Market Update 10 31 11 _ It's Halloween and the market is spooked

 

What better day to announce the failure of a primary dealer than Halloween? 

 

Remember the old movie “Wayne’s World”?  There were some scenes in the movie where Wayne and Garth would play street hockey out in front of their house.  They’d put the goal right in the middle of the street and one would be the goalie and the other would take shots.  When a car came down the street one of them would yell “Game off!” and they’d run for the sidelines, then when the car passed they’d yell “Game on!” and they’d come back out and play.  This scene reminds me of our current market.  Each time a danger comes close, market participants yell “Game off!” and run to Treasuries.   Then some amount of time will pass and it’s “Game on!” again and Treasury prices fall and yields bump up a bit but inevitably another car comes down the street and it’s back to “Game off!” and yields drop down again.  The economy just can’t get any sustainable momentum…each time you think it’s safe to play in the middle of the street another car comes by.

 

Today someone was playing in the street and they got flattened by a European car.  Today’s big news is the failure of MF Global…a US Primary Dealer.  Here is the description from the NY Federal Reserve website of what a Primary Dealer does:

 

“Primary dealers serve as trading counterparties of the New York Fed in its implementation of monetary policy. This role includes the obligations to: (i) participate consistently in open market operations to carry out U.S. monetary policy pursuant to the direction of the Federal Open Market Committee (FOMC); and (ii) provide the New York Fed's trading desk with market information and analysis helpful in the formulation and implementation of monetary policy. Primary dealers are also required to participate in all auctions of U.S. government debt and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.”

 

MF Global will no longer be performing any those functions listed above.  I don’t know what the “MF” in “MF Global” stands for…but I’m pretty sure I know how “MF” was used this morning behind closed doors when the NY Fed realized that one of their primary dealers was going bankrupt. 

 

MF Global was not only a Primary Dealer; they were deeply involved in derivatives and commodities trading. It will be very interesting to see how the ripples from this failure affect other markets and market participants.  Apparently the firm suffered very large losses from their holdings of European sovereign debt.  This will remain a very interesting story as the recent plans in Europe are to force haircuts on debt, then backstop their own banks with a big liquidity fund so they don’t get hammered like MF Global did. 

 

Anyone who thought that the European problems were just going to go away with the new announcement of some plans last week just got a shocking wake-up call…the problems are still here and they are big enough to take down big important firms run by really smart people.  The good news is that if anyone was looking to become a primary dealer…there is now an opening. 

 

Market reaction

 

The Treasury curve is up sharply at every point on the curve.  The 10 year is up a point and five tics to trade at 2.18%.  The 30 year bond is up over 3 points to trade at 3.21%.  The Dow is off about 200 points currently.  This story has to have a lot of people thinking that we are pushing a very shaky apple cart.  How far and fast can the global recovery go?  Who will be the next to fall?  How widespread will the damage be?  How much money will flow back into the safety of the US Treasury markets and how low will it drive yields?  What does this mean for economic recovery?  What about market liquidity?  Does this affect our year end planning outlook? 

 

These questions will be wrestled with as we go forward…for now I’m going to just assume that more people will succumb to problems coming out of Europe and I also have to assume that those stories will help keep a lid on interest rates.  Fear will continue to have us yelling “Game off!” and running for the sidelines. 

 

For now I’ll leave you with words of encouragement from Wayne’s World to help get you through month end…“Party on, Garth”.

 

If you have any questions or if there is anything I can be doing for you just let me know.

 

Steve Scaramastro, SVP

800-311-0707