Welcome to the Weekly Report. Due to family illness, this week's letter will be shorter than usual. This week we re-visit the scenario used for the Occasional Letter series as another milestone is passed.

The Scenario:

bubble, easy money, inflation in fiat money supply, inflation in commodities and hard assets, inflation, fear of inflation, rising rates, YC inverting, flattening, rising and inverting again, tightening, withdrawal of liquidity, corrections, crashes, talk of stagflation, FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.....Deflation.

I wrote the above scenario many years ago. My only regret was that I didn't write it more clearly. It was not written as a linear listing of events, it was meant to show an interactive series of events that run parallel to each other. These events overlap, some are a reaction to others but they all move in the same direction. Let me attempt to show you how I "see" this. I am going to quantify the various factors that make the scenario and measure them on a time line. This will give us a visual representation of the various strands. The relationships on the chart are important, not the numerical value.

Don't worry about whether you think EZ money should be a higher value, that's not what I want you to see. Instead think of the trends and how they relate to each other. The diagram displays the historical as well as the future trend. Right now I see a post bubble, low interest rate environment, where EZ money is disappearing as credit contracts. Funds have poured into commodities as unstable stock markets and topped out bond markets make traditional investment havens unattractive. Meanwhile money, real paper and coinage, continues to slow and contract as the real economy suffers.

Which brings us to the milestone. Current interest rates are not reflective of current circumstances. Think of the attractiveness of assets and their returns. Commodities are currently appreciating in capital, prices are rising but they do not pay a dividend or a yield. We have been here before and not that long ago, last time it was tenuous promises of dot.com companies, this time its hard and soft commodities. The "attractiveness" measure of assets is about to change.

The IMF issued a downbeat report on the UK economy earlier this week. Whilst it is country specific, its relevance to other similar economies cannot be ignored, especially the US. (The latest IMF report on the US - http://www.imf.org/external/pubs/ft/scr/2007/cr07264.pdf)

Here are the paragraphs that interested me:

• 7. Three elements can help respond to these broader challenges.

  8. First, continued moderation in nominal earnings growth is essential. If secured even in the face of relative price changes, monetary adjustment and associated sterling depreciation may reduce risks to output, the external balance, and employment without compromising the nominal anchor. But if not, monetary flexibility to address these concerns will be diminished.

  9. The risks to nominal wages appear balanced. So far, nominal remuneration has held steady, encouraged by the flexibility of labor market institutions and public sector pay restraint. But key wage settlements remain outstanding, and tolerance for continued low real earnings growth is uncertain.

  10. In this context, we see no scope for further near-term monetary easing absent assurances of continued wage moderation, fiscal policy that is tighter than planned, or signs that house price and credit developments are significantly curbing domestic demand, relative to our central case projection for continued growth. Indeed, given the risks to the nominal anchor, monetary policy should stand ready to tighten at the earliest clear signs of emergent nominal wage inflation.

  11. Second, as the commodity and consequent relative price shocks have a permanent element, the appropriate focus of the policy response is fiscal. In this context, budget consolidation should rebalance demand-away from domestic in favor of external-to the benefit of the current account balance, activity, and employment.

  13. Third, efforts to stabilize financial markets remain essential. This will not only reduce lagged effects on credit flows from past strains, but will reduce remaining tail risks and support more efficient pricing of risk in future.

There is no respite for the UK consumer. If inflation pressures remain high (commodity pricing) and sentiment amongst workers changes to demand higher compensation then both the taxation burden and interest rates should rise. Even if prices moderate, current levels of taxation and rates are judged appropriate. It is the effective pricing of risk that should draw your attention. Risk has not gone away, indeed without centralist intervention risk pricing should be at much higher levels today. The natural pressure on interest rate direction is for higher levels of return, not lower.

In effect the IMF wants to see a relatively high rate of interest and a sustained taxation burden to force a slowing of consumer and business demand at a domestic level whilst hoping that a depreciation of Sterling occurs, allowing an export oriented growth regime to be created. Any attempt to increase worker compensation should be denied and a reduction of domestically orientated employment will help curb wage demands.

For those readers who are familiar with the UK situation the direction of the IMF report comes as no surprise. The UK Government and the Bank of England have been following such a path for sometime. The IMF recognises this and in a week that has seen Prime Minister Brown under severe pressure, they silently slipped a dagger into his back, albeit quietly and "buried beneath other news"

• 19. First, building on the success of the recent Comprehensive Spending Review (CSR) in slowing the pace of expenditure growth, there are advantages to reversing the relative status of the golden rule and the medium-term spending limits........The implied change in the status of the golden rule would end concern with adjustments to its definitions, which despite having had only modest implications for fiscal space, have eroded confidence in the rule. It would also reflect the success of the broader policy frameworks, which have underpinned reduced economic volatility thereby diminishing the need to define fiscal or other rules "across the cycle."

The golden rule is central to PM Brown's arguments about his fiscal responsibility and his fitness to lead during difficult times. He relied upon the golden rule heavily whilst chancellor. It is apparent that he is hoping to move, unnoticed, away from such constraints. With PM Brown and his party losing heavily in a recent election to a vacant seat and calls for PM Brown to change direction, the IMF assurances may become unhinged and a large increase to their downside risks may occur. PM Brown may well be unable to withstand the pressure of calls for higher wage compensation and a decrease in taxation. This would lead to increased pressure on the Bank of England to raise rates to combat inflation, even if the Government attempted to discourage such a move. Such a scenario could play out over the next few months, making assets such as gilts attractive in an accumulative purchasing strategy.

With US policies of direct cash infusions (tax rebates) and current low interest rates the order of the day, we can see that the IMF advice has already been ignored by the Federal Reserve and the US Government. Unless domestic recessionary forces become stronger, adversely affecting employment and degrading the ability of workers to gain higher wages, interest rates in the US are going to rise, sooner rather than later. Either way, the scenario for US consumers looks poor, they face either higher prices and interest rates or higher prices and a loss of wages through unemployment or inflation. Whichever path is followed, the US consumer faces a loss of disposable income, a direct deflation of cash. With a continued and increasing constraint on credit availability consumers are left with no choice but to curtail spending. Again like the UK, an accumulative purchase strategy of US Bonds as rates rise would be attractive.

A reduction in credit, real money and inflation whilst interest rates are rising would make the prospect of "stair stepping" into Bonds to achieve higher nominal and real returns much more attractive than holding long positions in commodities.

The timing of such a move, a change in the attractiveness of assets, may be closer than many realise.

Have a good week.

Welcome to the weekly report. This week we look at inflation and deflation, the Dow, gold and FTSE but start with a look at a recent speech by William C. Dudley who is the executive vice president of the Markets Group at the Federal Reserve Bank of New York. He is also the manager of the System Open Market Account for the Federal Open Market Committee. The Markets Group oversees domestic open market and foreign exchange trading operations and the provisions of account services to foreign central banks.

If you want to know the effect of the Fed facilities on the markets, Mr Dudley is the man to ask. In a follow up to a speech he gave back in October '07, Mr D looked at the effects that the various Fed facilities had on the LIBOR/OIS spread and whether the facilities had done the job they were designed to do, i.e. introduce liquidity for assets. The speech covers a lot that my readers already know so I'll reproduce the salient paragraphs and charts and then add my comments afterwards.
This is the problem as W C Dudley sees it:

• "Let me first define the underlying problem. The diagnosis is important both in influencing the design of the liquidity tools and in assessing how they are likely to influence market conditions.

  As I see it, this period of market turmoil has been driven mainly by two developments. First, there has been significant reintermediation of financial flows back through the commercial banking system. The collapse of large parts of the structured finance market means that banks can no longer securitize many types of loans and other assets. Also, banks have found that off-balance-sheet exposures-such as structured investment vehicles (SIVs) or backstop lines of credit that are now being drawn upon-are adding to the demands on their balance sheets.

  Second, deleveraging has occurred throughout the financial system, driven by two fundamental shifts in perception. On one side, actual risks-due to changes in the macroeconomic outlook, an increase in price volatility, and a reduction in liquidity-and perceptions about risks-due to the potential consequences of this risk for highly leveraged institutions and structures-have shifted. Many assets are now viewed as having more credit risk, price risk, and/or illiquidity risk than earlier anticipated. Leverage is being reduced in response to this increase in risk.

  On the other side, the balance sheet pressures on banks have caused them to pull back in terms of their willingness to finance positions held by non-bank financial intermediaries. Thus, some of the deleveraging is forced, rather than voluntary."

Mr Dudley then goes on to explain the reinforcing (viscous circle) that has occurred because of these pressures, culminating in the Bear Stearns episode. After looking at the effects of intermediation and deleveraging, the LIBOR cheating and subsequent reset higher, FX swap prices and increased counter party risk W C Dudley still feels these areas may explain some but not all of the reasoning behind the funding pressures.

So Mr Dudley digs a little deeper (they may move slowly at the Fed but the analysis can be good) and pinpoints what he sees as the real problem:

• "So what has been driving the recent widening in term funding spreads? In my view, the rise in funding pressures is mainly the consequence of increased balance sheet pressure on banks. This balance sheet pressure is an important consequence of the reinter - mediation process. Although banks have raised a lot of capital, this capital raising has only recently caught up with the offsetting mark-to-market losses and the increase in loan loss provisions. At the same time, the capital ratios that senior bank managements are targeting may have risen as the macroeconomic outlook has deteriorated and funding pressures have increased.

  The argument that balance sheet pressure is the main driver behind the recent rise in term funding spreads is supported by what has been happening to the relationship between other asset prices-especially the comparison of yields for those assets that have to be held on the balance sheet versus those that can be easily sold or securitized."
  

Here comes the good bit, central to Mr Dudley's speech:

• "Why is this noteworthy? Jumbo mortgages can no longer be securitized, the market is closed. Thus, if banks originate such mortgages, they have to be willing to hold them on their balance sheets. In contrast, conforming mortgages can be sold to Fannie Mae or Freddie Mac. Because the credit risk of jumbo mortgages is likely to be comparable to the credit risk of conforming mortgages, the increase in the spread between these two assets is likely to mainly reflect an increase in the shadow price of bank balance sheet capacity.

  If this is true, then the same balance sheet capacity issue is likely to be an important factor behind the widening in term funding spreads. After all, a bank has a choice. It can use its scarce balance sheet capacity to fund a jumbo mortgage or to make a 3-month term loan to another bank.

  If balance sheet capacity is the main driver of the widening in spreads, this suggests that there are limits to what the Federal Reserve can accomplish in terms of narrowing such funding spreads. After all, the Fed's actions cannot create bank capital or ease balance sheet constraints materially. "
  

Now for my readers, myself and a few other writers and bloggers out there, most of the above is "old news". We recognised the effect that a re-pricing of assets would have on bank balance sheets, especially when Basel 2 kicked in quite some time ago. Whether Basel 2 caused the re-pricing or not is now mute (in the US B2 only applies to the top 10 international banks). It happened and we have to live with it.

By concentrating on bank balance sheets and the repairs required to capital ratios, investors have an important anchor point for fundamental analysis. For instance (and this is why you love me) in the FTSE 100 we have a large bank sector which has and is being battered, except for HSBC, which despite huge write offs still sees its share price supported and rising. A quick glance at the global business models of the FTSE 100 banks shows why and is pinpointed by Mr Dudley in his speech:

• "The overnight index swap rate is the expected effective federal funds rate over the stated maturity of the swap. As shown in the two exhibits on page two, this pressure on term funding rates has occurred in the United States, Euroland, and the United Kingdom. It is a global phenomenon."
  

Oh go on then, here is the HSBC chart, TA followers will like it:

Back to Mr Dudley who after identifying what he sees as the central issue, bank balance sheets, then goes on to explain the reason d'être of the fed facilities:

• "In essence, the Federal Reserve's willingness to provide liquidity against less liquid collateral allows the reintermediation and deleveraging process to proceed in an orderly way, which reduces the damage to weaker counterparties and funding structures. One can think of the Federal Reserve's actions as smoothing and extending the adjustment process-not preventing it-so that the adjustment causes less damage to the financial system and less pernicious macroeconomic consequences."
  

The Fed has morphed what should have been a very short, sharp and hugely disorderly event into a controllable, slow, deflation of the banking and financial system. The longer term impact of this should not be under-estimated. The Fed took a big risk stepping up to the plate and hitting home runs, there will be a form of payback expected from the financial sector. The effects will also be felt for some considerable time in the real economy too. Credit availability, in all forms, may well remain tight for much longer than anticipated.

To me this is good news. The removal of a credit reliant economy, where consumers overspend against future earnings and business mal-invests using loans to attempt to increase profitability is welcomed.

An Austrian School economic model may well be imposed upon the US, not through a political will but through the exigencies of the outcome of the credit crisis. In other words, the failure of the current Keynesian/Monetarist model (and it has failed, having a part of an economic theory that allows for centralist intervention doesn't mean that it works) will inevitably lead to a proper pricing model of worth, risk and production.

No decision will be made to actively seek such an approach, it will occur as required by circumstances over a period of time. We will have to get used to banks and financials not being the front runners in the future, the new go-getters will be those companies that using savings from profitable enterprises to re-invest and expand.

Many wonder what the next "big thing" might be, the next dot.com, the next housing or commodity explosion. I don't see it that way, I think the next big thing will be well run businesses that operate transparently and use profits to invest. They will carry little or no debt and will not require it to continue operations. In the current and future environment of expensive and scarce credit availability, these companies will have a competitive advantage that will be difficult to overcome. The actual line of business, what is produced, isn't important, what is important is how the profit is achieved.

In such an environment, deflation or the increasing appreciation of fiat currency is not to be feared, except by those reliant on credit. With the banks and financials being led by the hand toward responsible lending, coupled with tighter standards and low or no leverage, the future expansion of credit will become much more difficult and probably politically unacceptable.

The future benefits of a system based on true pricing and worth, located in the US with all its resources would be a formidable economic power. Is the US brave enough to take the first step?

As usual Gold, Dow and FTSE trend updates are available on the Trend Indicators page.

Have a good week.

Welcome to the Weekly Report. This week we look at Gordon Brown the UK Prime Minister, US and UK mortgage markets and the US consumer.

Before we start, a friend sent me an email that I would like to show you. I'm sure he would appreciate the readers help:

• Hi to all my friends

  Please say a prayer for my wife Sam as she had a heart attack on thursday, I nearly lost her on that day, she is now in the Royal Brompton hospital in London and it looks like she is going to have a pacemaker fitted.

  Please give her a positive thought that all will be well as I believe in the power of prayer and positive thought.

  Thanks

  David
  

In the early nineties the UK suffered a housing bust that lasted for at least 7 years, possibly longer if you measure it until the bottom of the cycle. Indeed, I well remember selling a property in London in 2000 that the Estate Agent was pessimistic about, needless to say the price eventually went much higher than their estimate. They didn't get the sale. From 2000 to 2006 the property market could be viewed as benign, prices went up (and up) whilst affordability from a debt servicing point of view increased. This coupled with loose lending standards (125% mortgages, mortgage limits set at multiples of 5 or 6 times gross earnings) encouraged a buying spree.

However, when you view the figures of mortgage possession actions in County Courts, you can see the clear "suckers rally" that has now turned sour:

Possession claims, orders and repossessions have risen markedly since 2004 and show signs of acceleration. Notice the Q1 '08 growth when compared to Q1 '06 and '07, that's not a good indicator of the future prospects of UK housing. Here is a chart that shows the previous peak in possession activity, the retracement to a low and now the new rise:

I know it's a dangerous game to try and extrapolate a future trend from one figure but let me be conservative in this. If the rest of '08 shows no further acceleration of possession action, then the final figure will be around 161k. For the final figure to be back inside the 2000-2004 good times then only a 20-30k increase over the next 3 quarters is allowed. I doubt very much the latter is going to happen, personally I see 2008 as going on record as the 2nd worst year for home repossessions. There is an extremely strong possibility that it may try and take out the figures for 1991. Why do I feel this is possible?

It is down to the difference between the US Govt/Fed reaction to the mortgage market implosion and that of the UK powers that be.

The US has attempted to loosen regulation, expand the book of the GSE's, lowering capital ratio requirements, slashed rates and actively pursued a dialogue with lending banks and institutions. The icing on the cake was the direct interference with the credit system, allowing credit markets to function using the Feds assets.

The UK has a lending facility that is expensive and restrictive, rates have stayed high, lending banks have ignored pleas from the Government and mortgage products have disappeared in their 1000's and the remaining products have new, tighter standards. The UK Governments response is shoddy at best, negligent at worse. This is the best they can offer:

• Chancellor of the Exchequer Alistair Darling yesterday met mortgage lenders to discuss lending conditions. Caroline Flint today said that the government will also ask lenders to improve the advice it offers customers seeking to refinance debts. ``For the minority of owners who may need support and advice now, we want to ensure it is there for them in the right place and at the right time''

In other words, they are doing nothing. Notice it is the lenders who are asked to offer better advice. Now you know me, I hate intervention in free markets and believe that bubbles of any nature would not form if the participants understood that there was no safety net. However, in the "real" world, away from my ideals, there is interference and intervention that is causing participants to rely on a safety net.

The problem for the UK is the flawed character that is Gordon Brown. Here is a man who in the face of a defeat that outranked any other that happened to the Labour party in 50 years, struggled to see what he had done wrong. Eventually he allowed the rise in taxation of the poor, that he instigated as Chancellor of the Exchequer, to be blamed but only after his party membership told him it was going to happen with or without his blessing. Even when Brown admitted it had been a "bad night" for Labour, his remedy was to "listen and lead". Well we can all do that, it's not hard to listen to someone and then blindly carry on as before.

Has the increased tax burden been reversed? No, Brown will try and divert attention away from such a move and talk about compensation from other schemes that will help "most".

This exposes the first flaw. He is unable to admit that any action he has taken (even when circumstances change) is wrong. He will attempt to blame others or deflect attention by promising "action" that in reality amounts to no more than "jawboning".

The second flaw is much more serious. Brown came to power after ousting Mr Blair, he did so without meaningful opposition or a public vote. He had been manoeuvring for well over 10 years to attain the Premiership and eventually succeeded. What I never understood was his timing. Brown is not unintelligent; he had an iron grip on all matters economic and yet he allowed himself to take over the leadership in a short burst of activity, regardless of the global economic circumstances:

• May 10, 2007

  CHANGE AT DOWNING STREET

  Blair Announces Plan to Step Down

  After 10 years in the post, Tony Blair is resigning as prime minister. Dogged by popular backlash from the war in Iraq, the outgoing leader hopes history will focus more on his achievements.

Brown took over 6 weeks later. Were there indications of what was to come? Certainly by the 10th May '07 many of the bloggers and writers were calling for a credit crunch, along with one or two more far sighted analysts and a list of credit related events was piling up:

• 3 May

  GM finance unit loses heavily on sub-prime mortgages

  UBS closes its US sub-prime lending arm, Dillon Read Capital Management.

  17 April

  US government-backed lenders try to tackle sub-prime crisis

  2 April

  US home sales fall sharply

  New Century Financial filed for Chapter 11 bankruptcy protection after it was forced by its backers to repurchase billions of dollars worth of bad loans. The company said it would have to cut 3,200 jobs, more than half of its workforce, as a result of the move.

  16 March

  US-based sub-prime firm Accredited Home Lenders Holding said it would sell $2.7bn of its sub-prime loan book - at a heavy discount - in order to generate some cash for its business.

  13 March

  Wall Street hit by sub-prime fears

  12 March

  Shares in New Century Financial, one of the biggest sub-prime lenders in the US, were suspended amid fears it might be heading for bankruptcy.

  8 March

  Biggest US house builder DR Horton warns of huge losses from sub-prime fall-out.

  22 February

  HSBC fires head of its US mortgage lending business as losses reach $10.5bn .

Yep, I think there was enough going on in the US to have made Brown stop and think about the possible consequences. But he didn't stop and think, he allowed his normally cautious approach to be bypassed. His desperate need for power over-ruled every other consideration. I can only surmise it was either to move out of the Chancellor slot before the proverbial hit the fan, or his ambition blinded him to what was coming.

Either way, Brown is an egotistical, self centered individual who despite his protestations is clearly concerned with his image and place in history. His inability to see beyond his own intellect and a belief in his own infallibility will allow him to make decisions that will clearly not be in the public (the peoples) interest. Brown will continue to blame the "global situation" rather than acknowledge that his spending and borrowing plans, the allowing of loose lending standards and the massive over-supply of money he presided over as Chancellor has set the UK economy on a path that may take a decade to recover from.

It his flawed character that will prevent him from taking the kind of concerted action that is required if you wish to keep the current financial system viable. To take such measures would undermine his claim to have been the best Chancellor the UK ever had and destroy his reputation. So, instead of committing political suicide he will allow the situation to get worse, rejecting calls to change policy. He will damn the people by inaction.

Still, at least the public now see him for what he is, judging by the recent local elections and the polls. The trouble is, by the time Brown goes to the electorate and gets the boot, it may well be far too late.

The US consumer is now in deep trouble, below is a chart showing the change in US Personal Consumption, from Bloomberg:

So far the consumer has relied on credit to make up the shortfall on income. Credit (red line, chart below) continues to reach historically high levels but it would appear it is not to bolster sales (blue line). I hope I am wrong but are consumers using credit cards to supplement mortgage payments?

Either way, consumers in the US are retrenching at some pace and I doubt the $600 tax rebate is going to do much other than offset gasoline price hikes.

>

For those of you who read my latest Occasional Letter "The Bernanke Conundrum" you will have seen why I believe that for consumer and business, it is different this time. I do not believe that the US (and UK) can avoid a period of deflationary recession, at a minimum, in the face of a full on credit contraction.

Without meaning to influence your trading or investing (you must make your own minds up) I am extremely cautious right now. I expect the situation to deteriorate in H2 '08.

That's it for this week.

Welcome to the Weekly Report. This week we look at moral hazard and I show you how it's about to unleash forces that no Central Bank or Government can control and we look at next weeks trend indicators and targets.

I have spoken about moral hazard before, especially in relation to the current actions carried out by the Federal Reserve and the Bank of England after the bailouts of Bear Stearns and Northern Rock. To avoid moral hazard arising strict controls have to be placed upon the facilities that are created and the use of the assets supplied from those facilities. A failure to control the results of centralist intervention will encourage the very behaviour that caused the original problem.

Let me be blunt. There is no risk to the financial sector that is so great that could justify invoking a moral hazard. If a bunch of banks and investment houses collapsed under the strain of unserviceable debt or losses so great that creditors required compensation, so be it. The pain would be enormous and the recession deep but the US economy and importantly the US financial sector would re-emerge stronger, leaner and fitter than at any time since WW2.

As we know such an event will not be allowed to happen, the Fed and the US Govt are working together to ensure that credit markets at least allow maturing debt to be rolled over, giving time to the banks and investment houses to rebuild their capital reserves. It is a 2 pronged attack, the Fed keeps the banks functioning and the US Govt drops money directly onto consumers in an effort to encourage spending or re-finance mortgages that have become too burdensome. These measures have no time limit, they can be repeated and increased until the day occurs when banks tell the regulators "all is well".

The groundwork for an episode of moral hazard is laid out but not yet constructed as long as the facilities are controlled and the assets applied to the task at hand.

What would initiate construction? The loosening of control, the allowance of a facility to be used for a purpose other than its original intention would see the foundations poured. That loosening has now occurred.

• Release Date: May 2, 2008

  For immediate release

  Central banks have continued to work together and to consult regularly on liquidity conditions in financial markets. In view of the persistent liquidity pressures in some term funding markets, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing an expansion of their liquidity measures.

  Federal Reserve Actions

  The Federal Reserve announced today an increase in the amounts auctioned to eligible depository institutions under its biweekly Term Auction Facility (TAF) from $50 billion to $75 billion, beginning with the auction on May 5. This increase will bring the amounts outstanding under the TAF to $150 billion.

  In conjunction with the increase in the size of the TAF, the Federal Open Market Committee has authorized further increases in its existing temporary reciprocal currency arrangements with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will now provide dollars in amounts of up to $50 billion and $12 billion to the ECB and the SNB, respectively, representing increases of $20 billion and $6 billion. The FOMC extended the term of these reciprocal currency arrangements through January 30, 2009.

  In addition, the Federal Open Market Committee authorized an expansion of the collateral that can be pledged in the Federal Reserve's Schedule 2 Term Securities Lending Facility (TSLF) auctions. Primary dealers may now pledge AAA/Aaa-rated asset-backed securities, in addition to already eligible residential- and commercial-mortgage-backed securities and agency collateralized mortgage obligations, beginning with the Schedule 2 TSLF auction to be announced on May 7, 2008, and to settle on May 9, 2008. The wider pool of collateral should promote improved financing conditions in a broader range of financial markets. Treasury securities, agency securities, and agency mortgage-backed securities continue to be eligible as collateral in Schedule 1 TSLF auctions.

The expansion of the Term Auction Facility comes as no surprise, it has been stepped up since its inception and will probably increase further. However the inevitable reaction to the Bear Stearns bailout has now occurred. The Term Securities Lending Facility has been expanded to allow an increase of lower rated asset backed debt beyond commercial and residential mortgage backed debt.

A reminder:

• The Term Securities Lending Facility is a 28-day lending facility that offers Treasury general collateral to the Federal Reserve Bank of New York's primary dealers in exchange for other program-eligible collateral. It is intended to promote liquidity in the financing markets for Treasury and other collateral and thus foster the functioning of financial markets more generally.

  What are the differences between the TSLF and other Federal Reserve operations, like the TAF and term repo operations? The Term Auction Facility ("TAF") offers term funding to depository institutions via a bi-weekly competitive auction. In contrast, the TSLF will offer Treasury GC to the FRBNY's primary dealers in exchange for other program-eligible collateral. The FRBNY term repo operations are designed to temporarily add reserves to the banking system via term repos with the primary dealers. These agreements are cash-for-bond agreements and have an impact on the aggregate level of reserves available in the banking system. The bond-for-bond lending of the TSLF, however, will have no impact on reserve levels.

Quite right too, the swapping of assets on a 1 to 1 basis if they had equal price would not affect reserve levels. Ahh you see the hole in that argument too? In fact there are 2 holes, firstly the assets swapped are not equally priced, "program eligible collateral" is only swapped because it is useless. With no one willing to accept it as collateral on lending there is no choice but to use the TSLF. In other words assets that should be priced at zero (thus lowering reserves) are swapped for fully priced assets. Only by refusing to mark to market does the Fed assertion of no increase in reserves ring true. Secondly it is this refusal to mark to market, allowing the TSLF to operate as a Conduit /SIV where toxic debt is parked to take it off the balance sheet that is allowing a moral hazard to occur.

The expansion of eligible collateral is a step into a minefield. "Primary dealers may now pledge AAA/Aaa-rated asset-backed securities". The worry is that this new collateral is not secured on a physical asset, ABS is a complex structure of intertwined pools of debt and receivable payments, grouped together and collateralized by cash flows from underlying assets. It is the mix and match of the various debt that allows the ABS to receive a rating which is normally higher than the underlying debt would achieve alone.

Security is a misnomer in the world of derivatives. We now face a situation were Primary Dealers are expanding their borrowings using top rated debt that has been swapped for debt that could (and is) reliant on credit card debt, unsecured loans, auto loans and even private revenues from ventures. This will now allow an expansion of Dealers activities beyond the rolling over of maturing debt.

The TLSF was not "sold" to the financial world and the public as an investment vehicle, it was advertised as a method to "promote liquidity in the financing markets for Treasury and other collateral and thus foster the functioning of financial markets more generally." Nowhere do I see the words expand, replace or reinvigorate. This is an extraordinary facility introduced to allow the market to function because of this:

Asset backed and financial CP issuance continues to fall. This is a function of an aversion to lending against collateral that lacks confidence. The correct thing to do with the TSLF is to allow short term lending to be unwound in an orderly fashion. Capital is supposedly raised by banks and investment houses in times like this to pay off liabilities and reset positions and leverage to low levels. Yet we do not see this happening, instead we get an expansion of the emergency facility to allow even more dubious debt to be removed from the balance sheet.

The Fed is not supposed to replace the commercial paper market, it should allow the CP market to unwind to an acceptable risk level in an orderly fashion, if you believe in intervention. To allow Primary Dealers to use the TSLF to expand business is moral hazard writ large.

The use of lower rated ABS to enable the borrowing of treasuries does not avoid the risk of expanding debt by using debt as collateral. This is how the credit crash was caused, the unwinding of leveraged debt derivatives as underlying assets were re-priced lower and payment streams dried up. ABS is no different, a pool of debt and future payment streams based on an underlying asset that could be easily re-priced lower.

If that were to happen then Primary Dealers would either have to add more collateral or reverse the swap on instructions from the Fed:

• In addition, the FRBNY can call for collateral substitutions by a dealer if the pledged collateral were to deteriorate in value or quality and fall out of the eligible collateral pools.
  

If the deterioration causes a "margin call" what exactly would the Primary Dealers have to do? As we saw in previous re-pricing episodes, there is no safety in a rating, all debt suffers and similar ABS would also be re-priced lower. The margin call would have to be answered with a higher grade of debt which is probably already in use as collateral for borrowing. Either the position enabled by the TSLF or the position using the required collateral would have to be unwound.

Very recent events should have imparted lessons that would not be forgotten for some time. Obviously that hasn't happened, the recent credit crunches are still viewed as one off, extreme, events that somehow circumvented risk assessments. Yet they happened more than once in a short space of time destroying all methods used to measure risk.

(Except those who took a look at this debt derivative issuance some years ago and studied it properly, concluding that debt, obligated on collateralized securities, underwritten by unsecured borrowings was to be avoided.)

The lesson is that current measures of risk are useless, methods used to construct risk models are based on misplaced assumptions and faulty theory. The moral hazard of allowing the same risk models and systems to be employed whilst enabling a re-expansion of borrowing through centralist intervention is not just stupid, it is dangerous.

We have already seen what happens when risk is supposedly diluted from the few to the many via artificial constructs with misplaced event models. It does not work, like any system reliant on a stable base (that debt lent to consumers and business would not suffer from any significant default) has an inherent weakness. Such assumptions automatically increase the likelihood that such events will occur.

The Fed now stands in the way of forces that it cannot change. The assumption that the Fed will underwrite the risk of using toxic debt to enable further debt is completely false. Yet because the Fed is acting to allow a discredited system to continue, the expectation that the Fed will underwrite the markets is now allowing risk to be increased, threatening the credit and monetary systems with further destructive events.

When you see comments from analysts, writers, bloggers or journalists supporting the Fed/US Govt actions or calling for more intervention make a note of their names. When the edifice of this self-serving, intervention prone bailout of the financial system comes crashing down, send them an email, remind them of their words and put "Moral Hazard" in the title.

That's it for this week. To view the new ranges within longer trends, visit the Trend Indicators page. Have a good week.

Welcome to the Weekly Report. This week we look ahead to the new pricing system for Mortgage Backed Securities and Asset Backed Securities created by the Bank of England, developments in bonds and yields and why the Federal Reserve is central to current yield changes. We ask if the credible policies are leading to increased inflation expectations and look for global reaction. We update the long term trend update for the Dow, FTSE and Gold.

By now I doubt there is an investor or trader worldwide who isn't aware of the Federal Reserve, Bank of England, Bank of Canada, Reserve Bank of Australia and the ECB have been doing in their efforts to infuse liquidity and arrange swaps or borrowings of AAA Government bonds to replace credit paper/notes affected by the loss of confidence in its ability to avoid default events.

This week Mr King at the Bank of England made it clear (how unusual is that!) that the Special Liquidity Scheme it has introduced will last for at least 3 years and if it is required to expand beyond the initial £50Bn then it will happen. The new facility is in addition to this, quoted from the B of E site (it is a large quote but contains some vital information):

• Central bank operations

  Banks routinely borrow money from central banks in exchange for assets. They do so to manage their day-to-day cash needs as they lend and borrow funds. In response to the stresses in financial markets, central banks worldwide have extended their lending facilities.

  Since August, the Bank of England has increased by 42% the amount of central bank money made available to financial institutions. It has increased from 31% to 74% the proportion of its lending to the market that is for a term of at least three months. Since December, the Bank has also widened the range of high-quality assets accepted in its 3-month lending operations to include mortgage-backed securities.

  The stock of outstanding lending against that wider range of collateral is £25bn. These changes have aimed to alleviate the problem of financing the large overhang of illiquid assets on banks' balance sheets.

  The Bank of England will decide the margin between the value of the Treasury bills borrowed and the value of the assets banks are required to provide as security. For example, if a bank were to provide £100 of AAA-rated UK residential mortgage backed securities, it would, depending on the specific characteristics of the assets, receive somewhere between £70 and £90 of Treasury Bills. A complete list of margins is included in the market notice.

  The main category of assets will be securities backed by residential mortgages. Securities backed by credit card debt will also be eligible. These assets will be high quality - rated as AAA. If the assets were to be down-rated, banks would need to replace them with AAA assets. The facility will not accept raw mortgages and none of the underlying assets can be derivative products. The Bank of England routinely accepts assets denominated in currencies other than sterling. It will not accept securities backed by US mortgages.

  The Scheme is designed to deal with the overhang of existing assets on banks' balance sheets, not to create artificial incentives to undertake new lending. To that end, only securities formed from loans existing before 31 December 2007 will be eligible for use in the Scheme.
  

What's so important or vital you may ask? Well, how about the pricing of AAA rated Mortgage and Credit card backed securities, valued at 70-90p on the Pound. Surely that sets a mark to market maximum price for the next 3 years. Borrowing using AAA mortgage and credit debt as collateral just got expensive. Borrowing using anything else as collateral is next to impossible. Borrowing using collateral "invented" after 31 Dec 2007 isn't allowed to be used in the Special Liquidity Scheme. It also means the best route to move losses off the books is to deal with the B of E and it's not free:

• Banks will be required to pay a fee to borrow the Treasury Bills. The fee charged will be the spread between the 3-month London Interbank interest rate (Libor) and the 3-month interest rate for borrowing against the security of government bonds, subject to a floor of 20 basis points.

That though is not the most important point raised by the B of E. They have refused to take ANY securities backed by US mortgages. The US just got downgraded by the Old Lady. Now if the B of E won't deal in US mortgage securities, why would any UK bank buy them or accept them as collateral on their lending? Without the "King Put" the risk is just too great.

Can you smell contagion? It gets worse, not only has all US MBS been downgraded to junk but ANY derivative of ANY MBS or ABS is not acceptable as a swap for Gilts.

Here though is the clincher, US Asset Backed Securities backed by credit cards and rated AAA, are acceptable. US credit card debt is more valuable than US mortgage debt. So, who does the B of E rely on for the ratings criteria?

• Credit ratings as set out above must have been provided by two or more of Fitch, Moody's, and Standard and Poors.

But the Old Lady has one more swift kick to deliver, it maybe the nastiest of all:

• Eligible securities will be valued by the Bank using observed market prices that are independent and routinely publicly available. The Bank reserves the right to use its own calculated prices. If an independent market price is unavailable, the Bank will use its own calculated price and apply a higher haircut. The Bank's valuation is binding.

The haircuts can be considerable as seen by this table:

The US GSE is for conventional debt.

It looks to me that the use of the rating agencies in this matter is very limited. The Bank has decided to make a market on the assets swapped for Gilts, regardless of market conditions and not rely on ratings. Just when you thought it was safe to dump your toxic waste, you realize you could get margin called on it. Of course, if the B of E are marking to market, what's the reasoning for anyone else not to do so? In an attempt to get around a moral hazard that we know is troubling Mr King, the Bank may just have initiated the very scenario they were trying to avoid.

Sometime ago I said that the Facilities set up by the Federal Reserve had an inherent flaw, one that could be taken advantage of by speculators. That flaw may well be exposed and the speculation could have begun.

To spot the flaw we need to have a look at the effects the Facilities are having on bond markets.

On April 21, 2008, the Federal Reserve will offer $50 billion in 28-day credit through its Term Auction Facility. Additional information regarding the auction is listed below; the auction will be conducted as specified in this announcement, Regulation A, and the terms and conditions of the Term Auction Facility (www.federalreserve.gov/monetarypolicy/taf.htm).

• Description of Offering and Auction Parameters

  Offering Amount: $50 billion

  Term: 28-day loan

  Bid Submission Date: April 21, 2008

  Opening Time: 11 a.m. EDT

  Closing Time: 1 p.m. EDT

  Notification Date: April 22, 2008

  Settlement Date: April 24, 2008

  Maturity Date: May 22, 2008

  Minimum Bid Amount (per bid): $5 million

  Bid Increment: $100,000

  Maximum Bid Amount(per institution): $5 billion (10% of Offering Amount)

  Minimum Bid Rate: 2.05 percent

  Incremental Bid Rate: 0.001 percent

  Minimum Award: $10,000

  Maximum Award: $5 billion (10% of Offering Amount)

Notice the rates? Below is a picture of the yield curve from www.StockCharts.com, the red line was the curve at the beginning of April, the black line the curve as of Friday:

Whilst the short end rate has remained anchored the rest of the curve has risen, notice the bulge around the 2year/5 year maturity? We saw a major issuance from the US Treasury in those maturities in April. Setting aside talk of money moving from US Treasuries into stocks, which is mainstream media talk for "we don't know what happened" the increase in yields has is better understood as an act of monetary inflation in the form of credit issuance and as a result of a credible attempt by the Fed/US Treasury to show inflationary tendencies. An indicator of this is the move by the 30 year Tsy yield:

Courtesy of Stockcharts.com.

A move through the 200 day moving average could see the 30 year yield try to regain the highs of 2006/07 at around 5.30%, lets not get ahead of the move just yet but keep in mind there is a positive divergence between the MACD (higher lows) and the yield (lower lows) since late 2008. It would appear that The Fed has been successful, so far, in supplying liquidity to the credit markets, going by the drop in prices for Tsy bonds.

The effects are starting to be talked about in the financial media and showing up in surveys, as we expected from the work we did on the Eggertsson Theory:

• April University of Michigan consumer sentiment showed 1 year inflation expectations at 4.8%, up from 4.3% in March.

  OUTLOOK: From Citi: "Food price inflation, rising much faster than unit demand, is having a larger negative effect on global real incomes, while gasoline pricing is having a more substantial negative effect on the U.S. The net of the two is a significant drag on consumers worldwide, quite distinct from one merely confined to the U.S."

  US MKTS: A source says there is buzz about higher inflation expectations, and "higher gasoline prices are a drag on growth" and a sign of stagflation.

  US OUTLOOK: Oakworth Capital analyst John Norris worries about inflation: "In the face of $3.60/gallon gasoline, historically high grain prices including rice, $4+ milk, and all of it, the Federal Reserve is cutting interest rates and Washington is priming the pump even more. In short, the official policy is to apparently create as much money as possible."

The FOMC meet this coming week with markets looking for another 0.25% cut. However this may not be good news for stocks (excluding the traditional "bounce" on announcement) or be effective in helping consumer rates of interest from here on in. With many rates set from the 30 year yield the Fed cut might be futile in an attempt to lower mortgage or other debt.

Stocks have a different problem. This from Bloomberg:

• April 26 (Bloomberg) -- Japanese government bonds tumbled, causing the biggest jump in five-year yields in nine years, after inflation accelerated, global stocks climbed and the dollar rallied against the yen.

  Ten-year bond futures plunged as much as 1.8 percent yesterday, forcing the Tokyo Stock Exchange to order a 15-minute halt in trading for the first time since September 2002. The statistics bureau said consumer prices climbed 1.2 percent from a year earlier in March, adding to speculation the Bank of Japan will increase its target interest rate this year.

  ``The market is in a bit of a panicked state,'' said Masahiro Sato, joint general manager of the treasury division at Mizuho Trust & Banking Co. in Tokyo, a unit of Japan's third- biggest lender. ``I can't say how far Japanese bond yields will rise, because they've already broken through my forecast levels and the selling pressure could snowball from here.''

  The yield on the 0.8 percent note due March 2013 rose 19.5 basis points yesterday, the most since 1999 for five-year securities, to 1.24 percent at Japan Bond Trading Co., the nation's largest interdealer debt broker. For the week, the yield gained 31 basis points and the price fell 1.416 yen to 97.973 yen. The yield was at the highest since October 2007.

With the move higher in Japanese yields and borrowing costs the Carry Trade (sell low yielding Yen, buy higher yield Dollar assets) is now reliant on a move higher in US yields for it to be sustained. If the Carry Trade breaks down, i.e the yields become inverse then selling pressure could become intense on Dollar priced assets.

To show the relationship here is a chart of the Daily Dow, with the 200 daily ma:

Look familiar? There is a correlation between bond yield moves and stocks. When rates rise, so do stocks and when rates fall, so do stocks. Therefore if the FOMC cut this week and yields follow lower stocks may well head in the same direction. Notice the 200 day ma for the Dow and for 30 year yields?

We could be at a pivotal point.

For the longer term it could be that the problems that the Fed et al have put off will re-visit us at some future point. If so I expect the future fallout to make the past 8 months look like a walk in the park. That though is for expansion upon in the next Occasional Letter.

For the updated long term Dow, FTSE,Gold and GS charts and new targets, visit the Trend Indicators page.

Finally, if you are reading this you have joined The Occasional Letter website. I hope you find the site useful and informative. I intend to still publish a small part of the Occasional Letters and the Weekly Reports at a few selected sites but as you may have noticed with this Weekly Report, the good stuff is for subscribers only.

Welcome to the Weekly Report. This week I have to highlight conditions in the bond markets as a priority, we maybe about to endure a bust of quite large proportions. I will also look at some longer term stock market indicators, confirmation that the Bank of England will follow the US and show why the current rally in stocks is due to a visit from an old friend, as readers at Livecharts.co.uk will know only too well.

Before we begin I need to comment on something I read this week.

• "Hedge funds played their part in the violent rise in spot prices early this year. To that extent they can be held responsible for the death of African and Asian children. Tougher margin rules on the commodity exchanges might have stopped the racket. Capitalism must police itself, or be policed."
  

Who wrote this, some socialist leaning European, a US Treasury/Fed spokesperson? Maybe it was the remnants of a socialist/communist government in the Caribbean? No, no one like that, it was none other thanAmbrose Evans-Pritchard, International Business Editor at The Telegraph.

Here is how he describes his orientation to all things economic:

• "For the record, I am a Burkean conservative, aged 50, with a libertarian bent, and a penchant for Monetarist and Austrian economics - though Keynes had a point in the Slump."

Well at least he has all the bases covered, I suppose. Unfortunately all it shows is a confused methodology toward economic thinking. Some of his influences are in direct conflict (vitally about the Slump) and Ludwig von Mises is probably spinning in his grave.

What is more worrying is that AE-P is allowed to write such bilge as we see in his remarks about Hedge Funds. (I have no connection, in any way, to Hedge Funds.) Hedge Funds didn't cause the rise in soft commodities, they did not enable it. To say that they did (even partly) and are responsible for mass starvation shows a complete lack of understanding about the true nature of monetary inflation and Central Bank sterilisation methods and their destabilising effects on free markets. Yet thousands of readers will have taken that statement as a fact.

Without me saying this is the cause, a simple point about the rising costs of transportation of foodstuffs, shortages and pricing mechanisms blows his statement out of the water. He also seems to forget a very simple rule, for every buyer, there is a seller. Who sold to the buying hedge funds at prices that were acceptable? No mention of that I see.

Hedge Funds operate in a (supposedly) free market. They buy and sell as they feel fit, just like everyone else does. They make profits and when they make losses, they go bust, unlike certain banks or brokers who get centralist protection and bailouts. Capitalism polices Hedge Funds, they either survive or go under. If they do something illegal, fine, regulators should get the batons out and beat them to a pulp.

Instead what do we see in the mainstream media - shrill and hysterical statements pointing the blame at those funds operating correctly in a free market. Calls for more regulation and as I mentioned would happen not long ago, calls to restrict margin availability. If AE-P truly believes what he wrote, he needs to expand upon it. If he wrote it to garner readers he should change his "credentials".

Ambrose, if you read this and want to reply feel free.

I am seriously concerned that many are not ready for what is to come in the US bond markets, especially US Treasuries. As we have witnessed the Federal Reserve is happily swapping lower rated debt, stuff that no other lender wants as collateral, for US Treasuries to enable Bank and Broker credit to be continued.

Now, in a way this could be viewed as a neutral debt creation policy, a swapping of assets rather than new issuance. However that situation is about to change and bond markets are beginning to price in the effects:

• The Treasury's two-year note sale on April 23 may tally $30 billion, according to Jersey City, New Jersey-based Wrightson ICAP, which specializes in U.S. government finance. That would be the most ever sold for the maturity, according to the Treasury. The government may sell $20 billion of five-year notes the following day, which would be the most since 2003, according to Wrightson. The government announces the amounts April 21. (Bloomberg)
  

As discussed in the last 2 Occasional Letters this should come as no surprise, issuance of Government debt is required to lend credibility to increased inflation expectations. (You didn't think I did all that theoretical work for no reason did you?) It will not be the last surge of treasuries into the markets either.

Bond markets are faced with further supply, as we can see here:

• NEW YORK, April 18 (Reuters) - U.S. high-grade corporate bond issuance hit a record in April as companies took advantage of improving market sentiment and strong investor demand for new deals.

  U.S. investment-grade corporate bond volume totaled $50.7 billion through April 18, according to research firm Dealogic. The previous record for this month was in April 2001, when companies sold $47.35 billion of high-quality debt.

  This week's issuance alone included a few marquee deals from a finance subsidiary of General Electric Co, JPMorgan Chase &, XTO Energy and Lehman Brothers. General Electric Capital Corp's $8.5 billion transaction was the fifth-largest U.S. corporate bond sale since 1995.
  

On top of all this is the new muscle beginning to be flexed by the GSE's, for example:

• WASHINGTON (AP) - Mortgage finance company Freddie Mac said Thursday it would buy up to $15 billion in home loans for higher-priced properties, using new flexibility granted by Congress earlier this year.

  Freddie Mac, the second-largest U.S. financier and guarantor of home mortgages, said it would buy the mortgages of up to nearly $730,000 from Wells Fargo & Co., JPMorgan Chase & Co., and Washington Mutual Inc.

  Richard Syron, chief executive of the McLean, Va.-based-company said the move "shows how we can bring new liquidity to markets other investors have all but abandoned and make full use of the new tools Congress gave us to help restore stability during the current housing crisis."
  

I am not going to discuss all the ins and outs of the debt issuance and credit expansion again as it has been covered elsewhere. What we can see is the emergence of debt issuance has been reignited, thanks to the back stop provided by the Federal Reserve. Here is moral hazard writ large, as new debt is used not to shore up current positions but is creating further liabilities.

For the first time in many a year, it appears that the bond markets are reacting to this increased supply as confirmation that the US Govt and the Federal Reserve truly intend to inflate over the longer term and are decoupling from the Fed Fund Rate(2.25%) along with LIBOR.

• "When the Fed and Washington radically altered the rules of U.S. finance last month, they placed in jeopardy huge positions that had been put in place to hedge against and profit from systemic crisis. With the end of "Stage one" arises a major short squeeze in the Credit, equities, and derivatives markets. And when it comes to contemplating the scope and ramifications of today's "hedging" activities, we're clearly in Uncharted Waters. It is not beyond reason that a disorderly unwind of "bearish" Credit market positions could incite a mini bout of liquidity, speculation, and Credit excess that exacerbates Global Monetary Instability - while Setting the Backdrop for Stage Two of the Crisis."
  

For bonds that means a sell off, and the possibility of the long end (30 year) yield climbing significantly. If the Fed cut at the next meeting, it could be enough to trigger a panic steepening trade, reinforced by stops being hit.

Here is the nasty bit. That means credit for the consumer and corporate business gets more expensive. Unless, of course, you happen to have access to the Federal Reserve Facilities allowing you to borrow cheaply at the short end and lend high at the long end. A domestic carry trade, designed purely to re-capitalise banks and brokers at the expense of everyone else. I wonder if the public will view the bailout of Bear Stearns and the support of the banker/broker sector so benignly in 6 month's time? Pain is coming and the morphine has been taken away.

If I had a portfolio of bonds, priced in dollars or sterling, I would want protection going into the next FOMC meeting.

Why sterling you say? Because the bank of England is about to commit to the same path as the US (except Gordon Brown took away a tax break for the low paid. This is an error both politically and under Eggertsson Theory.) I give you this:

• "LONDON (Thomson Financial) - The dollar and pound rebounded across the board Friday as their respective central banks moved to differentiate their support for mortgage and credit markets from monetary policy, allowing them to sound more hawkish on inflation.

  The Bank of England is finalising a plan that would see it accepting mortgage-backed assets in exchange for Treasury gilts in order to kick-start interbank lending back to life, a measure adopted earlier by the U.S. Federal Reserve.

  This program is allowing rate-setters to 'de-couple' their monetary policy from their support for financial markets and mortgage lending.

  "There is a different strategy being used which is to differentiate calming mortgage markets from monetary policy," said Hans Redeker, head of forex strategy at BNP Paribas."
  

You should note, although I wrote 2 Occasional Letters getting into the mindset of the Federal Reserve et al and their application of Eggertsson, I do not necessarily agree with the successful outcome. That though is for another day.

Notice something in the above quote? Dollar and Sterling appreciated on the move higher in yields. Now call me old fashioned but the "story" from the Fed and the BofE talking heads last week was about the worries of higher inflation. Even the ECB boys are beginning to sound worried. Since when does a currency appreciate on inflation worries? When the worries are an excuse for implementing policy maybe?

Of course an old friend returned to the marketplace this week. It's a straight talking indicator that needs no interpretation; we always listen when it speaks:

The carry trade is re-invigorated. That's why the stock markets suddenly "feel" like the pre-credit crunch era. Sell low yielding Yen and buy Dollar and Sterling assets. So much for a change in behaviour in market sentiment. The problems of the credit markets have been postponed with a timeline just long enough to allow the capital reserves of the banks and brokers to be rebuilt.

The question that now sits in the middle of the room is simple. Does the market believe that debt issuance and monetary policy can be separated? Who is right, the bond traders selling or the carry traders buying?

Finally a look at my long term weekly Dow chart showing weak or strong stock performance:

The indicator (circled) has broken above zero. The MA has already had a retest as support and the Dow has moved above the January/February highs. Right now I view the Dow as trying for a higher move, the 13700 area looks obvious. A (weekly) close below the Jan/Feb highs would put a revisit to the MA on the menu.

Closer in, below is the daily Dow trend chart, there are 3 green arrows, 12563 support, 12834 support and resistance at 13195. We may consolidate the break of 12742 this week. As you can see from the past 5 days, we didn't break support at 12250 and then went higher hitting all the previous targets. There is a slideshow here showing the targets placed before the moves.

I will be watching for supports to get tested.

For the Gold, FTSE and Goldman Sachs charts click here and scroll down.

That's it for this week, please take time to have a look around the website and let me know what you think at mickp@livecharts.co.uk or mick.phoenix@gmail.com