As we have seen during this crisis debt markets have been a good leading indicator for equity markets. That is why next weeks large bond auctions in the States are likely to be very interesting for the markets. With all of the talk of soverign rating worries and Chinese concerns over fed treasury purchases (printing money) the demand for US paper will be very interesting. If there does happen to be a big drop in demand, watch out for the markets as their is an enormous amount of debt to be raised - unless of course we all resort to crazy money printing
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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.
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