Thursday of next week will be important

The new year flow of course will be interesting, in past years the mutual funds and hedge funds have had excess money to put to work in the market as everyone comes back from the Hamptons after a two week vacation. This year the flow is severely diminished, will they have some extra cash to invest? Doesn't seem likely. As I have pointed out, there's a difference between sidelined cash and cash that is gone for good. The nature of the mutual fund redemptions is one that suggests the cash is gone for good as redemptions have occurred in even positive market environments. The cash pulled by European banks from hedge funds is not coming back as they need to raise capital. We have seen evidence of this repatriation of capital since August when the PrimeX funds sold off for the first time below par. Some of you who have been here for 4-5 months probably remember how that effected the Euro and sent it higher with the market as algos chased what the computers thought were cheap stocks, but what was really the selling of US dollar denominated assets by EU banks and then selling the dollars, buying Euros and sending the Euro higher. It looked like a positive environment and the computers didn't know the difference, but it was due to a liquidity freeze, so once again as we often see in the market, that which looks positive is actually negative and vice-versa.

In any case I have mentioned several times that one of the best metrics of what is going on in Europe is the French bond market for OATS, the reason being is that they do not qualify for secondary market ECB intervention, which has been almost futile any way. As Italian bond yields rise, the ECB on a weekly and multi week basis goes out in to the secondary market and buys up Italian BTPs to lower the yield, like the F_E_D, they can't participate in primary auctions, but with France, they can't even get involved with buying on the secondary market so as French yields go, so to goes the EU. It's a metric that can't be manipulated, unless the ECB does exactly what it just did with the LTRO and gives the banks the money to buy the bonds for the ECB, it's a little like the F_E_D's POMO operations.

However, to date that money that could be making a 6% or so carry trade profit, has thus far ended up in the ECB's vault at a negative .75% reverse carry trade loss, we saw similar actions in the US at the last 4 week auction in which money was essentially parked at the Treasury at a 0% yield for 4 weeks rather then have it exposed anywhere in any asset, some big dollars were and seemingly still are afraid of something occurring over the next few weeks.

In any case, next Thursday the French auction off several OATS to the tune of a targeted $7-$8 billion Euros. On Thursday alone, they have Oct. 2021/Oct. 2023/ April 2035 and April 2041 Oats up for auction. Traders will be watching the yields these auctions command and any rise in yields will be a very bad sign for France. I can't imagine the auctions will be positive with all of the downgrade talk and the S&P specifically waiting for the new year to start issuing such downgrades. France losing their Aaa rating, which seems likely as a 2-notch downgrade has even been mentioned, will essentially leave the full faith and credit of the EU squarely in the very reluctant lap of Germany.

It is actually quite a busy schedule for the first 2 months of 2012 and has the potential to be a huge market moving catalyst. However our first real test will be Thursday of next week.