From Potential Chaos, Opportunity?

ESZ3 Daily 161013Good Morning, Friends. Despite the many years that I’ve spent in the markets as a professional on institutional trading desks in FX and fixed income, I sometimes find myself scratching my head. I suppose that if people want to buy futures and stocks this morning in the hope that the folks in Washington will reach an agreement that is more than just a pact to do it all over again in a few weeks, that’s their right. I’m happy to trade the market that’s in front of us on the 3-minute E-mini chart, but I’m not really tempted to add to my longer term stock holdings here. I’m long MSFT and QCOM, but have calls and puts written against both, leaving me with a fair cushion, and in the case of Mister Softee, a decent dividend yield. 

We have a “sort of” binary today. We may or may not get an agreement between the Senate, the House, and the White House that isn’t just a postponement of the tough decisions. I personally think that’s becoming a long shot given the time constraints, but reasonable people can reasonably differ over that question. It may also be the case that a technical default by the Treasury, whether it comes tomorrow or sometime later in the month, won’t have a dramatic impact. I’m definitely not willing to bet on that, but since that will put us in territory that hasn’t been visited lately, I could easily be wrong.

I do know that the financial system runs on leverage, which in turn is dependent on the willingness of counterparts to extend credit, which depends on the provision of collateral. All of the trading and swaps that take place among financial institutions – and the sums are enormous – are backed by collateral, and the most solid collateral of all has always been U.S. Treasury bonds and notes. The T-bill market has already become very skittish, since they will be the first obligations to face the test of repayment after tomorrow. Many of my bond manager friends are spending time with their internal and external legal counsel trying to figure out what their rights and responsibilities are if a default or downgrade makes the collateral that they’re holding, or posting, worth much less than was the case last week.

The point isn’t to bore you with this stuff, but a steady flow of credit and collateral is as important to the markets as oil is to a car’s engine. It seems pretty likely that a positive response to good news in Washington is already being priced in, but on a solid agreement I would expect to see the highs at 1723.75 retested in the E-minis. If we get through the day without any progress, I would expect to see a swoon this afternoon that should continue until a pact is reached. The potential for panic exists, but I don’t see much point in speculating as to where support might lie in such a case; as noted, we haven’t done this recently. 

Mel Gibson’s character in “The Patriot” reminds his sons “Aim small, miss small”. That parallels Todd Mitchell’s advice; if we stick to the short term charts, trading the 3-minute bars as he teaches, the noise doesn’t matter nearly as much. Just be aware that the chances of a spike in either direction exist, and since they’ll be in response to headlines, they can’t be handled as readily as can responses to a scheduled economic release. Another quote, this time from a TV show (“Hill Street Blues”): “Let’s be careful out there.”

Best of luck, Friends.

About the Author kevin


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