Tuesday, February 07, 2006

Turbulence in the Flow of Funds

What if they had a refunding and nobody came?

Quarterly Refunding weeks were almost always exciting when I was trading currencies at Chase, particularly the first auction week of the year. The whole floor was buzzing as each trader tried to siphon off his share of the billions of dollars of flows which financed the Federal Government.

I imagine the excitement these days must be even more intense as the flows, in terms of dollars, have multiplied. Yet, if the magnitude has increased the oscillation pattern in prices is somewhat similar. As I recall, the US dollar tended to trade a bit stronger on the FX market prior to and into the auction, presumably, or so I was told, because bond buyers needed dollars to settle their trades.

A similar pattern is evident in the Gold market. Over the past few years, Gold, in terms of US$ has reached a short term peak just prior to or during the February refunding.

Efficient market theorists might explain this pattern as a hedge in the event of a failed refunding. Adherents to the secret market manipulators theory might explain this pattern as intervention to make the $ market appear stronger than it is while intervention apologists might respond that such is simply to facilitate smooth market flow during a period of temporary, but normal, financial stress. Regardless, the pattern is fairly evident, albeit less prominent in some years than others.

Speculators in Gold, as opposed to investors, might be thinking, after watching today's steep slide, now you tell us, while a skeptical subset thereof might be thinking, yeah right, you want us to believe you knew it was going to fall. No, I didn't know it would fall, only that the pattern tends to recur around this time. Further, I don't try to profit from the noise as a price taker, which is not to suggest that substantial profits cannot be made that way, it was my bread and butter on the sell side.

I'm intrigued to see how prices respond in the coming weeks. For Gold, in 2003, the Q1 refunding coincided with the beginning of a 20% drop in the price of Gold from a peak which was not seen again for quite a few months. 2004 and 2005's Q1 refundings coincided with less dramatic peaks and in the case of 2005 the post refunding week low was the low for the year for Gold.

Among the $48B of securities to be sold this week will be $14B in 30 year bonds, reintroduced after a few year's absence. Perhaps a bit of new supply in the long end of the curve will steepen the curve a bit and give the Fed room to tighten further without inverting. I'm also interested to note foreign, specifically foreign official demand in the long end of the curve.

Curiously, this auction is proceeding while the US Treasury is still waiting for Congress to raise the debt ceiling. As the Treasury explains:

Securities issued during the Quarterly Refunding will not be affected due to debt limit constraints. All securities auctioned during the Refunding will settle as normal on February 15, 2006.

While Treasury is working with Congress to promptly pass legislation to raise the debt ceiling, Treasury market participants should be prepared for possible delays in the auction schedule if Congress does not enact legislation to raise the debt limit.

So the quarterly refunding will not be affected due to debt limit constraints but Treasury market participants should be prepared for possible delays in the auction schedule if Congress doesn't raise the debt limit. 'nuff said.

What an interesting confluence of events; the Federal Government of the US is in a stand-off with Iran, is in a War in Iraq that, by the way, will be partially financed by this auction, and is defending itself from charges of illegality in Congress, who by the way, need to vote soon to raise the debt ceiling. Ah to be the NSA monitoring all the horse trading going on. Alas, I don't have security clearance so I'll just have to watch the effects of the horse trading in the markets.

This should be an exciting week.