Saturday, May 9, 2009

To get a run out of bonds into hard assets, first people must want to own hard assets rather than locked-in cash flows

TO BE NOTED: From Inner Workings:

How serious was yeseterday’s Treasury auction? May 8th, 2009
David Goldman

A prominent economist writes today that he has taken his personal money out of dollars and put it into Australian and Canadian dollars, the commodity currencies. The sloppy 30-year auction today, he believes, is a true crack in the dam.

I am less certain: my core view is that America will undergo something closer to the Japanese scenario, in which economic growth stays extremely low, asset price deflation does not reverse, short-term rates stay close to zero, savings rates remain elevated, and bond yields stay low. All that has happened since March is that the end-of-the-world premium has been taken out of the Treasury market.

Remember that credit protection on the United State of America reached 75 basis points in early March — that’s where protection on Brazil was trading pre-crisis. It’s now down to “only” 35 basis points, given the success of the Fed’s and Treasury’s efforts to refloat bank equity with a few trillions of dollars of liquidity.

What the Federal Reserve and Treasury have set in motion is the mother of all crowdings-out. The Fed is compelled to buy substantial amounts of Treasuries to prevent the federal deficit from turning into a $1.8 trillion black hole that sucks in all the free savings of the world and then sum. The moment that yields start to rise, the stock market reacts negatively. There is no “give” in the economy for any substantial rise in yields: the penalty to growth expectations is exacted immediately.

By ballooning the deficit and tying the credit of the United States to the balance sheet of the banking system, the Fed has avoided panic, but has crippled the economy for the long term. There is no way to finance the deficit except by suppressing financing for everyone else. The massive amount of liquidity created by the Fed has no inflationary effect as long as the market does not wan to hold real assets — and it will not as long as the federal government sucks up the available savings. The most like scenario is a paralytic, zombie-like stasis.

The major commodity indices still remain close to their lows with an modest uptick reflecting the mildest hopes for recovery.

Red=UBS, Yellow=GSCI, Green=CRB, Blue=ROgers
Red=UBS, Yellow=GSCI, Green=CRB, Blue=ROgers

source: Bloomberg

To get a run out of bonds into hard assets, first people must want to own hard assets rather than locked-in cash flows. I just don’t see it for the next couple of years.

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Addendum on the Treasury auction: Sovereign credit continues to improve May 8th, 2009
David Goldman

Credit protection on the US sovereign continues to improve in tandem with the banks. We had been out to +75; now we are back to LIBOR +27 for five-year credit protection on the US sovereign.

The risk to the credit of the US Treasury comes from the link to the banking system, and as long as the frame holds (and the Fed doesn’t have to take hundreds of billions of dollars of losses on its multi-trillion-dolalr portfolio, all will appear well. All isn’t well, to be sure; since Alexander Hamilton funded the public debt in the 1790s has the credit of the US been at this kind of risk. But the frame is likely to hold, which means that the credit of the US will hold, along with the Treasury market.

From Markit Partners:

G7 Industrialised Countries CDS
Ticker CLIP Name 5Y Today Daily Chg (bp) Weekly Chg (bp) 28 Day Chg (bp)
USGB 9A3AAA Utd Sts Amer 27 -8 -9 -20
JAPAN 4B818G Japan 57 -10 -13 -21
DBR 3AB549 Fed Rep Germany 25 -9 -13 -19
UKIN 9A17DE Utd Kdom Gt Britn & Nthn Irlnd 71 -11 -26 -23
FRTR 3I68EE French Rep 27 -8 -16 -19
ITALY 4AB951 Rep Italy 78 -13 -29 -41

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