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| Daily Jurojin - Wednesday, May 27, 2009 |
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Wednesday, May 27, 2009 Global Bond BreakdownWe've been twiddling our thumbs lately wondering whether to buy government debt. Actually, we've been waiting for the price of government debt to fall far enough, or for yields to rise far enough to make it appealing enough. However, as that happened, our minds have changed somewhat. Bonds have just leapt over the waterfall and a new bear market appears to be underway. We see absolutely no prospect of a Fed rate rise in 2009 and the chances of a 2010 rate rise are pretty slim too. We continue to take the central line that there are limited inflationary risks from the Fed and treasury actions surrounding fiscal stimulus. While conventional thinking might be currently glorying in the victory that fiscal profligacy will lead to inflation, it's a shallow victory. If government spending added to private spending, we might also conclude that inflation be the result. The government, however, realizes that without its efforts to buy corporate debt and remove the harness from the otherwise frozen solid credit markets, economic activity would continue to contract. Yet bond markets continue to trade on the fear that inflation is just around the corner. Regardless of whether that's the case or not, this scenario - like any other - makes for interesting market price gyrations, regardless of the outcome. In this case, although we dispute the outcome, we can't argue that we are right. We must place our money where our mouth is. On Tuesday, enormous Asian central bank appetite for a short-dated bond auction helped offset positive fundamental news. A consumer confidence survey depicted a return to good news six-months forward. Some of this is likely related to a rebound in the fortunes of the stock market lately. As the market digested all of the day's news the price of 10-year notes slumped, forcing yields as high as 3.55%. In Europe, the price of the German 10-year bund shot up early in the session thanks to a sharp decline in first quarter consumer spending and industrial production. However, the slip in global bond prices ultimately took their toll and reversed bunds' good fortune. In all it looks like all of the favors asked for by global central banks have run their course. The cumulative rise in the global budget deficit is currently enough to tip bond markets over the edge - regardless of whether they are right or not about whether the work in progress will rescue ailing financial systems. Bunds also faced the flight to quality prospects after an interview with Germany's financial regulator who stated that bad debts on banks' balance sheets could explode "like a grenade." The tidal wave of selling captured bonds of all nationalities on Tuesday, refusing to negotiate. It would appear that recent news consigning the U.K.'s credit rating to below AAA-status has left a larger hallmark on government bonds around the globe. With price action breaking to cyclical lows, and thus yields to the highest in many months, the prospects don't look good. As with any sea-change in trend, one can expect a fresh wave of liquidation before the situation might self-rectify. Between now and then, passengers should remain in their seats and pass the bucket if they want to endure the rougher seas. For those feeling sea-sick, we'd suggest selling across the board until then. The Supreme Council of the Secret Order of Jurojin |
