Monday, July 4, 2011

Happy Independence Day to US Traders

This would be the perfect time to discuss US debt. While this is the country which is known for its strive for independence, one can not deny that US depends on outside creditors for its debt. China and Japan are the largest holders of our government debt; other sovereigns have been investors in our treasuries as well. It is widely known that Big Panda has been diversifying its foreign reserves out of US dollar and debt into other assets around the world*. Japan has been concentrating its reserves on  endless domestic problems: fight with deflation and lack of growth, as well as  post-earthquake recovery efforts. Many of the sovereigns have been pulling back from our treasuries for various reasons. So who has been buying all of our debt? FED. It is now the largest holder of our govt debt through purchases in QE1 and QE2. Speaking of QE2, while it just ended, FED will still reinvest the interest on treasuries that it accumulated. So all those who think it is over - it ain't. QELite is here to stay for a while. Mr. Bernanke said at least 2-3 FOMC meetings will pass before the end of the easing campaign. FED's balance sheet has swelled by $3 trillion, a lot of interest is paid on that principal (perhaps as much as $200-300B in the next 12 mo).  Many have been saying (and have been wrong for a while) that treasuries are the next bubble to burst. This notion has been keeping bond funds like PIMCO on sidelines lately, further reducing the pool of available treasury purchasers. To throw a monkey wrench into all of this, our government has decided to have a stalemate debate this coming week about raising the debt ceiling. Except for Domino's working overtime to deliver pizza to hungry politicians, as they work into the wee hours of the night to get this done quickly and go on canceled Summer recess, I see no point in all of this. Congress has been very ineffective this year, and I would not be surprised when the news about the lack of progress on this issue will weigh on equities in July.
So why all the details about US debt here? As a trader I have to be aware of major catalysts which could create the opportunity of a lifetime. How many times have we had our debt ceiling reached? I am preparing myself for a possible ugly day or a week in equities in July or August, when the debt ceiling is not raised and US default is imminent. Do I think the default will happen? NO. Mr. Geithner will look around inside of his Treasury murse and find as many Benjamins as needed to keep us afloat until debt ceiling is raised (poor man will be so exhausted by then, "he finds his job too taxing" and he will be leaving, that had to be the funniest thing I have heard about him). But perception is the reality now in the trading world. Let's see if we can have another Dow 777 point decline, like we had after failed TARP passage on first attempt. Politicians got the message and passed it days later, when they realized their constituents just lost that much of their net worth, as more than half of Americans own stocks in their retirement portfolios. Opportunistic traders were ready back then and picked up the equities on the low from fearful. My SPX levels on the downside will come handy should the debt ceiling debacle happen. Be ready, plan ahead, and stick to your plan. (more on trading the plan in my next post)

* In late breaking developments China has been identified to be misleading US on its debt purchases. I remember Rick Santelli from CNBC screaming about huge increase in direct bidder percentage at auctions, and asking where the heck was all of this coming from. Well, we get our answer now

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