Here is one market questions that I have picked out or found on various forums or the Internet and will answer for you.
Someone asked why it doesn’t make sense for why U.S. treasuries are considered “safe” investments. The person is wondering why they are considered safe in light of the huge U.S. debt, unfunded future liabilities.
This is a good question as it talks about the economic – trading/financial market link. It goes right to the concept of order flow and liquidity.
This individual talks about how the huge U.S. debt should make U.S. treasuries appear unsafe. There is a huge debt, unfunded liabilities, congress unwilling to get serious on cutting spending.
Those are all good points – but only from an economic and statistics perspective.
Once you start analyzing financial markets and want to trade them and profit from them, your thinking needs to change. Markets are not necessarily moved by what people think “should” happen. They are not moved by what economists think the data and statistics mean for the U.S. economy. It is possible on some occasions that they do, but that is not the market foundational principle.
I don’t start from those beliefs.
I start from a belief in order flow and liquidity. The market will move when traders act to execute large orders, consume the liquidity at the current price, and thus push prices higher. Trading success comes from predicting how traders will act in the future. Trading success does not come from what economists or people think the market should be at. That is my first belief.
From there I proceed to ask what will cause order flow to come into the market. If the answer to that is what the economists are saying, then so be it. They line up, it generates order flow and makes you money. But if the answer to the order flow question is the exact opposite of what the economists and other people in the financial media/forums think the market should go, then so be it. It can be completely irrational to me, but I still need to follow the order flow. Irrationality, even irrational exuberance, as long as it is followed with order flow, can make you a lot of money. It can make you rich.
There are plenty of people making a small fortune in the gold market right now.
Why is that? Because the market only cares about order flow and liquidity. That is what it cares about. If the economists are saying one thing, and the people on the financial news/forums are saying a similar thing, but they do not generate order flow, then it doesn’t matter. It is all about what will generate order flow.
Now, knowing that it gets much easier to understand why people would pile into and buy U.S. treasuries in droves even after the U.S. had its credit rating cut. The treasury market wasn’t going to sell off because no market participant in the treasury market is dumb enough to dump treasuries. Yes the credit rating was cut. Yes that means that the U.S. is a slightly higher credit risk, but that is about it.
There is a macro trade going on right now with people buying up U.S. treasuries due to slower economic growth, falling equity markets, and risk aversion in the marketplace. It has generated a lot of bullish order flow into treasuries. A lot. Were any market participants prepare to aggressively dump treasuries onto the marketplace, they may push the price down, but there would be a ton of macro bargain hunters swooping in to buy them up at attractive prices.
Money has to flow somewhere. If people are scared that global economic growth is slowing down. If people are scared that equity markets are going to fall. If people believe that there is going to be some risk aversion in the marketplace, money can flow into bonds. Money can flow into them despite the credit rating downgrade. Japan had their credit rating downgraded, but the yields on their bonds are still super low.
You may ask why doesn’t China dump their treasury holdings? The answer is, and then what will they do with the money?
They are going to convert it into Chinese yuan and push up their currency? They don’t want to do that.
They are going to buy equities with the money? Equities are falling.
They are going to buy up other government bonds? Who are they going to buy hundreds of billions of government debt from? Russia? Venezuela? Brazil? The U.S. has a far higher credit rating than all of those countries. The U.S. also still maintains the worlds deepest and liquid markets for the Chinese. If the Chinese were to dump treasuries precipitously that would just serve up even better levels for the macro traders to come in and buy them.
That is the current market environment which can definitively change.
I will post answers to some more random market questions in the next article.