Bond Outlook March 26th

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The consequences of the credit squeeze have so many dimensions that we can appropriately speak of the end of an era, or of history in the unfolding.

Bond Outlook [by bridport & cie, March 26th 2008]

The same big three basic causes, an economy built on financial deficits, falling house prices and excess leverage remain unaddressed by all the manoeuvring of the Fed. Very clever manoeuvring it is, and necessary to avoid collapse, but only time and belt tightening can resolve the big three.

 

It is now possible to outline the unfolding of the big three's impacts in a number of areas:

 

  • this is the end of a nearly free financial market and the beginning of tighter regulations. Public money is now at stake in the Bear Stearns rescue and in attempts to save the mortgage market, and public money implies a demand for more control
  • the entire structure of securitisation has collapsed. It will have to be rebuilt, or replaced. If rebuilt, it must be more transparent
  • bond insurance is still very unsettled. For municipal bonds, new entities are filling the vacuum: the Federal Home Loan Banking system, Dexia from Europe and Warren Buffett. Ambac has somehow maintained its AAA rating, but we cannot help wondering if this is real
  • the mortgage market in the USA looks to be on the way to a quasi-nationalisation. Fannie Mae and Freddie Mac are taking on more and more mortgages, and thoughts of an outright nationalisation of the two are now appearing
  • the many ingenious ways by which US households have been able to borrow to spend more than they earn look like coming to an end. Out of sheer momentum they might continue to run up credit card debt, but, after that, we see nowhere to turn. Old-fashioned personal banking will to return, but that is still some way off
  • the USD is no longer mighty. All the reasons for its chronic weakness remain, and its status as a reserve currency is being questioned
  • rebalancing of global trade is underway. A sign of this is that Japan's growth has expanded thanks to sales to the rest of Asia
  • world integration is actually increasing as non-Western entities buy into more and more of the West's banks and industrial enterprises (Sovereign Wealth Funds, Tata from India, and the like). This is a move from passive investment in the form of central bank buying of government bonds to active share ownership

 

If all this sounds like "the end of an era", maybe it is precisely that. If there is one consistent theme in this Weekly over the nearly ten years of current authorship, it is that the USA's profligacy cannot last in consuming far more of the world's output than it delivers. This current crisis looks remarkably like the end of the road.

 

While some investors are seeing the stock market bounce last week as a sign of the crisis ending. Both the above considerations and our own experience trading in the bond markets suggest a large degree of wishful thinking.

 

Focus

 

(+) Fed: FRB of NY is creating a Delaware-based "Resolution Trust Mark II", echoing the takeover of the Savings and Loans banks in the 1980s. It will have $30 billion of poisoned assets. Blackrock are running it

 

(?) US housing: sales of existing houses have picked up, while new sales and prices have fallen. Lower prices and foreclosures may explain the bargain hunting

 

(!) Commodities: a mixed week with some up (cereals), some down (coffee, petroleum, silver, gold)

 

(!) Iceland: a further increase in the overnight rate by 125bps has lifted the rate to 15%, allowing the exchange rate to gain 4% after losing 23%

 

(–) New York: a loss of 20,000 finance related jobs expected as Wall street profitability falls 80%

 

(!) Credit losses: Goldman Sachs write of USD 1.2 billion overall, with 40% in USA, and announced financial institutions losses are about half way through (similar but larger to what we recently wrote in this Weekly)

 

(+) positive for bonds (–) negative for bonds (!) watch out (?) begs a question

 

Recommended average maturity for bonds.

 

Stay long maturities in USD and EUR. Quite short in CHF and GBP.


Currency: USD GBP EUR CHF
As of 09.01.08 2018 2010 2018 2011
As of 22.08.07 2014 2010 2014 2011

Dr. Roy Damary