Learn to bear bravely changes of fortune. Cleobulus - MAJOR change in market from last five trading days..

We had major move overnight, again in, fixed income in the US, trigger seems to have been Mr. Greenspan comments, but truth being the 10-y bond auction yesterday was horrible..Indirect bid, which translates to foreign central banks, was a mere: 10.98% versus an average of 15.2% in the last five auctions. It the lowest since March 2006.

Credit default swaps linked to 20 bonds rated BBB- fell 2.5% to 62.38. The most interesting being that its REAL RATES which is rising across the world, as inflation expectations remains contained and even indicates lower inflation in the coming months. Interpretation: Fixed income players simply wants more RISK PREMIUM to take risk! This is major change - as the last three years has seen nothing but lower yield and volatility.

Table 1 10 y. US generic yield

It is MAJOR event when 18 years of trend is broken. Being in bear market for fixed income have serious implications for how cash-flows and future earnings. Anyone with MBA knows how going from zero funding rate to 4% massively changes the cash-flow analysis. Steeper yield curve also make long-term financing, read Private Equity, more expensive and generally there is less of the credit available as the natural consequence of higher yield, is more people fall behind on their credits increasing defaults.

The move yesterday is even more significant from trading perspective as it happened in vacuum of new data!

To illustrate the magnitude of this move I had my associate Carl F. Beck plot the last 1200 trading days changes PERCENTAGE wise day-to-day:
Std. Deviation: 1,29%Average: 0.03%

The change from Wednesday to Thursday last was 3.34% or about 3 std. dev. Changes of 2.9% or above have only happened for 24 trading days.

There is more pain in the system potentially as every single central bank in the G-10 is looking to tighten their monetary policy further.

Price Matrix for future moves by Central Banks (Source; Lehman Brothers)

From strategy point of view we are:

Short US Fixed income, t-bondsLong puts on Dax Julyshort EURUSDShort SilverShort S&P SeptemberShort NZD, and AUD

We have some concern at the disconnect on carry trading, which despite the new rates regime have not moved, however we feel that the size and direction of global real rates will eventually take it toll on carry trading. AUD/JPY and AUD/CHF are by far the biggest positions in the market right now.

Generic Carry model going from strength to strength (note the excess return profile and Sharp! Unreal)

Conclusion

This is crunch time - how the market reacts to this new higher regime next few days important. Keep an eye on mortgages, CDO's and other highly leverage strategies, if this get real legs it could mean excessive move in yields, but risk as always being tomorrow we can not even remember we had the scare.
Be careful out there

Med Venlig Hilsen Yours Sincerely Steen Jakobsen, Chief Investment Officer, Saxo Fund Management Saxo Bank A/S -London 40 Bank Street, 26th Floor Canary WharfLondon E14 5DAPhone: +44 (0)207 151 2010 Fax: +44 (0)207 151 2001Please visit our website at: http://www.saxobank.com/