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Friday February 18, 2005 - 11:28:15 GMT
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The yield "conundrum"


“In order to act quickly and flexibly in the world, we assume much of the missing information.”

Robert Ornstein, The Psychology of Consciousness

FX Trading

Mr. Greenspan referred to the behavior of long-term yields as a “conundrum.” A conundrum is defined as, a hard or puzzling question, which is the way I am sure Mr. G meant it, or did he! A second definition for conundrum reads: a riddle, especially one with a pun in its answer. You know what this means, its time to call for Batman—the Riddler is on the loose.

Playing the role of Batman today is Greg Weldon, editor of Weldon’s Money Monitor. After feeding all of Mr. Greenspan’s riddles through the Bat-Disgronophocator, our masked hero came up with this:

“…NEW SECULAR HIGHS IN LIQUIDITY, and, the explosive liquidity under the direction of hedge funds, and their preferred investment vehicle, equities. Gee, might these FACTS have something to do with the violence of the divergent macro-market trends …

“• US currency-in-circulation component of money supply, a gauge of global, bulk USD liquidity, sits at a NEW ALL-TIME HIGH

“• US Bank Reserves at a NEW CYCLICAL HIGH

“• Hedge Fund ‘reserves’ at a NEW ALL-TIME HIGH, nearing $1 trillion, on the back of explosive growth in the number of funds.

“The Fed is talking-the-tough-monetary-talk, but they are NOT walking-the walk, as money supply and excess liquidity EXPLODE. Indeed, there is CAUSE for this, as far as the Fed may be concerned. Consider that Japan and the EU are in RECESSION. Thus, the Fed CANNOT ‘restrict’ credit, or risk a global recession, or worse. The money/credit data PROVES it.

“The crunch in credit spreads is EVIDENCE, as foreigners now begin to plow excess liquidity into corporate bonds. The excess liquidity is SEEN in the hunt-for-yield, which supports high yielding currencies, emerging markets, and global yield curve flattening.

“Of course, Greenspan is NOT going to reveal his magician-like monetary misdirection, since the US domestic scene is NOT currently experiencing the degree of eco-distress currently being felt in Japan and the EU.

“Greenspan will keep raising rates, without tightening via any magnitude that would ‘cause’ credit to actually ‘contract’, NOT when the US consumer is, again, the ONLY focal point for global growth in final goods consumption.”

Foiled again Riddler?

Maybe there was much to glean from Mr. Greenspan’s testimony after all. Maybe the crowd that implies the Fed won’t be aggressive, despite it’s signaling of more hikes ahead ARE on to something. Maybe it’s why Mr. Greenspan suggested that real rates (nominal minus inflation) are tightening because inflation was subdued—a subtle little signal indeed that the Fed may be closer to the end of tightening that many believe.

Or maybe out Bat-hero has it all wrong. Maybe Mr. Greenspan has decided that he doesn’t want to be remembered as the Fed Bubble-Ologist, after an otherwise long and distinguished career. If so, it means the budding consensus is underestimating his resolve—we have seen that before.

This is from Morgan Stanley economist David Greenlaw: “[I]n response to a question regarding the so-called neutral fed funds rate, the Chairman noted that he doesn't know what the number is but that it is the point at which Fed policy imparts ‘a degree of stability to the economy and removes any sense of excess that would create inflation pressures.’”

After all, don’t asset bubbles represent inflation in another form? I think they do. And if Mr. Greenspan believes that, the excess liquidity train may soon come to a screeching halt.

The riddle seems to produce more questions than answers. Ut-oh! Could it be? Yikes! It’s the proverbial conundrum wrapped in an enigma. Nice try Batman! But to solve this one, we’re going to need a whole bunch of superheroes.

Jack Crooks


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