Friday, November 18, 2011


Fear has entered the marketplace.

Investors are fearful of (in order of importance):

* the eurozone's continued debt crisis;
* a liquidity squeeze in which banking credit is cut off;
* the perception that Republicans and Democrats in the Super Committee will fail to make the needed compromises; and
* a technical breakdown in the averages.

But fear is a necessary reagent to a sustainable market advance.

"I am deeply unhappy with the current forecast of prolonged high unemployment, and will continue to review whether there is more that we could do that would bring more benefit than cost...If additional asset purchases were deemed appropriate, it might make sense to do much of this in the MBS market. This would have a greater direct impact on the housing market and would be less likely to disrupt market functioning compared with further purchases in the Treasury market."

-- Federal Reserve Vice Chairman William Dudley

Dudley appears to be previewing the possibility of more quantitative easing -- perhaps as early as at the next meeting (Dec. 13, 2011).

Rumor has it that the continued torturous MF Global situation is scaring potential providers of credit and swap lines to Jefferies.

While I recognize that this is a ridiculous long shot, our political leaders might wake up and learn from the eurozone's policy mistakes and effect meaningful and outside-of-the-envelope policy that more swiftly cleans up the mortgage mess (by addressing the shadow inventory of unsold homes), directs more serious attention to our structural unemployment problem and enacts pro-growth fiscal legislation.

The process of limiting the debt contagion in Europe has continued for too long and has become the tail wagging the dog (and the world's equity markets), as demonstrated by the sickening late-afternoon market swoon on Wednesday.

One of the differences I have with the bears now is that I expect, before the problems in Europe get too worrisome and out of hand, that the ECB will ultimately step up by lifting its purchases of Italian and Spanish bonds, will further cut targeted interest rates and will introduce a large quantitative-easing program, so I am willing to look over the valley of eurozone uncertainty.

To date, the ECB has been tame and timid, so the speculators and bond vigilantes in Europe have continued to put pressure on sovereign debt prices until the ECB enters the shock-and-awe phase.

Shock-and-awe will come sooner than later; the adverse economic ramifications and poisoning/collapse of the European banking industry are alternatives that will ultimately be unacceptable to Europe's leaders and populace.

The French bond auction went better than expected, as the bid-to-cover ratio expanded. That's the good news.

The bad news was that the Spanish auction was worse than expected, as bid-to-cover ratio contracted. (Yields have risen by 26 basis points.)