The markets returned to full risk mode today as investors deemed T-bill rates yielding less than nothing to be a clarion call to run into investments with some yield and possible appreciation. Bill Gross and Barron’s were both advising investors to buy stocks that have fairly high dividends and low debt ratios–the ultimate culmination of the carry trade. Where the most beneficial carry trade could be found in interest rate differentials the low global interest rate environment forces even the most astute investors to seek more risk in the equity markets. This is the atmosphere we find ourselves in and the angst it creates is very great. Let there be no doubt about it—the FED wants/needs inflation wherever it can be found. Asset inflation relieves pressure on pension obligations and this helps corporate balance sheets. The next area is for inflation to arise so that illusionary gains will relieve the enormous pressure on commercial real estate. Inflation will relieve the pressure for deleveraging that continues to weigh on bank balance sheets. Back in the 70′s people wore WIN buttons—whip inflation now. Today the FED is passing out SIN buttons—start inflation now.

Market moving news today was found in the “robust” home sales number, but the DEBT markets shrugged that off as did the Dollar as Treasuries closed basically unchanged and the DOLLAR weaker. When we digest the data we realize that the gains all come from prices being 15% lower year on year and the bringing forward of sales due to the government’s incentive program. Borrowing from tomorrow for today! Also impacting the DEBT markets was a statement from Dominique Strauss Kahn the head of the IMF that it is necessary for the developed countries not to remove the monetary and fiscal stimulus too quickly. This places him in the Bernanke camp {37ers} who will err in not removing the stimulus until they are sure that a recovery has fully taken hold. We are not fans of the IMF for they are usually late to the table and when they are not late in their analysis they are wrong and their advice less than worthless. The market continues to give it some credibility so we pay attention but only with an entire salt shaker.

Two things we wish to bring your attention to come out of Europe and it is important to take note.

1. In a speech today given by Trichet he warned the Spanish that they needed to resolve the issue of increased production costs which were responsible for widening current account imbalances within the EU. “In this country, the burden of the crisis has fallen disproportionately on the temporary workers. Compensation for those employed on a permanent basis has seen only minor adjustments. Looking into the future, wage flexibility will need to be made more widespread.”

   The importance of this is that it creates a tremendous deflationary drag on Spain and others within the European Union. Imagine the impact of lowering wages in a heavily indebted economy. The downward pressure on wages will not be politically possible and therfore the growing deficit imbalances which remain unresolved unless the surplus countries transfer some of their capital to support the deficit countries. Will the good burghers of Bavaria send the funds needed to support Spain, Greece, Ireland, Italy, et. al.–for this will be the real test for a united Europe. They make it so hard to stay long the Euro but in this environment of anything but the dollar just not profitable to fade. Put it on your radar screen and be aware of the coming stress with the European financial system.

2. A story braking out from Germany tonight is that West Landesbank may be heading into insolvency by next week. The issue of the Landesbanks being in trouble is not new. Prior to the September elections, all of Germany’s immediate problems were pushed to the back burner but now that Merkle has won and secured office the previous issues are back to full boil. The Landesbanks took on way too much risk after they were cut loose from state support in 2004 and 2005 and they are very vulnerable to the global credit crisis. If the 3-5 billion Euros that are needed to shore up its balance sheet do not materialize the German state will have to step in to dissolve one of the most powerful regional lending institutions within Germany. This issue will cause severe problems with the European competition commission so we will watch to see if it leads to EURO weakness on the crosses. If EUR/CHF were to sell off it will be interesting to see how the Swiss National Bank reacts. This Landesbank default could have implications for all the EURO crosses so be alert especially in these thin holiday markets.