Bond Outlook May 14th

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The data used to calculate LIBOR may be improved by threatening the participating banks, but how can we deal with official statistics which have been creatively manipulated for decades?

Bond Outlook [by bridport & cie, May 14th 2008]

In a week of “more of the same”, i.e. a continuing series of bad news with little impact on the rather sanguine mood of financial markets, we have an opportunity to consider the reliability of the economic data given to us, or should we say, “served up”? We have long criticised the focus on core inflation as a means of producing lower inflation data by excluding food and energy. It appears however that creative manipulation of US data is broader and goes back nearly 50 years. Kevin Phillips, a US writer and commentator, has written at length on this subject in May’s Harpers Magazine. He identifies the following:

  • “discouraged workers”, those who would like to work but have given up looking, have been excluded from unemployment numbers since 1961
  • The “unified budget”, dating from 1969, combines the current cash surplus of Social Security with general tax receipts without any consideration given to the huge future liabilities of the Social Security system
  • The separation of core from headline inflation took place in 1973
  • “Owners’ equivalent rent” was introduced in 1983 and takes a large share of the blame for the current housing crisis

The Phillips’ article ends by suggesting that, without the above changes, unemployment would be over 9% and inflation over 7%. Without distortion, data would reveal “a nation in deep difficulty not just domestically but globally”.

The issue of data reliability is now being picked up elsewhere. The BBC has been highlighting how food and fuel takes a much greater proportion of the budgets of poor households, while manufactured goods, including clothing, have been holding down the overall inflation. Now even the official inflation in the UK, at 3% and rising, stresses the economic problems in that country, which has been following much the same debt-laden path as the USA.

Statistical manipulation is not limited to the realm of government. LIBOR has been very close to being renamed “LieBOR” after it was revealed in April that the 16 banks of the British Bankers Association had been announcing interbank borrowing rates which were lower than reality, apparently in an attempt to reduce their own borrowing costs! At least the BBA is acting to resolve the problem; the mid-April threat that banks not telling the whole truth would be excluded caused a sudden jump in 3-month dollar LIBOR!

Last week we raised the issue of insurance companies’ exposure to CDSs. We pointed out that marking to market was nothing compared with the eventual impact of actual defaults. The default rate for “speculative grade” bonds is rising. It is now at 2% vs. 1% last year, and is reckoned by Moody’s to exceed 5% by the end of the year, led by the USA. Where junk bonds head first, higher quality, bonds may well follow. Add in BoA’s expectation of home equity losses a rising from 2% to 2.5% of its USD 118 billion portfolio, and our assessment that CDS issuers face big losses holds water.

We also expect credit card debt defaults to grow (and saw this first with HSBC’s announcements last month). However, not much is being revealed by the lenders, apart from the switch in credit card spending from travel, entertainment and hard goods, to necessities like fuel and food.

Somewhat curiously, it is very difficult to buy financial sector bonds. We suppose that the good demand is a reflection of the high yields and the sense that central banks are providing a safety net.

Focus

(–) Lithuania: increase of inflation to 11.7% vs. April 2007.

(–) Romania: inflation at 8.62% but also GDP expansion of 7.5% per annum in Q1

(–) China: inflation at 8.5% per annum in April, the highest in 12 years

(–) Spain: inflation slowed April to 4.2% vs. 4.6% per annum in March

(–) UK: the UK CPI increased in April by 0.8% over March bringing the annual rate to 3%

(?) AIG: a record quarterly loss of USD 7.81 billion. New equity capital of USD 12.5 billion being issued

(?) USA: modest decline in the trade balance to USD 58.2 billion vs. 61.7 billion in February. Exports are at record high thanks to the weak dollar

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

Recommended average maturity for bonds.

Short across the board.

Currency:

USD

GBP

EUR

CHF

As of 23.04.08

2011

2010

2011

2011

As of 02.04.08

2015

2010

2015

2011

Dr. Roy Damary