Notes From Underground: Are European Bonds Rallying Because Austerity Is Being Rolled Back?

It seems that the European debt markets are rallying in response to the end of ADVERSE FEEDBACK LOOPS. In a mind-numbing thought, it appears that the implementation of austerity budgets actually had the effect of increasing deficits as economies slowed as austerity began to bite. (The outcome of the adverse feedback.) The more austerity, the larger the deficit, which is compounding the debt problems of peripheral nations. Greece is the poster child of austerity gone awry. So as the threat of AUSTERITY diminishes, the more a nation’s bonds rally. The ITALIAN BTPs (10 years) saw its yields drop precipitously as a new government was formed over the weekend. But the rally in the BTP futures had begun well before the new government was actually crafted, as I noted last week. The BTP FUTURES had closed over the February 25 high–that was made before the failed election was a reality.

The Spanish BONDS have also rallied even as the economic situation continues to deteriorate, opposite of what previously occurred. It seems that as markets sense less austerity and negative feedback loops the greater demand for bonds … truly mind numbing. But if investors sense that the EURO will be maintained at all costs and less austerity provides some economic breathing space, then why not acquire some higher European yields? THE CLASSIC CASE OF LESS IS MORE? The drop in two-year yields for peripheral sovereign debt has been very dramatic:

Italian 2-year 1.13%

Ireland 0.75%

Spain 1.72%

France 0.08%

Don’t mind the economic data as there is no problem funding the debt of Europe’s weak economies. This is the greatest illustration of Mario Draghi’s magic trick of having a major market impact without ever having to answer to the Outright Monetary Transaction (OMT). Many analysts expect the ECB to cut its lending rate at Thursday’s meeting but with the debt markets causing no pain–and reacting positively to austerity relief–why waste the ammunition and anger Chancellor Merkel?In this case, more is less.

***Outside the box: For the last two years I discussed AIG stock as a positive investment as the financial crisis left it intact as a global insurance company, with great market exposure to China and other developing nations–access to the greatest growth stories, with a pristine balance sheet. Over the weekend it was announced that Berkshire Hathaway had hired four high-level executives from some of AIG‘s best performing sectors. It makes one wonder if Buffett is going to make a play on AIG because of its vast global insurance network. It may be that Mr. Buffett is going to build from within or maybe there is something bigger in the works. Just another investment to keep our eyes on. Remember, AIG was born in Shanghai around 1920.

***Today there was a Bloomberg piece about Australian revenue being in shortfall. Prime Minister Gillard reported that tax revenue has failed to meet projections as the strong Aussie dollar has put pressure on corporate profits. Since there is an election in September, look for the Gillard government to put pressure on the Reserve Bank of Australia to cut interest rates to help stimulate growth and weaken the Australian dollar. As the Aussie 2/10 yield curve is a relatively flat 51 PIPS, the RBA has room to move to help aid Aussie growth.



Tags: , , , , , ,

6 Responses to “Notes From Underground: Are European Bonds Rallying Because Austerity Is Being Rolled Back?”

  1. ssrodes Says:

    couldn’t the demand for European bonds be primarily the result of yen looking for a “safe haven”, and less to do with whether austerity is on or off?

  2. jerry thoel Says:

    What are your thoughts on the future movements of the yen should the RBA cut rates??? Is it full speed ahead and continuation of liquidity injections or maybe breathing room for BOJ to pause?
    Kindest regards,

  3. Alex F Says:

    I don’t think the European bonds rallying is that surprising given all the Japanese investors searching for a place to park their money. Gilts offer a negative real yield and with the support of OMT these bonds don’t really trade like a risky asset anymore. OMT has reduced the tail risks for bond investors.

  4. yra harris Says:

    Alex–I certainly agree but OMT is dependent on the conditionality of enhanced austerity and the Japanese I agree with but much of the media is talking about how Japanese investors are searching at home for investments since Kuroda’s enhanced QE–I don’t buy that as I have questioned if that is so why has the YEN dropped 5% in the same period

  5. yra harris Says:

    Jerry—I think the YEN and the Japanese will be back and forth until the time that the Japanese turn the nuclear power plants on,as it will signal that a weaker yen is a negative for the importing costs of oil and LNG–will write about this soon as I have some work done but the RBA certainly has room to move because of the BOJ–but more importantly because of some slowing in the Aussie economy which is what the yield curve has been signaling

  6. Notes From Underground: Are European Bonds Rallying Because Austerity Is Being Rolled Back? :: Jim Sinclair's Mineset Says:

    […] More… […]

Leave a Reply

%d bloggers like this: