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Equity Markets Continue to Bleed. Why? German Stupidity, Volcker Rule and the Carry Trade Unwind

As usual European news leads the way with a ridiculous ’shoot in the foot’ decision coming out of Germany…

Merkel will announce, on Wednesday, a financial transactions tax, and a ban on naked short selling on 10 of the “most-important” financial institutions in Germany. Ban also applies to CDS and Euro govt bonds. Will remain in place for an indefinite period of time.

…Neighboring countries have not agreed to implement the same tactics.  Best guess, this ludicrous stance from Germany will only lead to confusion and have a negative effect on Bund prices as rates will rise. Moreover, as we learned in 2008, banning short selling in the shares of financial (FIN) institutions does not stop the decline in share value. In fact, as the record from 2008 reflects, said ban only serves to highlight the precarious position of the financial institutions and leads to more selling.

The idiocy of Merkel’s decision is mind numbing and only proves the current German administration has no understanding of how markets work. I haven’t the time nor the inclination to explain all to these neophytes but I will offer this simple insight: Short-sellers are natural buyers on the way down. They are short term position takers and as stocks drop they buy to cover. Preventing this behavior will obviously result in more erratic price movement.

Well done Merkel, you have succeeded in highlighting the weakest FINs and during a time of extreme volatility, you have accomplished the single worst feat: You have reduced liquidity!  For your actions, we award you with this ‘Larry Summers’ medal of honor.

I find the next news story much more disturbing. The passing of the Volcker rule would add to the cacophony of voices attacking the financial sector. In my last post I wrote, “Make no mistake, as the volume of negative news and behavior towards the FINs grows louder the equity markets will suffer.” The Volcker rule will act like a bullhorn. A quick glance at the price charts of leading FIN stocks will confirm that many in the group have already taken out the lows set during the 1000 point Dow sell off on May 6th. As expected the rest of the market is following….

FT Says Volcker Rule, Given Up For Dead, Is Likely To Pass

As the FT notes, “the political mood is such that a straight vote on derivatives would be close and the Volcker Rule would be likely to pass.” Should the Volcker Rule pass, this will be the beginning of the end for the current casino capitalism system that has gripped Wall Street. And don’t be surprised to see a 10% drop in the market as a last ditch self defense mechanism by the primary dealers.

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…The final story helps explain the particular negative action today.  Almost all markets are selling off today in unison; Dow, S&P, NASD, NYSE, Transports, Utilities, Commodities etc.. We saw this type of indiscriminant selling during 2008 and it was usually a sign of the carry trade unwinding and margin calls being met. Hard to tell what the markets will do from here. Sometimes this type of selling across the board helps set up at least a temporary bottom. Of course, this action could also lead to a repeat of May 6th or worse….

Carry Bloodbath Resumes With Full Blown Liquidations Imminent

After earlier we saw the decimation of the European currency, it is now Asia’s turn where an impressive bloodbath is now raging. The AUDUSD is in freefall, having moved a massive 300 pips from yesterday’s high to today’s low. At under 50 pips from 0.855, the AUDUSD will likely breach 0.85 at which point the destruction at carry desks will become an epidemic, and full liquidations will soon ensue, coupled with billion dollar margin calls, forcing global asset liquidations at bulge brackets. With the carry collapse pervasive, don’t look to futures to stage any miraculous Fed-inspired ramps tonight: Germany may have well called the Fed’s bluff.

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About Bret Rosenthal

Interpreting the news that moves markets. Principal of RCM, LLC, and founding partner of the Fortune's Favor Family of Funds
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