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Dollar Slide Drives Burgeoning U.S. Deficit as Japanese Desert Treasuries Add another ailment to the U.S. misery index of soaring gasoline and wheat costs and falling home values: a federal deficit that is burgeoning as foreign investors led by the Japanese recoil from the slumping dollar. The Japanese, who own $586.6 billion, or 12 percent of U.S. government debt, had their worst quarter in Treasuries this decade, losing 7 percent in the first three months of the year as the dollar fell to the lowest since 1995 versus the yen, Merrill Lynch & Co. indexes show. Dai-ichi Mutual Life Insurance Co., Meiji Yasuda Life Insurance Co. and Sumitomo Life Insurance Co., three of the nation's four-biggest insurers, would rather accept the world's lowest bond yields in Japan than buy U.S. debt. After raising their holdings by $9.2 billion to $620.6 billion between March and July 2007, Japanese investors trimmed that stake by $34 billion through February, the Treasury said April 15. America relies on foreign investors, who own more than half the U.S. government debt outstanding, to finance a deficit that New York-based Goldman Sachs Group Inc. predicts will expand to a record $500 billion for the year ending Sept. 30, after a $163 billion gap last year. Without their support, long-term interest rates would be 0.9 percentage point higher, a 2006 Federal Reserve study found. Asian investors outside Japan are also pulling back. Money managers in China, the second-biggest overseas holder of Treasuries, with $486.9 billion, and South Korea say they favor debt in Europe, equities or commodities. Beijing-based ICBC Credit Suisse Asset Management Co., controlled by China's biggest bank, said last week Treasuries are ``not attractive'' because of currency risks. South Korea's $220 billion National Pension Service in Seoul said yields on the debt have lost their ``charm.'' U.S. borrowing costs will rise in the ``longer term'' because central banks may slowly cut their holdings of dollars to about 30 percent of their reserves in 15 years, from less than 60 percent now, said Kenneth Rogoff, a former chief economist at the International Monetary Fund in Washington.

Playing Chicken with the Fed -- the smart way With the FOMC meeting upon us, the kitchen sink has been brought to the forefront of our collective psyche. Inflation in things we need, deflation in things we want, credit dependency, cumulative imbalances and the notion that we must choose between asset-class deflation and dollar devaluation all seems to come down to a singular question. After the Federal Reserve cuts interest rates by 25 basis points -- which is less aggressive than what we've seen since the financial crisis began -- will the collective perception be that they're proactively operating from a position of strength or defensively posturing as a function of need? Through that lens, the magnitude of this week's rate cut pales in comparison to the influence of auction facilities, lending windows, working groups and other policies currently in play. Therein lies the subtle yet important distinction when weighing the reaction to whatever the Fed says on Wednesday afternoon. While the structural metric will be in the spotlight, the psychology surrounding it will tell the tale. Why wasn't the equity sell-off more severe given the risks in the system. I would offer that it would have been had it not been for massive government intervention. Mind you, I'm not rooting for dire times or market spirals. I'm simply stating that in order to effectively navigate this market, we must understand the rules of engagement have shifted. Unseen influences remain in play. With the structural, technical and psychological metrics ready to collide, volatility is about to tick upward in a major way. The current juncture is akin to a giant game of chicken, with powerful agendas on one side and cumulative concerns on the other. Something is going to give and it'll likely happen this week.

Is the worst over? A belief is growing that the turmoil in credit markets that began last August could finally be abating. “The first quarter was the roughest I have ever seen in nearly 20 years of being in the business,” says Bruce Thomson, co-head of capital markets at Bank of America. “But there are now signs that we are working our way through the issues that have caused such widespread problems.” This improved sentiment can be seen in many corners of the credit world, leaving some observers hoping that the green shoots of recovery are about to spread through the financial system as a whole. Even the municipal market is showing signs of improved heath – though perhaps too late for Jefferson County. This switch in sentiment is pulling more investors back into these markets. Stocks have rallied too – cheered by a perception that a feared collapse of the financial sector has been averted by aggressive central bank intervention and banks’ own willingness to confess to their losses, take writedowns and raise fresh equity to bolster their balance sheets. The markets are still plagued by some startling pricing anomalies, which reveal the continued sense of dislocation and fear. While hedge funds and other investors used to rush to take advantage of such quirks, and thus trade them away, most remain too nervous to jump back in yet. Bank of England Says Crisis May Abate as Investors' Risk Appetite Returns, Paulson Says Credit Crisis `Closer to the End,' Joining Wall Street Bosses, World's Central Banks `Averted the Worst' of Credit Crisis, Goodhart Says

At the End of the Beginning of the Credit Crisis Phew! The credit crunch is over – or at least we're through the worst of it. According to the Bank of England, so pessimistic has the financial community become that it has overcompensated for the trouble ahead. Sure, the economy is in for a rough ride over the next couple of years but – compared with the current negative outlook – the prospects are positively rosy. That, at least, was the message from the Bank in its Financial Stability Report. One point of consensus, however, is that economic conditions will worsen. As we work our way through the credit crunch, economic woes will replace funding problems as the main source of anxiety for lenders. What the Bank fears is financial markets not returning to normal in time to withstand the economic storms ahead. JPMorgan says no near end to financial crisis: report, Downgrades Show Storm Isn't Over

Wolfgang Münchau: A painful global adjustment So this crisis is about to end, right? There are two failsafe ways to justify a solid dose of optimism: define the crisis in a sufficiently narrow way; and, even better, look at the wrong crisis. In that spirit I am happy to state my optimism about the prospective end of the subprime crisis. But this would be disingenuous. It is no accident that our multiple crises – property, credit, banking, food and commodities – have been happening at the same time. The simple reason is that they are all part of same overriding narrative. The mother of all these crises is global macroeconomic adjustment – a rare case, incidentally, where the word “crisis” can be used in its Greek meaning of “turning point”. It is a huge global macroeconomic shock. How long the financial part of the crisis will go on will depend to a large extent on how bad the economic part of the crisis gets. The economic part of the story started more than a decade ago with a liquidity-driven global boom. Property, credit and equity bubbles were all part of this. But even if we take six years as an estimate of the peak-to-trough period, that means the housing downturn will last until 2012 in the US and a couple of years longer in the UK. It is difficult to see how either of these countries could grow close to trend as long as the housing market is in recession. When you look at the global macro side, you are looking at similar timescales of adjustment. An important part of the adjustment will be a rise in the US and UK household savings rates. That, too, might take several years to accomplish, during which period economic growth could be below trend. The really important question about the US economy is not whether the official recession starts in the first or second quarter, but how long this period of economic weakness will last overall. In Japan and Germany macroeconomic adjustment of similar scale took more than 10 years, starting in the 1990s. Even if you believe that the US is structurally stronger, the country will probably not replenish its savings in a couple years.

Sell what in May and go away? April was a strong end to an otherwise wretched six months in which the Dow industrials lost 8%. That's the worst 'best six months' performance for stocks since 1973, when the Dow fell 12.5% between Nov. 1 and April 30, amid an OPEC oil embargo, according to the Stock Trader's Almanac. And if market indicators hold up, May through October could be a tough period, as per the old Wall Street saw 'sell in May and go away.' But in an unusually difficult year in which the housing and credit crises have sent the economy into a tailspin, the old indicators may not apply. Also, the forward-looking stock market may be on the verge of anticipating the start of an economic recovery, despite weak first-quarter growth.This year is an anomaly. April was the only one of the 'best' months to see gains.Because the stock market is forward looking, that means it was already pricing in the economic slowdown and the systemic risk to the financial system at the end of 2007.The calendar flip-flopped five years ago, during another period of great uncertainty. October 2002 through March 2003 was bumpy at best, driven by questions over if and when there would be war in Iraq. As the war drew nearer, stocks began to rally. The Dow gained 15.6% in the 'worst six months' period eventually leading to a multi-year bull market. A true rally may be a ways off but the markets are now starting to benefit from a lifting of some of that fog regarding the breadth of the crises, said Joe Clark, chief investment officer at Financial Enhancement Group.

Economic Clouds? Wall Street Sees Signs of Sunshine Main Street may be struggling, but Wall Street is on a bit of a roll. Despite a drumbeat of bad economic news, the stock market is up — almost 11 percent in the last few weeks. Junk bonds, those risky corporate I.O.U.’s, are rallying. The value of financial shares, bank loans, tricky credit derivatives — up, up, up. Many on Wall Street, the epicenter of the credit mess, seem to think that the worst is over. For the first time in months, analysts and executives sound upbeat again. Many of them see a broad, sustained recovery in both the economy and the financial markets coming in the second half of this year, a prediction some market strategists call hopeful at best. It is a remarkable reversal in attitudes from just a few months ago, when the broader economy seemed relatively healthy but Wall Street was traumatized by billions of dollars in mortgage-related losses. Now, bankers and investors appear ready to look past the crisis to more profitable times, while consumers find themselves in a more precarious position as the job market weakens and banks make it harder to borrow money. It is, of course, not uncommon for Wall Street to run ahead of the broader economy. Investors, after all, make money by anticipating the future. The job market, by contrast, improves more slowly than other aspects of the economy. But specialists say the two sides will eventually converge. Either the markets will give up their recent gains or, if the optimists are right, the broader economy will show greater strength as tax rebate checks and lower interest rates stimulate the economy. Analysts expect a sharp upturn in profits in the second half, in part because the earnings will be compared with weak results from 2007 but also because exports are surging. The $117 billion in federal tax rebates that will start going out this month should also help bolster profits.But some specialists say that the market’s expectations for profits are too lofty. They assert that slowing consumer spending will offset the gains corporate America is reaping from rising exports, which may also suffer because economies in Europe and Asia are starting to slacken.

(!!!) Fed: Banks Still Tightening Loan Standards The Federal Reserve reports that more banks are tightening lending standards on home mortgages, other types of consumer loans and business loans in response to a spreading credit crisis.The Fed reported Monday that the percentage of banks reporting tighter lending standards was near historic highs for nearly all loan categories. The survey, conducted in April, found that nearly two-thirds of banks surveyed had tightened lending standards on traditional home mortgages with 15 percent saying those standards had been tightened considerably. Fed: Lending Standards Tighten, Loan Demand Declines

`Suckers' Rally' Signaled by Options After S&P 500's Best Month in 4 Years The biggest rally in the Standard & Poor's 500 Index in more than four years is luring investors to equities from cash, just as options traders are betting the advance will evaporate. Jean-Marie Eveillard, who runs the $22 billion First Eagle Global Fund, is skeptical the gains can last because the worst housing slump since the Great Depression will reduce earnings. S&P 500 companies were valued at 22.7 times profit last week, the most in four years. Options traders are paying 63 percent more to protect against a drop in the S&P 500 than to bet on a gain, the widest difference since at least 2005. ``It may be a suckers' rally,'' said Eveillard, who is based in New York. ``Investors want to believe. But if I'm right, then there's truth to the argument that this is the worst financial crisis since the end of World War II. The same kind of reflex is the wrong reflex.'' The climb hasn't dispelled concern among traders of U.S. options. Implied volatility, the measure that calculates expected price swings of an underlying asset and is used as a barometer of options prices, shows that many investors are betting the U.S. stock market will falter. The implied volatility on options that lock in gains if the S&P 500 drops at least 10 percent in three months reached 24.67 on April 30, Bloomberg data show. That compared with 15.1 for options that pay out if the index rises at least 10 percent. The 63 percent difference indicates the highest demand for options insurance since at least 2005, according to data compiled by Bloomberg. A decline of 10 percent from the S&P 500's closing price last week would take the measure down to 1,272.51, below its March 10 low of 1,273.37. Investors are currently paying the highest prices relative to earnings since March 2004 and 15 percent more than when the S&P 500 reached its all-time high in October. Rally Signaled by Options After Surge (charts !!)