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| Daily Jurojin - Thursday, May 21, 2009 |
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Thursday, May 21, 2009 If you really want some yield, look over thereAs the cost of the Obama administration's Herculean effort to get the U.S. back on track makes that legendary digital scoreboard counting the per person cost of the national debt near Times Square in New York City work overtime, investors are looking to Europe for an alternative to government-issued bonds. Instead of buying bonds denominated in dollars, investors are favoring Eurozone debt issued by the governments at the 16-member nations denominated in euros. Traditionally the safest and deepest pool of liquidity is found in German government bunds.It's beginning to look as though America's efforts to revive its economy, backed by the copious commitment to issue $12.8 trillion in debt obligations, is likely to backfire if only in terms of raising the cost of borrowing. Meanwhile the European Central Bank's latest announcement to buy $81 billion worth of 'secured bonds' pales into relative insignificance. However, that stinginess might be enough to send European yields, which currently stand 19 basis points above those on comparable U.S. debt, to a 5 basis point discount before the end of this year. President Obama's government is likely to issue three-times the volume of debt that the 16-members over in Europe might issue in order to mop up the mess left behind in the wake of the Great Recession. Such an effort in a sense makes the role of the ECB that little bit easier. Investors are generally faced with the choice of which risk-free asset they should hold in the currency of their choice. But that decision bears the responsibility in deciding which currency is likely to act as a safe harbor for their investment without shedding capital. Euro-area investors tend to plump for German bunds, while dollar-denominations tend to favor U.S. 10-year notes. Investors currently view the Fed's decisive action at the helms of the printing presses as somewhat of a necessary evil. It's a little bit like street-lighting theory in that sense that we all benefit from it but nobody wants to pay for it, least of all the Germans who see clinically the root cause of the financial mess the world is in. In this case the perceived risks surrounding the U.S. dollar are currently elevated on account of the potential for a burst of inflation, which might debase the dollar. Hence investors seek a premium yield for lending to the government. But in its actions the U.S. has fostered the necessary conditions for potential recovery. While that's good for U.S. growth prospects down the line, it's unsettling for bond investors fretful that rate will eventually rise. In Europe, however, the U.S. rescue package provides the ECB with sufficient ammunition to argue that interest rates need not be lowered any further. The bottom line is that the euro is left grooming a 75 basis point yield advantage over the dollar, which is likely to remain intact at least through year end if not until a year from now. But that also leaves ECB-watchers slamming their heads firmly against the wall as they realize that its intransigence in lowering rates further hardly fosters the appropriate conditions for Eurozone growth any faster than otherwise. On the one hand the 10-year U.S. note is arguable set to suffer from an improved outlook and spiraling fiscal deficit, while on the other the thoroughly entrenched ECB is actively dampening growth prospects. These two events conspire to favor bunds over bonds anytime! One might understand this rationale if President Trichet wasn't the one facing an 11.8% unemployment rate next year. But according too the European Commission, the EU's executive body earlier in May, that's precisely what's on the cards in 2010. EU unemployment is currently at 8.9% and is likely to worsen especially after last week's 2.5% quarterly GDP contraction. Investors initially responded well to Chairman Ben Bernanke's plans to buy $300 billion in U.S. government debt and drove 10-year yields down to 2.47% in March. Now they are having a rethink predicated on the success of his logic. The spur to growth prospects he's provided has driven yields up almost 1% since then as investors digest the ramifications of his and treasury secretary Geithner's plans. But we think it safe to state that you couldn't level the same observations against Monsieur Trichet and his team. The Supreme Council of the Secret Order of Jurojin |
