The slide in treasuries continues again and it is clear the Fed has lost any control of the entire curve beyond a one year maturity.   Equity markets are at a very critical juncture right now with QE2 expected to end in June.  The reality is equity markets may very well begin pricing the end of QE in the near future, if you consider the Jackson Hole speech hinted at QE2 in August and saw equities price in the policy three months ahead of the November 2010 meeting.  

There is no shortage of people calling for endless QE (easily 80% of those voices truly don't even understand QE).  The environment now though has changed making the options to Fed monetary policy more limited. Probably the biggest headwind facing the Fed is rising interest rates.  The federal funds rate is at 0-25 bp and QE was intended to push down rates further out on the curve and it did work for a while.  The Fed conditioned all of us for low rates with their continual use of "extended period" with each FOMC statement.

The Fed needs to be careful moving forward.  The bond market has clearly signaled they are concerned about inflation, loss of confidence in the Fed and US fiscal policy.  The US is competing with other sovereign nations for capital at the same time they are increasing their supply with growing deficits. Imagine a shock even to the US economy.  The US is in no position to use emergency stimulus without risk of truly blowing out yields.

Two Year Treasury 

After catching a little bid last week the two year has given up all its gains and looks to test the lows again. The shorter end of the curve had stayed relatively low in yield but has risen more than any other maturity recently causing a bear flattening (higher rates and a flatter curve).  Not favorable for banks or those on the wrong side of interest rate swaps (which is a $458 trillion market).

Ten Year Treasury 

Has bounced along a multi year trend line after failing last week.  Looks like it too is set up for failure. This is not good for housing which is already under pressure and double dipping.  A 100 bp rise in 10 year yield equates to about an 11% drop in home prices.

Submitted by Ultra Trading.  If you would like to read more, please visit - Ultra Trading

This week's Commitment Of Trader report has a few notable divergences but overall sends a somewhat mixed message on short term market direction.  

Oil V Copper

The past few weeks copper has continued to show far greater strength than oil, setting new highs almost regularly.  Oil appears to be rolling over and then another Middle East country erupts causing a spike, that is subsequently sold off.  I present this chart below to simply show how the two have begun show a larger divergence than normal.

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The chart below is very interesting and supports the recent commentary by Chris Whalen that banks are sitting on far bigger losses than they are reporting.

The volume of foreclosure sales has stayed relatively flat yet the serious delinquent category has grown much faster.  Foreclosure inventory has not kept up with the growth in delinquency either.

I've heard reports of people not paying a mortgage for months, in some cases over a year.  That would be a delinquent credit, yet the banks in those instances are ignoring this non-performing credit.  Unless notice is given, the credit is performing and not delinquent.   Why do that? Why would a bank let someone not make a mortgage payment for months? Why does the foreclosure process take up to 19 months for the top banks?

It's all part of extend and pretend.  When a credit is delinquent, the bank is still accruing interest on that note even though the probability of collecting that accrued interest is very low. Additionally the asset is marked at full value.  When a bank finally seizes a property it becomes an REO (Real Estate Owned) and that is when the hit to the balance sheet for the value of the asset and the income statement for the accrued interest happens.

What we have seen the past few reporting seasons is banks reducing their reserves for credit losses when in fact there is a mismatch between their realized losses and future losses.   They claim improving credit quality and perhaps that is true but they still are under reserved.  Should housing take another leg down, strategic defaults will occur and this problem will grow.  For now banks are balancing their dwindling profit with balance sheet write downs.  This, is why the US economy is being held hostage by the TBTF banks.  The last thing they want to do is extend credit to anyone without a perfect credit score and very low LTV .

Submitted by Ultra Trading.  If you would like to read more, please visit - Ultra Trading