Morning Report - Liquidity squeezes ahead

Vital Statistics:

	Last	Change	Percent
S&P Futures	2120.7	-1.2	-0.06%
Eurostoxx Index	3675.4	-11.2	-0.30%
Oil (WTI)	50.25	0.1	0.20%
LIBOR	0.292	0.005	1.66%
US Dollar Index (DXY)	97.88	-0.151	-0.15%
10 Year Govt Bond Yield	2.39%	0.02%
Current Coupon Ginnie Mae TBA	103.6	-0.2
Current Coupon Fannie Mae TBA	102.9	-0.2
BankRate 30 Year Fixed Rate Mortgage	4.16

Markets are lower this morning as earning pile in. Bonds and MBS are down small.

Dodd-Frank has severely neutered the market-making function of the banking system. When the Fed starts tightening and bonds sell off, the natural buyers of bonds (primary dealer banks) will no longer be able to dampen the moves by standing on the other side of the trade. The Fed is unconcerned about this, but we shall see what happens when rates start going up and the bond market starts falling faster than they are comfortable with. 

Incidentally, Hillary will probably be forced to support a financial transactions tax, which is a tax on market-making as well. Basically it would slap a  tax on every stock trade, currency trade, and bond trade. Narrowing bid / ask spreads and a 90% drop in commission rates has basically eliminated the market-making functions (NASDAQ market makers, the specialists on the NYSE floor, block trading at banks) in the stock market. Machines are all that is left, and even they are not in the market-stabilization business. The next crash, they are going to suspend trading until things stabilize and there will be nothing but GTC (good till cancelled) buy orders for people to sell to. Washington should be careful what it wishes for. 

As China's economy cools off, and the US dollar rallies, we have seen commodities get absolutely slammed. Oil has been cut in half over the past year. Gold is in free-fall. Natural Gas is down big. This will keep a lid on inflation, and allow the Fed to keep rates lower longer. 

Everyone knows that Chinese money has been behind the building boom in many large cities. This is actually driven by policy. Chinese investors who invest $500,000 and can prove that their investment created at least 10 jobs (not hard to do on a construction project) get permanent green cards. These are typically wealthy Chinese investors who are trying to get green cards for their kids and are not all that concerned about return on investment, which means dirt cheap financing for developers. Now, the government is thinking of making some changes. Obama would like these investors to put money in low-income housing, not luxury condos. Also, abuses in the program have led other to question it altogether. The program has bipartisan support so it probably isn't going anywhere, but when you use policy as an economic lever you invariably create dislocations and marginal projects that don't make economic sense. Something to watch.