiar - the financial job tide is receding again! Falling trading revenues - yes, fixed income markets are difficult - and diminished confidence make the investment banking sector looked stressed.

Which is an issue for clients. Although the amount of cash to be invested in fixed-income markets has quadratically increased in recent years, the liquidity has diminished. Why? As the investment banks become less profitable, their willingness to underwrite risk diminishes. Clients should be asking how much they were making off with before the crisis! There hasn't really been a functioning market-making sector to the Eurobond credit markets since the crisis of 2007. Yet investment banks still function in fixed income markets by convincing clients that only they can offer execution services. It’s arrant nonsense.  

So time for some blatant marketing of why not to use banks….

As a leading player in futures and options, and a clearer on over 80 global exchanges – Newedge probably touches far more clients than any investment bank ever did. As agency brokers we offer a very different, but more effective service from the banks. We don't claim to make markets - we simply match buyers and sellers of risk. Just like investment banks we can't guarantee to sell a position, but because we don't take positions or underwrite deals, (simply taking a turn on each trade), you can be confident we aren't front running them either.

If you haven't tried using agency brokerage, you should. As this week will show, the current investment banking model is well burst...    

And on that bombshell… welcome to a new week!

Out of time…