This can't last!!! May end badly??

The Financial Times' John Dizard takes a close look at "free money" being generated these days by so-called "negative basis trades."

"Free money? Sounds too good to be true," you say. Man, you people are so cynical!
Here's how it works, according to Dizard. "Over the past few months professional managers of US dollar bond portfolios have been buying corporate bonds, then buying the credit default swaps (CDSs) that allow them to cover the default risk on the bonds."
Now that should not be profitable, you are wisely saying to yourself, because the cost of full credit default swap protection should be greater than the cost of the bonds.
Yes. And the difference between the two is called the "basis."
And yet, Dizard points out, "thanks to a bizarre anomaly in the financial markets, the cost of protection using the CDS market is less than the interest yield on the bonds. So we have “negative basis.�"
In other words, because of the negative basis you are being paid for taking the risk of owning corporate credit, but you don't have to actually take the risk! It's like magic.
Of the 150 most frequently traded corporate names in the US bond world, about a third have negative basis spreads available that are more than 10 basis points, Dizard notes.
That means a bond manager can buy, say, 10 bond positions of $10,000,000 each, then buy the corresponding credit default swap protection and collect (given the negative basis spread of 10 basis points, $100,000 a year. Risk free.
According to Dizard, this is all the result of our old familiar friend... excess liquidity.
Chris Whalen, of Institutional Risk Analytics, tells the FT: “It's kind of sad. People are running out of ways to deploy their capital intelligently, so they turn to this kind of financial masturbation, trying to get their performance far enough inside the herd so they don't have to deal with redemptions.�

Reflation has gone beyond what the interventionists originally planned so inflation (cpi) persistency should pressure Bennie and the Jetts to hike one more time later this year. I think we see this in the wording of the fed statement tomorrow. So the primary ingredient for the soft landing gang is removed while housing deterioration continues-Houston we have a problem.

Bill L

What ever happened to "were in the eighth inning?"

Or remember this gem...

http://www.nationalreview.com/kudlow/kudlow200512131623.asp

Such a dismal science.

Thats why IMO its useless to trade on econ or fundamental data. And its useless to have an opinion on the economy and trade on it - price tells all..

The way things have been trading it appears the Fed is 'fighting' inflation by intervening in the commodities markets and taking them down - and intervening in the 'paper' markets and melting them up.

I expect more of the same tomorrow - no matter what he says - the Fed's 'traders' will no doubt be active to ensure that the market receives Bennie's message correctly (ie: stay away from oils, golds, commodities etc..)

Whatever equities do - they won't fall far - hidden M3, coupon passes, TIO's, 'mysterious' (probably foreign based) futures buyers - are all standing by...

Long live central planning!

In fact here's another 'risk free' $5 billion dollar 7-day loan out of citizens tax receipts.

The money printing possibilities are just endless aren't they.

http://fms.treas.gov/tip/auctions/tio-auction-results-267-10242006.pdf

Bill, check out this article: http://www.minyanville.com/articles/index.php?a=11492

It seems pretty clear that the Yen carry trade is back big time. The correlation between the VIX and the Yen (inverse) is seemingly very high. The M3 expansion may very well be more international than domestic.

I will be watching these two charts closely.

Thx Moab. Pomboy is one of the best on the macro front. Numerous hedgies underperforming benchmark creating the reach for yield fostered in part by the BOJ. Note, the PPI in Japan was the highest in 25 years last month-more aggressive rate hikes in store? Also see the Forbes piece last month regarding leverage in the US banking system helped in part by over and under the counter derivatives-Twighlight Zone economy?

Bill L