Bill King: Bond Divergence

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During European trading on Wednesday, the dollar fell to a new ’09 low. This produced a SPU rally into the NYSE open. US traders then poured into stocks on a ‘cash is trash’ rally. But that was it for the rally.

As we have asserted for months the major prop under stocks is dollar debasement from Benito’s debt monetization scheme, which is euphemistically called quantitative easing (QE).

Bonds tanked on the dollar decline/stock rally and because the US Treasury had to sell $20B of 10s.

With dealers long US paper, bonds tanked into the auction but rallied after it as dealers marked up their inventory in the hope of inducing patsies to buy their merchandise. The post-auction bond rally eradicated the stock rally. But the standard late SPU manipulation generated a gain. Once again there was little action between the Euro rally-NYSE open and the late manipulation.

Stocks are beholden to the whims of traders and perceived linear relationships with the dollar and bonds.

As we alluded to in recent missives, bonds are acting ugly while gold has strengthened on dollar concerns. 115 on the USZs (~4.63% on the 30-year) is critical support. This is a double bottom from July and August. If this level is breached, Benito is in big trouble.

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If Bernanke increases the Fed’s debt monetization scheme of $300B that is scheduled to end in October, the Chinese and Mr. Market will be very unhappy. The dollar will tank further; gold, oil and commodities should surge. This action should actually force bonds lower.

If Benito refrains from further debt monetization, US dealers will be holding the bag and the short-term outlook for bonds would be negative.

Bernanke will soon be forced to choose between saving the dollar and bonds or stocks.
In the mean time, we continue to believe that although stocks are overextended any September pullback will be modest unless new developments appear. We also think it is still too early to short stocks or play for a significant decline.

And as we recently stated, because any meaningful rally from here is likely to be the product of funny money, dollar debasement plays should outperform other stock market sectors.

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