Notes From Underground: When Spanish Bonds are smiling, Bernanke visits Frankfurt in search of clues

The Spanish government sold $2.5 billion (€3.65) 10-YEAR NOTES at auction and Dr.Pangloss said it went well, as the average yield was 4.615 percent. Finance Minister Elena Salgado said she saw “absolutely no reason” to compare Spain’s situation with that of Ireland or Portugal. Well Madam Finance Minister, all is not well as you have 20 percent unemployment and an exploding deficit as tax revenues implode and expenditures increase. Spanish DEBT is yielding 210 basis points more than Germany. The Spanish economy is struggling and German growth is buoyant, and yet, Spain is paying more for long-term financing, there is definitely a problem. The Irish situation remained in limbo as EUROPEAN demands are being met with resistance by the politicians of the Emerald Isle. Deputy  Prime Minister Mary Coughlan said the Irish corporate tax rate was “non-negotiable.”

I warned in yesterday’s NOTES that the battle lines were being drawn and the Irish would not surrender the 12.5 percent corporate tax rate just to meet Brussels’s demands. The French are adamant about TAX HARMONIZATION across the EU but many of the peripherals will not surrender the sovereignty that goes with a nation’s taxing policies. This is a political battle and it can lead to a protracted stalemate. The Irish are confident that the German and French banks are more vulnerable than the Irish state. Let the games continue.

Ben Bernanke is speaking tomorrow morning in Frankfurt to a Central Bank meeting that’s in its sixth year. The speech was released by the FEDERAL RESERVE tonight titled, “Rebalancing the Global Recovery.” Now that the Chairman is safely out of Korea, he spends the brunt of the speech admonishing China for its policy of maintaining a weak currency as to enable its export sector to thrive. There is nothing new in the speech as we have heard it during the last four years in one form or another. It wasn’t that the FED kept rates too low in the post-dot-com bust. It was that the Chinese were building surpluses that led to BOND buying, which kept U.S. rates too low that caused the BUBBLE in the housing market that Greenspan built.

The language of the speech is forceful and what it really codifies is the piece in yesterday’s Financial Times by KOHN and Dynan. Again, Bernanke is pointing out the concept of a “PORTFOLIO BALANCE CHANNEL,” even if does not use the phrase directly. In the speech he says, “the term quantitative easing ” is inappropriate. Typically, it implies changing the quantity of bank reserves “in contrast, security purchases work by affecting the yields on the acquired securities and, via substitution effects in investors’ portfolios, on a wider range of assets.”

Basically, the FED CHAIRMAN is letting the Chinese know that the FED will force the restructuring and rebalancing of the global economy by forcing investors to seek higher returns outside the U.S., wherever those returns can be found. If the emerging markets provide the best returns then their currencies ought to rally as money flows in, or their interest will be lowered forcing a burst in domestic economic activity. Bernanke notes that the only real DOLLAR rallies have been based on the U.S. as a safe haven during times of great uncertainty. The chairman also explains that the world should not be concerned about FED POLICY because its success will lead to U.S. growth, which will ultimately make for a strong dollar.

The surplus nations have been put on notice: Either restructure away from export-oriented policies and let your currencies appreciate and domestic demand boom, or WE WILL DO IT FOR YOU. Remember, it was German Finance Minister Wolfgang Schäuble who called the FED CLUELESS. It is now Ben Bernanke in the living room with Colonel Mustard ….

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9 Responses to “Notes From Underground: When Spanish Bonds are smiling, Bernanke visits Frankfurt in search of clues”

  1. Arthur Says:

    Very good explanation about Fed-Bernanke. Ray Dalio was explaining that his biggest concern is Spain. So, what is your bet about Spain…

  2. Danny Says:

    Speaking of Ray Dalio and substantial buying pressure on bonds…

    Ray Dalio’s firm (as an outsider looking in) appears to have employeed a method of “risk parity” asset allocation over the years. While there is probably significant disagreement about a precise definition of risk parity asset allocation, but most would probably agree that it is oriented around the leveraged buying of safe assets. For Bridgewater, this strategy has worked incredibly well for the last couple of decades – and because they are constantly searching for seemingly uncorrelated “risk premia” to lever up there is no reason to think it wouldn’t work going forward. But for mainstream investors (somewhat incapable of scorrowing for uncorrelated risk premia), they might be shifting to a risk parity investment strategy right before it breaks down on a large scale.

    The concept of Risk Parity seems to be going mainstream which I am trying to wrap my head around what the implications will be if this does occur. It seems fair to argue that if Risk Parity goes mainstream in mutual funds, etf’s, seperate account managers, etc. there will be a persistent buying pressure (especially considering the concept of risk parity is oriented around levered buying) on so called safe assets i.e. less than 10 year government debt.

    This makes me wonder if the yield curve will actually stay steeper over a longer time horizon as there could potentially be secular shift in investment demand for “safe” assets and substantially more firepower aimed that way becuase of leverage. Of course there could be more than ample opportunity for investors to get burned as risk parity w/ bonds as had the 30 year tail wind of declining interest rates and declining inflation. This doesn’t seem likely to be a tail wind going forward.


  3. yra Says:

    They are the 800 pound gorilla—problems are immense and that is truly a solvency issue—-they will be given morepain soon as the budget deficit deteriorates and they will also force the light to be sined on Italy–so all and all it will not be good.The question of what the markets repsone will be and will the PIIGS be forced out which will cause many problems

  4. yra Says:

    Danny–this has been a problem for investors in so called alternative asset classes.Bridgewater is a great group because Dalio appears to be dynamic in his analysis and alwaystweaking and looking and changing as the world changes.The problem with all investment classes is just because here is more money chasing ideas does not mean there is a proliferation of good ideas—the vast amount of money lowers returns and increases risk–the market’s minsky moment

  5. Arthur Says:

    Thanks Danny and Yra, very hepful.

  6. Jim G Says:

    Here is a quote from Donald Trump that George Stephanopoulos reported:

    “When you have billions in dollars in deficits with a country, those are the trade wars I like. You don’t have to do business with China. You don’t have to do business with other countries.”

    Trump is right: Who comes out ahead if we have a cessation of all trade with a country that we have a gigantic trade deficit with?

  7. Mr.Kowalski Says:

    Ireland’s government is essentially borrowing five out of every eight dollars it spends to support insolvent banks.. and this is AFTER a serious round of budget cuts. The EU/IMF package does not solve the core problem Ireland has.. it’s banks are wildly insolvent. It is not a bailout of Ireland; it’s a bailout of bankers to be paid for by the Irish people. One cannot solve a crisis of debt with more of it.

    I love your blog Yra.. Ive learned much and yet have much to learn.

  8. yra Says:

    Mr.kowalski–your kind words are always appreciated.Right on target as to the basis of the bailouts—-French and German banks will be the major recipients while Irish citizens are stuck with the bill—reminds one of the old dine and dash—that is why it is ultimately a solvency issue

  9. yra Says:

    JIM G—the point is well taken.It again raises the question that the FED is letting the Chinese out of Trump’s theoretical position by being the one to purchase the huge amounts of DEBT that the Chinese want to dump–the Chinese are part of Niall Ferguson’s Chimerica unless they find a way out to “deleverage the relationship”

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