The Economy Guy

Don’t let anyone tell you that volatility is leaving the market, and things are settling down to the “good old days” of calm markets.  Volatility is alive and well.  Today’s moves were in the bond market and the Dollar market.

While stocks moved sideways, bonds made a major move upward in interest rates, achieving another near term HIGH interest rate.  In fact, bonds exhibited a real paranoia about inflation.  Imagine that this move was caused by traders thinking the FED would increase interest rates in the near term!!!!  The recession keeps the lid on FED moves, so I’m not worried about that happening.

The Dollar took off, and finished a 2 day increase in the Dollar value that hasn’t been seen in a LONG time.

Even Gold got caught up in the frenzy, and was beaten down in value. A decrease in Gold value is counter-intuitive as an increase in inflation would push gold price UP, not DOWN.  But, this does give anyone who wants to buy gold another opportunity.

Oil and gasoline continued giving up those HUGE increases they made last Friday.  However, they haven’t given them all up yet.  Don’t get excited until you see a price reduction at your gas pump.

The British Bankers Association (BBA) has invited “interested parties” to come and talk about how LIBOR (London Interbank Offered Rate) is set each day.  This time honored method of setting LIBOR is under attack.  The way it’s set is that major London and Continental banks send inter-bank interest rates to the BBA each day, and this is used to calculate LIBOR.  So, the BBA sets the US LIBOR rate in London, and there is no US government involvement in it.  There has been concern in the last 6 months that LIBOR has not followed the US 1 Year Treasury note well, as it has done forever in the past.  It used to track, but recently it has been extraordinarily HIGH.  Why should you worry, you ask????  Well, lots of US mortgages (ARMS) are adjusted according to LIBOR set in London (in fact, my wife has one of those), and this is causing mortgage holders to pay increased interest.  This is exacerbating a bad situation in both the US and UK mortgage markets.  LIBOR is the interest rate that one bank lends money to another bank in London. LIBOR is set according to the currency being quoted.  In other words, the British Pound LIBOR rate is different than the US Dollar LIBOR rate.  If you remember, the world banking system – not just the US banking system – has been having a liquidity crisis.  This means that banks didn’t trust one another to lend money – they didn’t know if the other bank would be around tomorrow (think about Bear Stearns).  Well, banks didn’t stop lending money, but they DID RAISE the INTEREST RATE – and that caused the LIBOR calculation to go up.  Just another manifestation of the financial mess we are in.

The FED is setting up a CDS Clearinghouse in September.  Credit Default Swaps (CDS) are derivatives where one institution guarantees the payment of another institution’s commitment.  The guarantor is known as a counterparty in the derivative.  Because multiple institutions are involved, if one institution defaults on its debts, and it is a guarantor for lots of other people’s debts, how does the CDS counterparty get unwound???  Why should you worry about this???  Well, the CDS market is BBBBIIIIIIGGGG.  It is $62 TRILLION in size.   By the FED getting involved there is good news and bad news.  The good news is the FED will be looking at all the banks records so it knows what will happen if a bank fails.  The bad news is that YOU are going to pay the bill if the FED has to kick in and cover some bad counterparty debts.  You will pay by increased taxes, or printing money = increased inflation and you money is worth less (worthless).