BEST OF DOUG NOLAND

July 6, 2005

The stage has been set for a fascinating second half. I realize that most of the bond bears have been trampled into submission; I am keenly aware of the dynamics of establishing market tops. In a manner of speaking, the bond bears were trapped by atypical Fed transparency and baby-steps. While fundamentals (mortgage finance, speculative excess, crude, current account deficit, imbalances, etc.) argued for significantly higher market rates, the bond bulls could squeeze (the impaired bears) with impunity with the precise knowledge of the Fed’s game plan. Well, things get a lot more uncertain going forward. Even the Fed now recognizes the downside to providing clear-cut market signals. Most importantly, the current structure of interest rates ensures mortgage Credit excess, housing inflation, strong consumption, massive Current Account Deficits and all the global liquidity for the Chinese and others to buy whatever they desire. And let’s not forget how impervious the technology Bubble was to 6% Fed funds? What are today's after-tax borrowing costs?

And it is worth noting today’s market action, the first session of the second half. Bond yields surged, spreads generally widened, currencies made wild moves, gold was hammered $8.10, crude jumped $2.25, and the Goldman Sachs commodity index added almost 3%. It was certainly not the type of market behavior one would associate with soundness and stability. I’ll venture a prediction that we haven’t heard that last of hedge fund travails. And in the spirit of speculative market environments tending to cause the most grief to the largest number of participants, the charmed bond bulls are way overdue. The bond bears have been impaired, the convertible arb players impaired, the dollar bears impaired, the crude and commodities bears impaired, and the equity bulls and bears (and long/short players) rattled.

And it is when speculator "impairment" reaches critical mass that underlying system fragility begins to fester. Speculator tolerance for pain is reduced by every loss. The inclination is, on the one hand, to rush into any winning trade (Google, the utilities, MBS!) to make a buck. On the other, there is heightened necessity to throw in the towel on the losers. Fear and greed take ruthless control of the markets, although either one can hold sway on any particular week, day or hour.