Recently financial markets have experienced more volatility than any historical period (since such volatility is being measured), according to a volatility index traded as a futures contract on the CME called the VIX. Aside from the anomalous trader profiting from the chaos, many investors have suffered large losses , and more importantly they are seeking safety in bonds and other debt-based instruments which have proven to be unsafe. Many previously high rated AAA bonds have been reduced to junk, and their exposure is almost everywhere. Many funds will invest in these risky bonds, either in the form of the repackaged sub-prime asset backed securities, or in the commercial paper market. For example, many money market funds had invested in CDO's, against the doctrine of the founder of money market funds, Bruce Bent.
"The money market fund was created to provide effective cash management, to guarantee at least a dollar in and a dollar back and beyond that, a reasonable rate of return," Mr Bent says.
Driven by fear, investors have moved quickly into treasuries, a 'flight to safety'.
Aug. 20 (Bloomberg) -- Yields on U.S. Treasury bills fell the most in two decades on demand for the safest securities amid concern over a widening credit crunch.
Bill yields have fallen five straight days as money market funds dumped asset-backed commercial paper in favor of the shortest-maturity government debt. Three-month yields dropped the most since the stock market crash of 1987 and more than in the wake of the Sept. 11, 2001, terror attacks in the U.S, as funds shunned assets that may be linked to a weakening mortgage market.
``The market is totally, absolutely, completely in fear mode,'' said John Jansen, who sells Treasuries at CastleOak Securities LP in New York. ``People are afraid that lots and lots of mortgage paper and mortgage paper derivatives of all sorts is completely opaque and they can't price it.''
The three-month Treasury bill yield fell 0.66 percentage point to 3.09 percent as of 5:06 p.m. in New York. It's the most since Oct. 20, 1987, when the yield fell 85 basis points on the day the stock market crashed, and eclipses the drop of 39 basis points on Sept. 13, 2001, the day the Treasury market reopened after the attacks. The yield has fallen from 4.69 percent on Aug. 13. The bills yielded about 7 percent in mid-October 1987 and 3.2 percent in the days before the September 2001 attacks.
``I've never seen it like this before,'' said Jim Galluzzo, who began trading short-maturity Treasuries 20 years ago and now trades bills at RBS Greenwich Capital in Greenwich, Connecticut. ``Bills right now are trading like dot-coms.''
However, treasuries are still US Dollar based. If Bernake lowers rates, and continues to lower, as indicated by the sentiment of traders, it can only sink the already sinking dollar more. In the next 12 months, if the dollar drops another 20%, and your treasuries have yielded 5%, your net gain is negative 15%. This may seem like simple arithmetic, yet no analyst on the street is mentioning the currency trade. They all know the carry trade, and that it's unwinding, but this is looked at as speculative trading activity. No one is commenting on the greater economic and investment impact of the 'credit crunch' as it relates to the dollar, and what it means for US based investors. They see the problem but not the solution. The current credit crisis is simple to understand.
- Average weekly wage as of December 2006 is $861 ($44,772 annually)
- Number of employed persons in US nationally is 135,933,200
- Total earnings is 5.7 trillion, GDP is 13.1 trillion (7.3 trillion sur-minus)
- Total national debt is 9 trillion
- Trade deficit is -$763.6 billion in 2006
The US doesn't have a surplus; we have a sur-minus. This is known as the national debt, but it comes in many forms. One claim is that we have a double deficit, that is, a current account deficit and a fiscal deficit. The consumer, the US government, and US based corporations all have negative savings rates, meaning they spend more money than they have.
What enables the economy to function in the red is a simple credit mechanism, which is unfortunately not backed by anything other than belief in USA. At some point, as the case with the credit market, there could be a 'tipping point' that could cause a whirlwind of dollar selling, a 'flight to convertibles' similar to the credit 'flight to safety'. Even the IMF states in a report that the USD is 30% overvalued.
Many stock analysts are recommending companies based on their overseas operations, placing a great value on companies that derive a great portion of their revenue from offshore markets. This is not a vote of confidence in sophisticated multinational operations; it is a derivative dollar short. These corporations are profiting in Euros and Pounds, and therefore have more gross revenue when repatriating those profits back home in the US Dollar, inflating their revenue by the value of the dollar decline. An investor doesn't need to invest in these stocks in order to profit by a dollar decline; one may simply short the dollar.
Shorting the dollar if you are a US based investor is a natural hedge, because if your trade is wrong, you will benefit from a long dollar position in your savings account (which is dollar based). It seems like a no-brainer, why isn't everyone doing it?
Real estate no longer is an appealing investment (if it ever was). Stocks are currently suffering due to subprime 'credit crisis' related exposure. Bonds are being downgraded to junk; ratings agencies rank bonds AAA one day and junk when they collapse, so what is the point of purchasing high-rated debt instruments?
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