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The European Central Bank starts its covered bond purchase program today, and implements a system that will provide $85b of liquidity to the market. The covered bond deal will swap cash, for an asset class that is backed by a security that is lodged at a set value on an institutions book.

Covered bonds literally have their value backed by an asset (real estate or public loans) with an accepted value in the open market. The lack of toxic assets, the fact that the ECB along with regional Euro-zone central banks are backing the scheme, and just the knowledge that the scheme was to start, has already decreased the spread on these bonds, and that in itself frees up liquidity.

The question is whether the banks will take the cash and lend it commercially, or horde it in a repeat of the 2007-2009 credit crisis format that had institutions afraid to commit to commercial debt. The cost of insuring risk in the Euro-zone has increased recently, in a sign that the equity selling may have legs; history shows few time that equities move higher in a market of fear. The overall impact of weaker equities may impede the Eur/Usd positives that come from the ECB bond purchase program.

Not to be outdone in regard to Central (read private U.S.) Bank moves into the bond market, the U.S. Treasury will feed four auctions this week, for the first time since the Treasury began issuing securities regularly in 1976. Monday’s $8 billion auction of 10-year Treasury Inflation- Protected Securities (TIPS) will be followed with $35 billion of 3-year notes on Tuesday, $19 billion of 10-year notes on Wednesday, and $11 billion of 30-year bonds on Thursday, in a relentless off-load of government debt-for-cash.

The Federal Reserve has bought $190b of U.S. notes and bonds since March 25th, the date that the equity rally moved forward with legs. The central bank said it would buy as much as $300b of the debt in its March 18 policy statement, and leaves the question; with another $100b still to hit the market between now and September, how are equity markets ever going to compete with a 4% return on notes, and how will the U.S. economy deal with an inflated dollar that matches the rise in Treasury values?

A hyper-inflated Usd may be good for overseas bankers, but will impede the economic recovery in the U.S. There are as many questions as answers right now in that regard, and that in itself offers fuel to the flames of a low momentum, low volume market environment that is not prepared to buy risk.

Watch for Usd strength all the tome that the Fed is back-stopping the value of U.S. debt, and equity markets move south. Oil and gold may pull back soon if global equity trade does not see some Long-sided volume.