T-Waves Thoughts for
Trading Week of 06-01-2009

by Stephen Tetreault, T-Waves | June 1, 2009

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Our economic calendar for this week is quite robust with several key reports (see list and schedule at the end of this report) we get the next look the ISM manufacturing and services reports, personal spending and incomes and lastly the most important of all announcements the non-farm-payroll report due out on Friday!

Please note…….TrimTabs Investment Research reports that on Monday, June 1, the Bureau of Economic Analysis (BEA) will likely revise its estimates of wages and salaries and the personal savings rate substantially downward (one reason for my bearishness as I agree with their analysis) for the last quarter of 2008 and the first quarter of 2009 when it incorporates actual wage and salary data from the state-collected Q4 2008 Quarterly Census of Employment and Wages (QCEW). The QCEW data will show that wages and salaries were much lower in Q4 2008 and Q1 2009 than the preliminary BEA estimates (this type of data could be just what the bears have been awaiting). Bernanke's “green shoots” are about to get hit with a big dose of weed-killer, when the BEA revises its wages and salaries estimates downward by as much as three-to-four percentage points for the six months prior to March 31, 2009," said Charles Biderman, CEO of TrimTabs. The BEA will confirm what I have known for many months, the economy is in much worse shape than preliminary estimates indicated.

TrimTabs uses daily income tax withholdings flowing into the U.S. Treasury to estimate changes in wages and salaries. According to this data, wages and salaries dropped 1.4 percentage points year/year in Q4 2008 and plunged 5.3 percentage points year/year in Q1 2009. In contrast, the BEA, in its initial estimates, used income data from the QCEW report for Q3 2008; it then reported that wages and salaries grew 1.0 percentage point year/year in Q4 2008 and declined by only 1.0 percentage point year/year in Q1 2009. “By relying on Q3 2008 income data, the BEA missed the huge turning point in the economy in Q4 2008 as a result of the Lehman collapse,” Biderman stated. “The downward surprise on Monday resulting from the BEA revisions is likely to hit the equities market hard,” he added. Worse still, the income picture darkened in May. TrimTabs real-time data indicates that net take-home pay, which is defined as after-tax wages and salaries plus income tax refunds plus government tax credits and tax rebates, is down a staggering 16.3 percentage points y-o-y so far in May, compared to a decline of 4.3 percentage points y-o-y in the period of February through April 2009. “Real-time data leaves little doubt the economy continues to contract at a rapid clip,” said Biderman. As such widespread expectations that the economy will recover in late 2009 are going to be dashed.”

For my Gold bug friends......The International Monetary Fund's decision to sell its gold reserves could get the necessary approval from the US Congress this week. At the G20 summit in London in April, participating countries agreed the IMF could sell 403.3 metric tons of gold as part of efforts to leverage up to $6 billion in concession loans for low-income countries over the next few years. In order for the sale to proceed, 85% of IMF shareholders need to approve the proposal. Since the U.S. has 17% of the votes, it has a de facto veto over the proposal, which requires Congressional approval, but IMF Managing Director Dominique Strauss-Kahn told Dow Jones Newswires this week he expects Congress will approve the sale; this could impact the supply/demand function of gold in the markets place!

The month of May represents the third consecutive month of gains for the various indexes, with the SPX gaining 4.7% on the month, the Dow 4.0% and Nasdog lagging the pact with a gain of 2.9%. May's gains were a bit smaller than March’s huge rise for the SPX of 8.5% and April’s remarkable 9.4% gain for the SPX, as the markets have started to either consolidate or distribute in a narrow range for most of the month. With continued gains and trading that was largely confined to a tight range, volatility continued to decline. This is evident in the 17.8% monthly decline in the VIX, which is now at 29.85 vs. 36.50 at the end of April. The daily swings in the broader market narrowed further in May as well, with an average daily swing of 163 pts in the Dow, compared to 188 in April and 248 in March.

On Tuesday, the markets were in a love tryst with stocks, by Wednesday we were all bond traders and stocks were out of favor, and now I’m just simply confused. Riddle me this old great-Batman: we get news of record mortgage delinquencies (12%), house prices declining at a record pace in Q1 almost 20%, continuing jobless claims holding climbing to a record 6.8-million (2.3 million collecting federal unemployment), a disappointing new homes sales number, crude creeping back above $66 barrel and the markets shrug off the contagions as sprouting green shoots of growth…hell the stimulus from Obama will ensure an iPod, Black-Berry, Dell-Computer and new sub compact car for all right? Call me an old cynic or doubting Thomas, but I agree with the views expressed by Art Cashin a savvy old trader, I believe the recent rally is almost entirely based upon speculators, pro-gram quant traders, suckers and gamblers betting on to many low quality names, with huge short-positions and hard to borrow status. He calls it cash for trash and yesterdays move was just more garbage buying. Crude goes up, and it’s a great catalysts for transports especially airlines right?

The good news the so called green-shoots is that over the past few months the economy doesn't seem to be getting much sicker, so the patient has not flat lined yet. The bad news is that it's not getting better either, its still on what I like to refer to as life support.

Day traders (like me) and program traders (manipulators like the trading desks of GS, MS, LM, BAC etc and hedge funds each day cheer or moan (mostly cheer or ignore) over each piece of economic data that crosses the wire as better or worse than expected. But true value and longer term investors would be better served to step back and look at the economy from afar so we can see the bigger picture.

The landscape that I’m looking upon shows the economy is still very weak. Thousands of people are losing their jobs every day, and very few are being hired. Thousands of homes are going into foreclosures every day. Businesses are still cutting back on their investments. Factories are shipping fewer goods out the door. Home sales are anemic to say the least. And credit is still extremely hard to get!

It's easy to get depressed about such numbers, but a balanced and objective view also recognizes that there has been some abating of the precipitous slide. In November, December and January, the economy was acting like an out-of-control duel-semi-truck with no brakes or steering heading down a steep, winding snow covered mountain road. Disaster loomed around every corner as the economy careened down the mountain during the blizzard.

Luckily, there was a runaway truck lane that served to gradually and safely slow the treacherous descent. Firms, consumers and investors were forced to adjust their behavior in significant ways, while the government stepped in like “superman” with massive injections of stimulus (taxpayer bailouts) also the Fed-heads have lowered interest rates to practically zero and the hordes of cheap and easy money (the same fuel that caused the last bubble), along with some government spending have mitigated the dangerous plunge.

Thousands are losing their jobs, but the green-shoots are showing that the number shows that fewer lost their jobs this week than in March. Shipments of capital equipment are still falling, but the pace has eased from a 38% annualized decline to 15% (though I find it hard to believe). Home sales have stabilized over the past three months though at an extremely low level. Foreclosures, on the other hand, haven't slowed one bit they are escalating!

Another half million jobs are expected to be slashed and burned in May. General Motors is heading into a potential deteriorating bankruptcy this week (more job losses there as well); hence it appears our truck is still rolling down the mountain, though the driver has regained some control. Fears of falling off the cliff have faded, but the danger hasn't passed as the brakes are now working….the economy is still far from its destination, but the steering hasn't been replaced yet.

A report on weekly jobless claims showed a larger-than-expected decline, while the monthly report for durable goods orders showed a higher-than-expected increase.

• Initial jobless claims fell to 623,000 in the week ended May 23, a decline of 13,000 from the revised figure for the prior week. Claims were expected to decline to 628,000.
• Durable goods orders jumped 1.9% in April, a larger increase than expected. Orders were expected to have risen 0.5% in April, according to the Briefing.com consensus, compared to a revised decline of 2.1% the prior month.

The number of new layoffs declined by 13,000 to 623,000 this past week, while the number of people collecting unemployment benefits rose by 110,000 to a record 6.79 million according to the Labor Department. Initial jobless claims will increase in the weeks ahead with massive layoffs related to plant shutdowns at Chrysler, and GM.

The four-week average of new claims (which smoothes out distortions in the week-to-week data caused by weather, holidays, strikes etc.) fell by 3,000 to 626,750 in the week ending 5/23. However last weeks initial claims for the week ending 5/16 were revised up by 5,000 to 636,000. Initial claims for unemployment benefits are down about 50,000 from the peak reached two months ago, but remain extremely elevated, consistent with an economy that has lost an average of net 665,000 jobs per month this year.

The cheerleaders on CNBC were signing the tune “Don’t worry be happy” as they claim that the slowing in new layoffs over the past few months suggests we saw the peak rate of job losses in the first quarter…I believe that they are wrong! Nevertheless the level of claims suggests that job losses remain very large in May. In the past 52 weeks, initial claims are up 67% and continuing claims are up a staggering 116%.

The number of people collecting state unemployment benefits rose by 110,000 to 6.79 million in the week ending 5/16….the cheerleaders failed to inform the public that another 2.2 million are collecting extended federal benefits, which kick in once a person has exhausted eligibility for the state checks, usually after six months…and the numbers are growing. This federal program is part of the Obama stimulus plan (bailout plan) passed by Congress. Its worth noting that the four-week average of continuing claims increased by 123,750 to 6.61 million. Initial claims represent what we refer to as job destruction, while the level of continuing claims indicates how hard or easy it is for displaced workers to find new jobs…and the data is dismal. The jobless claims report shows businesses are laying off workers at a rapid pace and finding a replacement jobs has never harder for those who've lost work.

New home sales in April rose 0.3% at a seasonally adjusted annual rate of 352,000 from a revised rate of 351,000 the month before, according to government figures. The market had expected an April sales rate of 360,000, while March sales were originally reported at a 356,000 rate. At the current rate, it would take more than 10+ months to sell through the existing inventory of homes on the market, according to the report. The National Delinquency Survey showed that more than 616,000 home owners were hit with foreclosure actions in the quarter. That's up 27% from the last three months of 2008, and the largest quarter-over-quarter increase in foreclosure starts since the MBA began keeping records in 1972.

A record percentage of U.S. mortgages entered foreclosure in the first quarter, and the jump in foreclosure starts compared with the fourth quarter was the biggest up-surge ever recorded in the Mortgage Bankers Association's survey. According to the MBA's quarterly National Delinquency Survey, 1.37% of all mortgages entered the foreclosure process in the first quarter, up from 1.08% in the fourth quarter. Total foreclosure inventory was also up, with 3.85% of all mortgages somewhere in the foreclosure process at the end of the first quarter, compared with 3.3% in the fourth quarter also a record jump…this is a dismal number but the markets seems to shrug off this mega contagion with only a glance!

The delinquency rate, which includes loans that are at least one payment past due but not those in foreclosure, came in at a seasonally adjusted 9.12%, up from 7.88% in the fourth quarter. The MBA survey covers 45 million mortgages, representing between 80% and 85% of all first-lien residential mortgages outstanding in the United States.

Jay Brinkmann, MBA's chief economist stated that “Now that the guidelines of the administration's loan modification programs are known, combined with the large number of vacant homes with past due mortgages, the pace of foreclosures has stepped up considerably,” he stated. Until the country's employment situation improves, it's not likely that the level of mortgage defaults will begin to fall, he added.

MBA's forecast, a view now shared by the Federal Reserve and others, is that the unemployment rate will not hit its peak until mid-2010 I believe it hits its peak mid 2011). Since changes in mortgage performance lag changes in the level of employment, it is unlikely we will see much of an improvement until after that. If the peak of unemployment doesn't hit until the middle of next year, it won't be until the end of 2010 or early 2011 that the foreclosure picture could improve, Brinkmann said. But that timing also hinges on the local pictures in states including California and Florida, which have had an oversized role in the increase in foreclosures; the sooner things improve in some of the worst states, the sooner the national numbers could also start to look better.

While subprime, option ARM and Alt-A loans were a focus of the foreclosure problem initially, the foreclosure rate on prime fixed-rate loans has doubled in the last year. For the first time since the rapid growth of subprime lending, prime fixed-rate loans now represent the largest share of new foreclosures. In some respects, these prime-loan defaults are the most difficult for lenders to address because they often indicate the loss of a job, or worse.

The association found that the combined percentage of loans in foreclosure and loans at least one payment past due, meaning the percentage of mortgage holders not current on their mortgages, was 12.07% on a non-seasonally adjusted basis - the highest level recorded in the survey's 37-year history. Even borrowers once considered safe are showing signs of stress, indicating the impact of the recession and unemployment, the association said.

The National Association of Realtors said about 45% of the existing homes sold in April in the U.S. were foreclosures and "short sales," whereby a homeowner sells for less than the amount owed on the house. The Realtors group said the large number of distressed-property sales contributed to the 15% decline in the median price from a year earlier.

As you can see from the chart above we still have not even reached the next wave of significant head-wind contagions! It was thought that te next wave of mortgage resets should be less painful given the recent drop in a key interest rate but they have reversed course more significantly than many thought! The next wave is nearly as large as this past one, but the big difference seems to be that the wave coming 2010-2012 has very little subprime mortgages resetting, and a much larger percentage of option adjustable rate and Alt-A mortgages resetting. What is the difference between subprime, option adjustable rate, and Alt-A mortgages, they may be resetting at distinctly higher rates!

If you think the housing slump can't get much worse, Martin Feldstein thinks that both home prices and the broader economy can and very likely will get a whole lot worse. The Harvard University professor and former chief economic adviser to Ronald Reagan isn't part of the crowd that continually forecasts doom. So when he spoke this past week Feldstein's grim calculations were noteworthy. There are now 12 million homes in the United States with a loan-to-value ratio greater than 100 percent. That's one mortgage in four. The aggregate amount of that is some $2 trillion, he stated. If you look at the median (midpoint) loan-to-value ratio in that 12 million group of underwater mortgages (mortgages with negative equity) the median loan-to-value ratio is 120 percent; a very dismal development. That means about 25% of all U.S. mortgages are exceed the value of the homes the mortgages are financing. In the case of half the homes that are underwater, homeowners are paying a mortgage that's now 20% higher than the value of the home.

Now this is quite bad; but it's likely to get a lot worse. A recent report by First American Core Logic, estimated that as of 9/30/08, 7.5 million mortgages, or 18% of all properties with a mortgage, had negative equity. The group thinks there are another 2.1 million mortgages that are within 5% of going underwater. Together, these two categories account for 23% of all properties with a mortgage. If home prices fall another 10-15%, as measured by the Case/Shiller Home Price Index, then four out of every 10 mortgages in the U.S. could be underwater, Feldstein stated. At those levels, it's hard to see how many people are going to be willing to keep up with their mortgages.

The implications for many homeowners are staggering. Before the recent housing boom of 2000 to 2006, homes increased in value at a historical annual rate of about 2.3% when adjusted for inflation. That means that for homeowners who owe 35% more than their home’s value, it would take, at historical averages, about 15 years just to break even on their home investment. So in essence they won't be building equity for quite a long time as such it would be a huge incentive for millions to just hand their keys back to the lenders and seek cheaper housing elsewhere!

The next problem is the $60-75 billion of adjustable-rate Alt-A mortgages, which fall between subprime and prime loans. Millions of these loans are scheduled to reset next year to higher interest rates. That could bring monthly mortgage payment increases of $1,000 or more if the loans aren't modified or refinanced. All this is happening amid what now clearly is a deepening recession, with the highest job losses and deepest drops in consumer spending in decades.

As job continue to be slashed and outsourced in growing numbers, a growing number of American homeowners with once solid credit are falling way behind on their mortgages, amplifying the current Tsunami wave of mega foreclosures.

In the latest phase (there will be 2-more) of our great nation’s real estate crisis the host of contagions has shifted from subprime loans (those extended to home buyers with troubled credit) too the far more numerous prime types of loans issued to those with decent financial histories. Many economists (most of whom always under estimate the contagion) are anticipating that the unemployment rate will rise into the double digits from its current 8.9% and this coming week we gat another glimpse at the non-farm payroll numbers, foreclosures are expected to continue to accelerate, which will likely exacerbate more bank losses, and will add more negative pressure to the financial system and the broader economy. Foreclosures were bad last year…and it’s going to get worse for the next several.

Economists refer to the current surge of foreclosures as the third wave (First it was the flippers, then it was the subprime borrowers, and now it's the prime borrowers those who have lost their job or some portion of their income or, for whatever other reason in a souring economy, can no longer afford to make their mortgage payments.), distinct from the initial spike when speculators gave up property because of plunging real estate prices, and the secondary shock, when borrowers’ introductory interest rates expired and were reset higher. We’re right in the middle of this wave, and it’s intensifying. The loss of jobs and loss of overtime hours and being forced from a full-time to part-time job is resulting in more and more defaults from coast to coast. Those sliding into foreclosure today are more likely to be modest borrowers whose loans fit their income than the consumers of exotically easygoing mortgages that formerly typified the sub-prime-slime-slide.

I read that we can expect that 60% of the mortgage defaults this year and next will be set off primarily by unemployment, up from 29% last year.

From November to February, the number of prime mortgages that were delinquent at least 90 days, were in foreclosure or had deteriorated to the point that the lender took possession of the home increased more than 473,000, exceeding 1.5 million, according to a New York Times analysis of data provided by First American CoreLogic; while those loans totaled more than $225 billion. During the same period, subprime mortgages in those three categories increased by fewer than 14,000, reaching 1.65 million. The number of similarly troubled Alt-A loans those given to people with slightly tainted credit rose 159,000, to 836,000.

Over all, more than four million loans worth $720 billion were in the three distressed categories in February, a jump of more than 60% in dollar terms compared with a year earlier; and these are green-shoots (NOT).

Under a program announced in February by the Obama administration, the government is able to spend $75 billion on incentives for mortgage servicing companies that reduce payments for troubled homeowners. The Treasury Department says the program will spare as many as four million homeowners from foreclosure. But three months after the program was announced, a Treasury spokeswoman, estimated the number of loans that have been modified were in the range of 10,000 to 55,000 a huge spread in a very mediocre total at best.

In the first two months of this year alone, another 315,000 mortgages landed in foreclosure or became delinquent at least 90 days, according to First American CoreLogic (a very dismal trend). I don’t think there’s any chance of this bailout program making more than a smidgeon of a dent in this growing contagion, the green shoots are going to turn into tumble weeds quickly in this scenario.

Last year, foreclosures expanded sharply as the economy shed an average of 256,000 jobs each month (now we hemorrhaging more than twice that a month). Since then, the job market has deteriorated further, with an average of 665,000 jobs vanishing each month (oh I forgot in the first 100-days Obama added 110,000 jobs so he says). Worst yet each foreclosure costs lenders $50,000, according to data cited in a 2006 study by the Federal Reserve Bank of Chicago, so an additional two million foreclosures could mean $100 billion in lender losses (but they will surely find some exotic accounting maneuver to hide these losses.

The government’s recent stress tests of banks concluded that the nation’s 19 largest mustn’t touch banks could be forced to write off another $600 billion by the end of 2010 (I believe the losses will be twice that), bringing their total losses to $1 trillion, as such the Federal Reserve concluded that these banks needed to raise another $75 billion, as these fed-heads that are bought and paid for by the big banks are in the mode of lets keep our fingers crossed that we’ve seen the worst.

Among prime borrowers, foreclosure rates have been growing faster in those states with particularly high unemployment. In California, for example, the unemployment rate rose to 11.2% from 6.4% for the year that ended in March, while the foreclosure rate for prime mortgages nearly tripled.

China bought less than a 1/6 of the Treasuries issued in the past 12 months through March. Less than two years ago, by contrast, Chinese purchases of treasuries, which included purchases in the secondary market as well as newly issued securities, at one point exceeded the entire borrowing needs of the United States. Financial statistics released by both countries in recent days (right before the Geithner visit) shows us that China oddly enough stepped up their lending to our government over the winter even as it virtually stopped putting fresh money into our greenback. This combination is possible because China has been exchanging one dollar-denominated asset for another selling the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac in a hurry to buy Treasuries (this swap doesn’t bode well for us). While this has been clear for months, new data shows that China is also trading out of longer-term treasuries for shorter-term notes, and this highlights China’s concerns that inflation will erode the dollar’s value in the long run as America amasses a massive mountain of debt.

So China’s rising purchases of Treasuries do not represent their proverbial confident bet on America’s future that they might seem to be on the surface. For instance, China does not appear to be dumping euros or yen to buy Treasuries.

China now earns more than $53 billion a year in interest from the United States…This spring China has also been stepping up its purchases of commodities, which are usually bought in dollars. Iron ore has been piling up on Chinese docks, government stockpiles of crude oil and grain are being expanded and stockpiles and receptacles are brimming and storage facilities are being started for products like gasoline, diesel and sugar.

After six years of silence, China unexpectedly disclosed last month that it had been gradually buying gold from domestic producers, and its worth noting that the country’s reserves had climbed from 600 tons in 2003 to 1,054 tons, worth $31.8 billion as reported this past Wednesday.

Another story that caught my attention last week: Some strong words out of China about its massive US dollar, agency and treasury holdings. For those of you who don’t know, massive imbalances have grown in the global economy over the past decade. Many of the goods we buy here in the United States are made in China and Asia (duh!). On the other hand, we don’t sell hardly anything to China/Japan and other Asian countries as we buy from them and this is creating a mega imbalance. Ultimately, that means they have a huge excess of dollars that they must either hold or re-invest in US assets. This has been going on for many years and as a result China and the rest of Asia have accumulated massive holdings of US assets, mostly treasuries. For example, according to the US Treasury, China held $727.4 billion in US treasuries as of December and Japan slightly less.

As Fed Chairman Ben Bernanke told 60 Minutes, in response to the financial crisis the Federal Reserve has essentially been printing money Ben Bernanke’s Greatest Challenge: This dilutes the value of the dollar in foreign exchange markets and destroys the value of foreign investors’ dollar denominated holdings not a development that they are jumping up and down about and China is none too happy about this and Premier Jiabao’s comments were a shot across the bow recently. China and the rest of Asia’s massive US holdings give them a measure of economic power over our economy. If China was to start to unload its dollar and treasury holdings (something they are holding over our heads) that would send the dollar plummeting in foreign exchange markets and the drop in treasury prices would result in a significant increase in interest rates. The falling dollar would make imported goods more expensive meaning higher prices for U.S. consumers. Rising interest rates would hurt all borrowers (and add to the housing contagion) and increase the strain on our debt-laden economy. So our Treasury and Federal Reserve must keep kissing China and the rest of Asia asses because of the economic power they now hold over us due to their enormous lending to the our spend happy government. Always good to keep money-creation in perspective; the most recent Fed Balance Sheet reading of $2.169 trillion is a mega increase and is only getting worse, and a couple hundred bucks away from the highest ever recorded of $2.17 trillion a month ago. This is just the beginning: Bernanke and his band of merry worriers have committed to monetizing $1.75 trillion of securities this year, and they still have $1.21 trillion remain to be purchased still. This means that the balance sheet will likely pass the $3 trillion mark at some point over the next 3-6 months. As to the yield on these securities once the total is over $3 trillion, if the current trend line of UST pounding is any indication, look for something north of 5%.

Just as a reminder, the total foreign central bank holdings of Treasuries and Agencies is $2.7 trillion…our Fed is 2.69 trillion and growing Very soon America's largest creditor will be... America what a reversal we have.

Quantitative Easing: Throughout the great recession the Federal Reserve, Treasury, and President's office have been spending money like it's going out of style. In order to spend what we do not have we have to borrow money at an alarming rate. As such we are incurring more and more debt and naturally we are required to pay interest on that borrowed money. Knowing this, the American government has been doing everything in its power to reduce interest obligations.

In December the Fed announced for the first time in 28 years that they would begin to actively buy T-Bonds in the open market (with money printed from the Treasury). They also made a similar announcement in March to purchase up to $300 Billion in mixed duration Treasury instruments. By purchasing long term T-Bonds (with treasury printed dollars) the government has been working to drive debt durations down. Why is lowering debt duration important? Low durations are required to ensure that overall borrowing costs remain as low as possible on any new debt issued. This is where quantitative easing comes into play.

Until recently the strategy of quantitative easing has been fairly successful (in near-term relative terms; however it can't work in the long term) as the world has flocked to United States debt as a safe haven investment. We have seen evidence of this in the fact that the average duration on all outstanding US debt is currently at about 4 years; the shortest in history. It can also be seen in US Treasury Yields which have been at their lowest levels in decades. The only problem with this exercise is that in order for it to continue to work, one of two things must eventually happen:

• Spending has to come to a halt, tax receipts need to rise quickly, and our government needs to act in a fiscally responsible manner in order to properly service existing debt obligations.
• Or….Interest Rates have to stay low indefinitely so that debt service payments remain manageable.

If these two things are the only way that quantitative easing can continue, what the result will be for the bond markets…this is the $64,000 question many are pondering right now!

It does not appear that our government will take or can take the first step in the short term. However, in the long term it is all but inevitable that this trail must be blazed. The only problem with the stop spending and raise taxes option is that we have an 8.9% (and rising at an alarming clip) unemployment rate, coupled with a lack of real economic gains, which continues to erode the nations already shrinking tax base. Plain and simple, at some point, in order to stop deficit spending and properly service debt we will need more cash in the treasury, now how will this come about! The only way to get that cash is through increased tax revenue, fiscal responsibility, and sustainable long term interest rates on US obligations.

This past week the US Treasury will be selling or has sold $40 Billion in 2 year notes, $35 Billion in 5 year bonds, and $25 billion in 7 year bonds. This whopping one week total of $100 Billion in US debt is unusual, and also incredibly important. For starters, this week's auctions clearly show that the government is still foolishly pursuing quantitative easing. A quick look at the maturity of the debt offered is evidence of this enough; no maturity longer than 7 years. As I have written about before market participants/investors, including foreign central banks, have cut long-dated Treasury holdings and parked cash in two-year notes and Treasury bills, a trend that may create a challenge for our government at a time when it needs to sell a record amount of debt.

What will we do when our short term debt matures and needs to be refinanced? What will be the interest cost in 18-48 months at this hyper spending rate cost us? This is what I call rollover risk and I know that real savvy traders/investors are pondering these contagions.

The market will then likely reduce the duration of loans to our once great government to the shortest possible duration to reduce exposure and inherent risks. This is when the mega risks of inflation will also come into the picture as the market lends to our government. Each debt issuance will likely lead to more premiums being demanded to compensate for a loss of purchasing power in US dollars over the duration of the loan. All in all this will ultimately drive bond yields significantly higher, drop bond prices continuously lower, and eventually dislocate the US debt markets.

Will the printing of new money greatly devalue the US Dollar and increase inflationary pressures…I believe this is a certainty but this is not likely to happen in the near term. More deleveraging in the financial system is significantly needed, and this event is unlikely while deflationary pressures remain strong. So, again, what does that mean for our debt? It means that while the Federal Reserve and Treasury continue pursuing quantitative easing, the markets are likely to become increasingly dislocated. It means yields will continue to rise, prices will continue to fall, and debt service costs in the United States will become unmanageable. Consumer borrowing rates will likely start to rise which will add further pressure to our problems.

The Financial Times in their article… China stuck in dollar trap on May 24th. What somehow escaped their analysis is that China likely will not touch any U.S. dollar asset except Treasury bonds. The monthly flows of capital into (or out of) our country which is known as the Treasury Department's “TIC” report, is telling us a very clear and present dangerous scenario. So far, in the three months of data which have been reported for this year (Jan., Feb., March), the net result was an outflow of capital from the U.S. totaling $211.4 billion. Does this number suggest China is really “trapped” into buying U.S. debt?

The March number is slightly more instructive. This marks the beginning of the newest propaganda-offensive from the U.S. corporate media in asserting (yet again) that the U.S. economy is starting to “recover” and that green shoots are sprouting up everywhere like blooming tulips. This was epitomized by U.S. court-jester Ben Bernanke prancing around, braying about all the “green shoots” he is seeing.

In March, the TIC inflow into the U.S. was a paltry $23.2 billion. However, net purchases of U.S. Treasuries totaled $47.9 billion meaning the net results for all other categories of U.S. debt was yet another outflow of $24.7 billion….this is not as bullish as hyped!

The important point about China's focus on short-term Treasuries is that this does very little to help the U.S. fund its gigantic, out-of-control mammoth deficits. The focus by China (and most other foreign buyers) on short-term Treasuries means that not only is the U.S. being forced to dump the largest glut of new Treasuries in history on this already-saturated market, but it is also being forced to try to “roll-over” additional, huge amounts each month as the short-term Treasuries mature…this is a very dangerous endeavor!.

I’m very perplexed as just how exactly will our government “fund” a deficit certain to exceed $2 Trillion (just in the current fiscal-year) with an outflow of more than $200 billion so far this year? The ultimate rebuttal to the nonsense of the cheerleaders is to simply note what is happening in markets.

The long-predicted bursting of the absurd and humongous U.S. Treasuries bubble has occurred. Since U.S. bond prices peaked in December of 2008, the 10-year U.S. Treasury bond has gone from a yield of 2.55% to a yield of 3.40% as of this moment a plunge of well over 30%. Now here's the $64,000 question that will soon be answered what will our bailout specialists do when the bond asset bubble bursts? Of course they will again attempt to re-inflate this bubble.

To figure out how the U.S. government plans to (attempt to) re-inflate this bubble all we have to do is to look back to last fall and see how they created this bubble, in the first place. The answer is clear to me my friends they start another panic (yes as I have written about before I believe that they were partly responsible for the stock market panic sell-off).

This panic, in turn, caused equity markets all over the world to crash and caused U.S. Treasury yields to plunge to their lowest level in history (with short-term Treasury yields actually coming very close to zero!). The lowest yields in history translate to the highest prices in history at a time when the U.S. government was just about to dump the largest supply of U.S. Treasuries in history on an already-saturated market {I know that some of you will just call me a conspiracy lunatic}. The problem is that soaring yields (as we have seen them start to reverse upward) means soaring interest rates and this will inevitably sent a stiff breeze into our economic house-of-cards and they will tumble downward!

Not only will rising interest rates accelerate foreclosures and more job losses which will eventually lead to the collapse of the commercial and residential real estate markets, but it will also accelerate defaults on every category of U.S. loans which are already at record, delinquency levels. {So what is the solution?} For the evil lecherous bankers, this potential burst-of the bond bubble is even more catastrophic. First, it will cause an exponential rise in losses in all categories of loans. Further, it will drastically squeeze profit margins on the viable components of their business.

Therefore, I am of the firm belief that we should all brace ourselves for the next panic, generated by the U.S. propaganda machine, and the financial-servants in the U.S. government. Fortunately for them, causing a panic is easy: all they have to do is tell the truth about the real economy (job losses, banks real contagions, weak profits etc.), and stocks will tank and investors will again rush into bonds sending yields lower.

Meanwhile, our precious greenback just hit its lowest level of the year. A look at this dismal chart suggests that the plunge of the dollar is much closer to the beginning than the end….unless we see an intervention...and if we see dollar intervention, then commodity prices/stocks could do an abrupt 180-degree turn, and the selling in commodities once triggered tends to get real ugly!

Our government officials have been prancing about like the proverbial emperor without clothes, and now they are being seen for what they truly are, and their years of lies and statistical “padding” of our declining economy is becoming unraveled; and now we are trapped by many years of grossly over-spending like drunken sailors. We have become trapped and held hostage by the self-destructive machinations and manipulations of the U.S. financial crime syndicate, which runs the U.S. government in all but name. Also the danger yet to be addressed is what happens when China runs out of things to buy with its hordes of U.S. Treasuries, it will stop accumulating them in my opinion! Instead, it will channel its huge budget surpluses into infrastructure development and other internal uses: and it would make sense for a huge economy which is still in the infancy of its development.

The recent talk/hype stating that China will lead the global growth recovery and that is expected by far too many so called economists (not me). Although China has certainly much more weight in the global economy now than it used to have in the past, it would be rather naive to think that China, per se, can really lift the global economy as they are a producer of cheap goods, not a consumer nation.

Also in real nominal GDP terms, the developed economies (still account for nearly 75% of the global economy), and the current crisis is the worst synchronized recession that the developed economies have experienced since the great depression (though the talking buttheads on bubblevision believe it’s over!).

At the present time, China is more dependent on the rest of the world than the world is dependent on China. Although commodity exporting countries such as Brazil or Russia are directly or indirectly exposed to China’s growth through its effects on commodity prices, they are also facing important financing constraints at the moment, especially for the latter.

It is true that the price of oil for example is heavily dependent on marginal changes of demand coming from China, but for this relationship to hold strong it is important that oil demand recovers in the major developed economies, as well (no sign of this happening as yet). This is exactly the kind of circular causality that makes it difficult to forecast any direct impact of Chinese growth on commodity prices, let alone on global growth.

China by actively mobilizing its huge fiscal and monetary reserves has enacted a rather large stimulus package that the government a needed substitute for growth in times where the export engine is havoc. However, this government-fueled development cannot support the economy for ever. Exports are still needed in the short term for China, even though in the long run the transition to a consumption-led, knowledge-based service economy is the real development they need to foster.

My turn wave forecast is getting significantly stronger, and it pointing toward a HUGE inflection period ahead, the window is tightening as we get nearer to the potential turn....and according to my wave analysis we have multiple waves converging and a major Inflection & Fibonacci collision possibility hitting the overall markets on/between 6/02 and 6/05 and since we have been in strong bullish up-trend from the March 6th lows This corrective wave could be (key-word could) be the start of a significant major Bearish corrective period ...my system and analysis is telling me that this could be a significant correction period lasting 14-21 trading days...with the potential for a slight retracement after the initial down-cycle then another downward corrective wave will likely play.

• I am looking for a potential drop of 850-950 Dow points
• I am looking for a potential drop of 145-170 Nasdog points
• I am looking for a potential drop of 95-125 SPX points
• I am looking for a potential drop of 90-110 Russell-2000 points

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Copyright © 2009 Stephen Tetreault
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