[DcifrThs]

Great thing about a thread like this is that i'm forced to come back to it and learn.

so i'll now post some thoughts on the performance of the major issues i was talking about.

first off, bond yields have significantly fallen since the 5.02%. the subprime issue appears to be spreading farther into the macroeconomic landscape than i initially thought.

does that change my position? and if so, how? well the issue really comes down to how will it affect growth given where we are in the cycle? the flow through affect seems to be fairly significant in a few senses.

first and foremost, it has slightly, and can significantly cause an effective tightening in monetary policy in the sense that consumption can come in a lot as credit is withdrawn from the economy (just as a higher fed funds rate would cause credit to become more expensive).

directly, mortgage holders' free cash is constrained by higher rates and their ability to take out more credit to spend (either by getting a mortgage or by getting more credit if they've defaulted) has been hugely dampered. that will likely have a direct affect on consumption.

indirectly, a few things appear. we see overall credit spreads widen, which makes company spending less likely to carry the same burden it did in the first quarter. it also makes credit for non-subprime mortgage holders harder to get (though not on the same scale). this can again reduce consumption both by individuals and investment in companies. risk aversion in, turn has increased. investors require higher returns then for LBOs and other takeovers than was priced into the actual transaction. the 300bil in the pipeline will cost more, cause some constraint on free cash flows of companies, and not give the same freedom to the lenders as previously thought.

further, the glut of homes in the pipeline push down housing prices and new home sales continue to deteriorate as old home sales stagnate or fall further. lower housing prices all around push wealth down and thus also hurt consumption.

no homes being sold, means fewer homes being built. the construction industry is thus at risk. one BIG sign to look for here is the construction job market. unofficial jobs have likely been cut, but when we start to see actual reported layoffs, THATs when the true hit to the economy is likely to begin as those workers are indicative of many different types of future consumption.

equity valuations can then (and have been) be subject to a correction, as is likely what happened (though possibly an overreaction...that is yet to be seen and i can't say whether we've even seen a big enough correction given current conditions). when equity values AND home values fall WHILE credit becomes harder to get, i'd expect consumption to take a fairly large hit.

bernanke doesn't seem to think so, but we'll see what he has to say about that next time he testifies.

another indirect effect flows through to actual job losses. 2 subprime mortgage companies have failed. this means that those workers are now 'looking for work' and don't ahve that income. they can thus be expected to consume less. but, this does have a positive outcome (though very slight). unemployment can be expected to come up a bit now as hirings by mortage issues is likely to tail off as well as construction.

add to all this the ease we've had in the recent past and how people tend to bake that into their expectations of the future and we see a large jump in the cost of insurance against defaults (and likely some buying opportunities as discussed earlier). the spike in vol has also been quite obvious and we've hit record volume numbers.

now that is growth. what about inflation? well we still have it, though it is a lagging indicator and thus likely to fall a touch in the near future as capacity may come down below 81% on the next read, which would be significant. below 80% would mean a massive increase int eh probability of a rate cut in the near future.

oil prices are still high and that may flow through to keep up headline CPI, but core is likely to fall a bit given all the above.

in turn, yields on risk free assets have come down while risky loan yields have stayed flat or jumped. thus spreads have risen alot. the risk free yields coming down reflects an increased priced in probability of a cut given the hit the growth/slowdown in inflation/pull back in capacity and industrial production + the "flight to quality" we tend to see when sh*t hits the fan, as it has.

those yields coming dwon push the dollar deeper into falling territory and this is where my gold bet falls apart. i'll likely lose my bet w/ Mr. Now since i've misjudged the liquidity vs. dollar effect on the futures price of gold. liquidity doesn't necessarily need to come from real rate moves, as spreads can widen and withdraw enough liquidity to keep rates at current levels. real rate moves are more likely to move prices as i've stated.

further, liquidity is a long term playout thing vs. the short term trading off of the dollar weakness we see in gold. i was wrong here. the dollar is weak and the int'l demand for US treasuries isn't enough to compensate for lower treasury yields.

one GOOD thing about that, is that exports to trading partners become more attractive and that might help us through the above mentioned growth issues we'll likely soon be facing. if our trade deficit comes in significantly (either due to increasingly expensive imports, or larger #s of exports) the economy will benefit (either by reduced input prices b/c fewer imports are purchased at high prices, or by increased demand for our goods).

this is why i'd think fed funds rates are going to stay the same in the US. the current reduction in yields (though not necessarily in all borrowing costs as discussed) can affect the economy in a similar way as a fed rate cut. despite that, the one bet i had on as a steepener has come to fruition slightly so not all my FI positions have failed [img]/images/graemlins/smile.gif[/img]

i still don't think we'll see a fed rate cut at all so i'd bet against that, though with a slightly weaker signal.

further, the long silver legs of my trades have come in and the steepening of the gold futures curve, while not winning, has a long portion to it so it mitigates overall losses.

that was a bunch to chew on so i'll stop there.

to sum, being wrong affords one the opportunity to think back as to the hows & whys and learn from it.

questions? comments? thoughts?

Thanks,
Barron

PS- i'm not rereading this entire post b/c it is so long so please take all errors in spelling, grammar, sentence construction in stride.

thanks.