38950830 the Weekly Peak October 8 2010

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October 8, 2010

Abigail F. [email protected]

www.peaktheories.com

Current Commentary on the Primary Financial Market Trend

The Weekly Peak

The Feds Liquidity Rally

The Federal Reserve is doing an excellent job with its chosen policy option of communication. With just three words, the Fed has brought

down rates while boosting equities, gold, oil, and most commodities.

Of course the three words Im talking about are those that Ive highlighted a few times since the release of the last FOMC statement or

provide additional accommodation but since that formal statement the Fed has used even more nuanced communication to herd investors

toward risk. And at this point it seems more stage-managing than just bluffing for a few reasons.

First, it remains the Feds option on whether or not to pull the trigger on another round of quantitative easing or what has become known as

QE2. This is an important point to remember, in my view, because while the markets have priced it in and some of the big banks have evengiven it a number $1 trillion quantitative easing has not occurred and thus it remains an option for the Fed to exercise or not to exercise.

Second, the Fed has not backed itself into a corner with the markets pricing in a QE2 of some sort. This is where the Fed has gotten really

creative with the Fed Talk around the possibility of a staggered QE2. The language around such a QE2 will be comprised of two parts: the

health of the economic recovery and the amount of QE2 needed. In other words, the economic recovery is modestly better now than it was in

August and September, but its not perfect, and thus some amount of Treasurys may be bought but only as the Feds read of the economic

recovery requires.

This would be much like the daily POMO drip but in a much bigger dose with the precise timing and amount unknown. If the Fed thinks the

psychology of a big dose is needed at a particular time, it could make such an announcement. If its assessment was off, it could make another

announcement until it finds the right dose to treat the investor disease.

The trick here is probably to make the first announcement large enough to satisfy investors that the Fed is serious even if its a relatively small

percentage of the total potential amount.

Third, the seeming dissent or dialogue among the various Fed officials keeps investors guessing as to what the ultimate strategy will be shaped

as, but this is to the Feds advantage and its similar to the first two points. The Fed is maintaining ultimate control and flexibility over any

actual liquidity put into the system. At this time, the Fed is committed to nothing, literally nothing, and the external appearance of dissent

makes the non-commitment look non-fabricated. In other words, a rather fluid and go-as-it-is-needed QE2 is a natural consequence of the

difference of opinion among the officials.

After all, we have Bullard talking about the option of timing and amount, Dudley talking about inflation catch-up, and Evans talking about it all

and in the context of an economy that needs some help. Just like the Fed has investors doing its bidding by devaluing the dollar and lifting all

of the riskier investment classes, Bernanke has siphoned that bidding off to other Fed officials as it is somehow known that despite the seeming

dissent, he, Bernanke, is in favor of executing a potentially significant QE2 and the investment communitys drug of choice. In my view,

Bernanke continues to look pretty brilliant.

The net effect of the Feds formal communication in conjunction with the bits and pieces of Fed Talk is what I have been writing about or thesteering of investors to risk while pushing rates down. Interestingly though this means were looking at a simultaneous risk-on risk-off trade

and this can last only for so long.

I suspect that if the Fed continues to find the success it has found already with its communication, risk will stay on while risk will come off as

happened in the spring of 2009. If stocks, precious metals, oil and other commodities continue to appreciate, low-yielding Treasurys are going

to look less and less attractive as happened last year. This will be especially true if QE2 is staggered with the Fed buying fewer Treasurys than

current rates would suggest. After all, investors are buying what the governments buying ahead of the government buying anything. Investors

may not be quite so keen to be in on this trade if it comes true only to some degree.

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October 8, 2010The Weekly Peak


And this is another effect of the Feds communication. In leaving room around QE2 and being able to find that room around an improving

economy, the Fed will create less of a mess for itself down the road. After all, Bernanke still has the headache of figuring out how to extricatethe Fed from its previous balance sheet escapades without wanting to worry about making those adventures completely impossible to forget.

If he can manage to produce the results of ballooning the Feds balance sheet further without ballooning it very much at all, I have to believe

the policy option of communication will be judged a real success.

The ultimate measure of success around all of this, however, will be a theme I have been writing on since early March or the velocity of money.

Will the Fed succeed in causing money to move through the system more quickly thereby eating up some of the economic slack while sopping

up some of the rescue liquidity injected in 2008 and 2009?

Time will be the test but for now the S&P 500s in rally mode on the prospect that the liquidity does come or that the degree of liquidity to

come will be made whole by an economic recovery that will bring with it better-than-expected corporate profitability.

Sams Stash, Gold, and the S&PTreasurys continue to strengthen with the 10-year below 2.4% on the prospect of the government coming in and buying Treasurys as has been

discussed.

As I alluded to above and have articulated in more recent pieces, I tend to believe this wont last. I continue to think that Treasurys will weaken

in the relatively near-term as the Fed is successful in herding investors increasingly towards risk and in the face of the possibility that the Feds

actual buying of Treasurys may be substantially less than investors are anticipating at this time.

With the 10-year right below 2.4% right now, I expect that this yield will move back above 3% and perhaps 3.5% as a combination of the two

factors above take hold. Things always have a way of going longer and further than you expect but when such things break in the other

direction it typically takes hold in a way that can be surprising.

However, I think any near- to mid-term weakening in Treasurys will be snapped away by another the unfolding of the next stage of the financial

crisis at some point and I continue to believe this will come out in Europe. At that time, there will be a flight to safety as has not been seen yet

and I fully believe the 10-year will go to 2% or below in response.

Ultimately, I continue to expect Treasurys to weaken significantly if not collapse due to the devaluing of the dollar and I will be writing on this in

detail at some point.

Speaking of the devaluing of the dollar, this week has been a doozie and it seems the dollar index is headed toward what Ive referred to as its

best level of support after breaking 79.507 days ago or roughly the 72 level. This view would seem to be supported by the fact that the dollar

index is caught in a Descending Triangle pattern that carries a target of 71 and truthfully slightly lower.

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What makes this potential decline a bit dangerous, in my view, is the fact that once the dollar index goes through 74.25 a negative reversal

pattern or a triple top will have been confirmed and it carries a target of 60. This is dangerous because when put in the context of the long-

term chart (not shown but it carries a significant downtrend), the dollar index may have a very hard time recovering from that level.

Of course, this is what I expect ultimately in the third stage of the financial crisis as I have outlined in Lender of Last Resort, but I guess I had

not anticipated this possibility to occur what would now seem so soon.

Many others are though considering what gold has been doing or just shooting through the roof even with yesterdays pullback.

It seems that some are calling for a correction at current levels and perhaps this comes true or perhaps gold simply pushes higher in seemingly

surreal fashion protected and boosted by that declining dollar.

And at this time, the declining dollar is something the S&P 500 has in common with gold. The further the dollar is pushed down, the greater

the potential for the equity index to be pushed up.

As it turns out, it seems that it was the dollars decline that began on June 7th

that the now confirmed and bullish Inverse Head and Shoulders

position was telling us about. Put more precisely, the pattern was telling us then about the potential for the liquidity wave that we may or may

not see, or even just its head fake possibility.

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This pattern carries a target of1,250 and this is less than 10% away while its next truly big hurdle of 1,217 is less than 5% away. Sometimes it is

amazing when the seemingly impossible moves into the realm of the possible and thats what appears to be happening here.

What seems more impossible to most, however, is the idea that the S&P 500 will collapse at some point in the future. Based on the chart

below and the confirmed double top that may be moving into a triple top, either of which carries a target of 425, this impossibility should be

seen as a real possibility even if not in the immediate-term. The Fed is simply succeeding in pushing the debt problem further into the future.

The only thing that I think is impossible at this point is that this chart will go unfulfilled in the long-term.

As always, thank you for taking the time to read this weeks piece.

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Opinions expressed herein are strictly that of the author and are subject to change without notice and may differ or becontrary to the opinions or recommendations of any professional associations held by the author including the authorsemployer. The opinions contained herein should not be taken as specific recommendations to be acted upon. Anyprices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities atany given price. No representation or warranty, either express or implied, is provided in relation to the accuracy,completeness, reliability or appropriateness of the information, methodology and any derived price contained withinthis material. The securities and related financial instruments described herein may not be eligible for sale in all

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38950830 the Weekly Peak October 8 2010

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