Steen’s Chronicle: Price of money rising; when is the bill due?

Stocks had a rough close Monday and, at least in the S&P E-mini, there was a key reversal. But for now, rotation continues into stocks from fixed income, as stocks are seen as a ‘tangible asset’ for many who continue to shun metals as an alternative in their portfolios.

Monday’s price action in the S&P was indeed compromising for an overall positive view on stocks. There is some risk that the move between asset classes is reaching a zenith – volumes are coming down while the fixed income market is at levels which either need to hold or break.

If a Tuesday rally doesn’t materialise (Tuesday tends to be very positive), we may need to readjust our medium-term target of 1385-00 on the S&P. But if there’s no rally, or rates do break lower, it would only pave the way to a repeat of last year’s April/May correction.

But it would be just that - a correction - because all roads still lead to QE3.

Looking at Southern Europe yields is obvious that the present levels are unsustainable over time:

Source: Bloomberg

Meanwhile, the medium- to long-term outlook in the US yields is clearly higher as seen here:

Source: Stockcharts.com

These rate expectations, combined with increased rhetoric from Fed officials on QE exit in June, have moved both yields and inflation expectations:

Source: Bloomberg

Thus, there is ample evidence, both in the market in the form of inflation expectations, and in actual moves by the Fed and ECB, to expect less accommodation going into the summer. The Fed and the ECB look set on preparing the market for normalization. In the case of the Fed, there’s ample evidence of this, including:

• The announcement of the US Treasury selling its mortgage portfolio
• The AIG auction – with the ensuing denial to Bank of America paying a dividend
• Regional Fed governors been all over the press confusing market with almost hawkish talk (Bullard + Evans)
• A new press policy from Bernanke – indicating need for more communication from Fed in lead in to higher rates

We see this as a massaging of expectations of hikes to come. But to come only if, and that’s and important if, unemployment rates start to move down, disposable incomes rise beyond the negative energy and food prices, and the stock market does holds support at 1250 on the S&P. If Bernanke is able to create an air of normality, compared to today’s crisis management, ahead of the 2012 election, he will have helped himself, his boss, and Geithner.

In the Eurozone it’s a little more straight-forward in communication terms. We have the expected rate hike from the ECB on 7 April. But this is to satisfy the German paymaster, who runs the EU with Iron Hand. There are NO other lenders of last resort left in the EU system.

In summary, central bankers are preparing the markets for normalisation. And yes there are a lot of preconditions, political and practical obstacles before an actual hike. Given the latter, we remain skeptical on policy moves, but bullish on the bond vigilantes’ ability to move longer rates higher and test the long term downtrend in rates.

2011 will truly be a battle of intentions, but we side with the theory/path of marginal cost will rise, and rise more than markets are pricing in.

source from: tradingfloor