Carry Trade Under Extreme Pressure

Charts: The S&P 500 closed at 1098, down 1% and below the key 1100 support level. Ever since the good jobs report came out Friday the dollar has gained ground, hammering the carry trade. The broad index has been in a trading range for about a month, which speaks to consolidation. Unfortunately, throughout this bull market we have yet to see consolidation pan out in a healthy manner. 1085 is the next meaningful support level under 1100. The 50-day moving average is 1079, this is next support. The 20-month moving average is 1060. If 1060 were violated the technical picture would be very bad.

Fundamentals: Dubai state owned corporate bonds and Greek government bonds were downgraded today, sending shock waves through credit markets. Moody’s threatened the UK and US governments by saying their bonds may “test the boundaries of AAA rating.” The strengthening labor market in the US means that governments across the globe need to curb deficit spending. But Obama gave a speech today promising a second gigantic stimulus program, which would throw the US fiscal deficit into even higher gear. And finally Senate leader Reid says that he has the votes to pass the monster healthcare bill which will of course cause the US government deficit to skyrocket. The private sector is healing itself but the world’s governments have gotten into the habit of mindlessly piling debt on top of debt. The Catch-22 is that a recovering world economy will nudge up interest rates while governmental debt loads are so high that any increase in the carrying cost of all this debt could be catastrophic. The US will spend only about $400 million in 2009 servicing the interest on its federal debt because short term interest rates are currently negative in real terms (accounting for inflation). Stock market bulls call these negative interest rates the “new normal,” implying super-low rates will last forever or at least several years. If the bulls are wrong, markets are unlikely to tread water in a healthy consolidation but crash.