Dumping the Dollar

Bernanke found a novel new way to dump the dollar today. The Fed will now swap Treasuries for MBS at banks. As always, there's no news on the all-important details: What's the haircut?

This juiced the Dow over 400 points, and understandably crushed Treasuries across the board. My account was down 12%, erasing half the gains of the past two weeks. Sold WM short near the top at $11.68.

What does this mean for the banks? How will this affect the default situation at Carlyle Capital? I will attempt to take a guess at what the ramifications may be.

This is just a tempoary fix (temporarily). This will help banks who have MBS that they can't sell. They'll take their lame-duck MBS to the Fed and trade them for a 28-day swap with Treasuries (minus the Fed's haircut). Then the banks can sell the Treasuries on the market. This will give the banks access to cash, as Treasuries are still liquid.

How might this affect Carlyle Capital? On one hand, the banks may get their capital through selling Treasuries. On the other, the banks may be even more eager to loot Carlyle, knowing that now they can take that loot to the Fed and swap it for Treasuries. In my opinion, the Fed is playing a dangerous game. They have already sold $80B out of $788B in Treasury holdings, or 10%. Their new swap facility will be up to $200B. That's another 25%. If this doesn't get the banks lending, the Fed will only have $508B left (plus their worth less MBS holdings).

The Fed is blatantly pursuing a policy of dollar devaluation. While they butchered Treasuries today (2-yr., -18%, 10-yr., -4.6%, 30-yr., -1.84%) the dollar jumped today against the Yen. Speaking of which, the Bank of Japan can't be happy about the dollar's plunge so far this year. This will not be good for Japan's economy. No wonder Japan was threatening to lower rates a couple of weeks ago. It should be interesting to see how they try to fight the Fed on this one. I guess it depends on how badly they get squeezed by commodities and lower demand for their exports due to a higher Yen.

As far as translating this into a trading and investment strategy, I don't think this changes things much. I think that the banks will just find crack-up boom plays to bet on with their Treasury-sale. I'm going to go shopping for anti-dollar plays the rest of this week. Also, I will look at more homebuilders to short. They were up more than investment banks today, even though HOV posted terrible earnings and TOl warned of additional losses from joint ventures. I will look to short TOl tomorrow. How plunging Treasuries with mushrooming yields pushing up mortgage costs helps homebuilders, I don't know. I guess some people think that the banks will start buying MBS again. Not going to happen. In the meantime, the consumer is going further underwater on their debts.

The Fed will lose this if the blowback from their dollar devaluation causes debts to be defaulted on even faster. So far, they've propped up the financial sector, preventing a major banking insolvency. However, the fundamentals of the debt market are getting worse. The Fed could win the battle against deflation if they can stop defaults and simultaneously stop the flight to safety. This requires a dollar devaluation together with an inflation of domestic assets. Their number one concern is to keep the banks from collapsing, and getting credit flowing again is a close second.