Unintend consequence of Stimulus #546

[Financialpanther]

Alan Kohler
The price of panic

Bond yields should now be falling, but they are rising instead.

The collapse in global trade over the past six months and the continuing contraction in the supply of credit as the world deleverages is hugely deflationary, which should be increasing the demand for bonds and reducing yields.

Yet the US bond yield has gone up from 2.05 per cent at the end of December to 3.45 per cent now, and the rise in yields has accelerated over the past two weeks. The Australian ten-year bond yield has gone up from 3.97 in early January to 5.37 per cent (that is, the spread between Aussie and US bonds has remained the same, at 1.92).

Despite the prospect of deflation, the bond market is panicking about a tsunami of supply, following decisions by governments everywhere to try to borrow their way out of the crisis.

Who, the market wants to know, is going to lend all the money? And more importantly – at what price?

Next week, the US is coming to market with $US101 billion in bonds; US debt sales in the fiscal year to September will be $US3.25 trillion, $US1.9 trillion more than the year before. This year the US government will borrow 50 cents of every dollar it spends.

The Federal Reserve has bought $US123 billion in bonds since late March as part of its $US300 billion program of buying US bonds with newly printed money, but the government needs the market to support the vast majority of its bond sales – especially as 2009 stretches into 2010 and 2011, with huge deficits as far as the eye can see.

There’s now a fear that the United States will lose its AAA credit rating. President Obama has been forced to say he doesn’t think this will happen, after Pimco’s Bill Gross said the other day that it would – “eventually”.

The Congressional Budget Office estimates that an extra $US10 trillion in debt will be added by 2019, but that is based on similar economic growth forecasts to those being used by the Australian Treasury – 4.5 per cent a year after 2011. If growth is less than that, taxes will be less and the deficits will be much bigger.

Last week Standard and Poor’s put England on negative credit watch, and the former chief economist of the IMF, Simon Johnson, described this as the “third stage” of the credit crisis: the first was last year’s financial implosion, the second was the economic crunch that followed and the third is a government debt crisis.

Some $US5 trillion in global government debt will have to be sold over the next two or three years, mostly by the US, Europe and Japan.

Many smaller countries are also desperately trying to sell bonds to finance their own fiscal stimulus packages and “automatic stabiliser” increases in budget deficit.

The Australian Office of Financial Management is now selling $1.5 billion a week in bonds to finance the Rudd government’s massive blow-out in the deficit and the yields are steadily rising – so far so good. The yield spread between the US and Australia is holding.

But by raising yields during a massive contraction in global GDP, the bond market is telling us there is trouble ahead – that the extra government debt may not all be able to be financed.

This is a bit of a concern really - not to say that the stimulus should never have been done (there is some merit to infrastructure spend - cash splash is questionable. But really what is concerning is the large increases to the long term swap rates and yields given the governments around the world are looking to finance their massive spending.

Speculation around the market that governments are pricing the issue of their bonds to be around the commercial rates. Which is raising the rates of commercial issue (and subsequently the cost of funds for financiers = and business) given the risk-free rate of govt bonds are now a lot higher = commercial bonds have to rise as well. In the last week - the big 4 banks have delved into the retail term deposit space and are pricing their funds so much more than they have ever before. This may ultimately translate to banks being forced to raise rates independant of the RBA and not pass on any further rate cuts should they occur.

Good for working families really

 

[morgoth]

This is a bit of a concern really - not to say that the stimulus should never have been done (there is some merit to infrastructure spend - cash splash is questionable. But really what is concerning is the large increases to the long term swap rates and yields given the governments around the world are looking to finance their massive spending.

Speculation around the market that governments are pricing the issue of their bonds to be around the commercial rates. Which is raising the rates of commercial issue (and subsequently the cost of funds for financiers = and business) given the risk-free rate of govt bonds are now a lot higher = commercial bonds have to rise as well. In the last week - the big 4 banks have delved into the retail term deposit space and are pricing their funds so much more than they have ever before. This may ultimately translate to banks being forced to raise rates independant of the RBA and not pass on any further rate cuts should they occur.

Good for working families really

Only so much cash to go round. More demand = higher price. Logical really.

 

[Financialpanther]

Only so much cash to go round. More demand = higher price. Logical really.

Agreed - and guess who will blame the bastard banks when increase cost of funds cause them to lift rates?

 

[Dry Rot]

Good one Rudd - what a great time to really ramp up our govt debt.

If actual rates for govt and commercial loans will rise as has been suggested here, where does such expensive credit leave the rosy future growth figures from Treasury?

 

[Financialpanther]

Bump - Hi CBA

 

[Ripper]

Bump - Hi CBA

And it has hardly started yet.

10 years bonds topped out at 5.8% last week

Interest rates will only keep going up from here and the start of a conventional interest rates induced turndown IMO.

Regardless , the big Gov't borrowing has put our heads back in the noose that Keating said the other Asian countries were wary of.

Yet despite a more sound fiscal condition and a lower inflation outlook, Australia’s bond yields are at the mercy of vigilantes operating in the US-debt markets.

http://www.kitco.com/ind/dorsch/jun102009.html

 

[medusala]

re UK but the argument is the same for those who label do nothing as an evil alternative.

http://www.timesonline.co.uk/tol/comment/columnists/matthew_parris/article6488769.ece

At the root of this Tory (and new Labour) conspiracy of evasion, however, I see a deeper problem than timidity about telling the possibly unwelcome truth. Even the boldest seem to start from the assumption that public spending cuts are an evil - however necessary an evil. The debate then becomes about whether it's best to be honest about bad news.

What few today ask - what few since Sir Keith Joseph in the 1970s have asked - is whether public spending is in principle something we want to maintain or increase, if and when we can afford to, as compassionate Conservatives seem to assume. Yet there is a powerful moral case, hardly heard from modern Tories, that public spending may sometimes be inherently damaging: an evil, not a good. And that more of it is not necessarily better, even when Treasury coffers are full.

Our failure to restart this ancient argument means that when spending cuts are forced by circumstance, the politician's eye goes first and mainly to the bottom line: how to get the totals back towards balance; a quantitative rather than a qualitative debate, and one that is concluded most easily by shaving a little bit off everything.

Focus on the qualitative, however, and we might think about big cuts in some areas of spending, and none (or even increases) in others. Perhaps our ancient universities should be raising their own revenue? Should farming be subsidised at all? Should we have a national health service in anything like its present form? Does overseas aid work? Why does Australia - not a country one thinks of as repressive, brutal or fascist - manage with a proportionally much smaller public sector?

As the Labour Party implodes, Conservatives should start getting back on to the front foot on the role of the State. It may not only be a matter of “admitting” that governments will “have to” cut spending to reduce debt. It may be time, not just to defend the economic necessity of cheaper government in straitened times, but to assert the moral superiority of smaller government at all times.