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Minyan Mailbag: Reflation Trade

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.

John,

From my perch, the reflation trade did somewhat lead this market higher, as well as the structural issues you discuss, so does the reverse of this force it lower? Keeping a third eye on the System Open Mkt Account Holdings to gauge Open Mkt Operations of the Fed makes sense to me to see how much and how quickly liquidity is being purged from the system; which would put a bid underneath the greenback and force the commodity, bond, and equity mkts down. Looks like from what I can find the growth in M2 has started to come in. The Graph below shows M2 has grown since they started tightening rates in May 04. I realize trying to game the micro-ticks in the decrease of M2 is a flawed proposition, but the overall trend is beneficial.

(or is there a better way to gauge liquidity/supply of money?)



As I see it, the greenback has caught a bid, while commodities, bonds and equities have come in somewhat.

I realize this is a small part of a bigger picture, but what happens when they really step it up and remove the sloshing liquidity (or am I behind and they have stepped it up?). Best guess, this could start a wave of further, aggressive selling in the aforementioned commodity, equity and bond complexes, especially if anything structural happens, particularly to China's growth (which looks probable). If the Fed is gunning to pop the so called real estate bubble will they do so at the detriment of everything else?

A little doom and gloom? Yes. Am I being too aggressive in my assumptions? Probably.

(Bubble used to be associated with fun when I was a smaller version of myself, why does adulthood take good words and make them bad?)

Thanks for any input.

Minyan Michael

Michael,

As you have illustrated, the Fed talks a good game, but has done little to remove the liquidity life support.

While they have raised the cost of money (short term rates), they have not stopped printing it (M2 aggregates remain strong). I believe they have simply bought long treasuries with it, keeping long rates low so as not to prick asset prices.

Our economy is more and more dependent on higher asset prices in lieu of dependency on more traditional income generation. Consumers spend borrowed money and collateralize it with rising asset price.

I agree. Any attempt to meaningfully reduce monetary aggregates will cause significant damage to financial asset prices.

Any increase in long rates will most likely be preceded by a drop in the dollar yen. So far we haven't seen this: Japan has surpassed even us in their printing fever.

Regards,
Prof. Succo

No positions in stocks mentioned.

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