USA: Why yields must rise - and what to do about this
Summary
In this phase of gloom, evidence is mounting that dollar bond yields have to rise. We suggest three forces propelling such a rise. Higher yields must infect America's Economic Time™ yet again, prolonging her mini-stagflation. We tell you what it is, and how to save money off this phase of The Economic Time™.Topics Covered
- Why US long bond yields must rise
- Why America's Economic Time™ must worsen
- How to save money off this.
Background
1. Why US long bond yields must rise
Despite America now starting to socialize her losses, whilst privatizing her gains, Secretary of the Treasury Hank Paulson could not stop the rot at the week end:
- Not even half of the mortgage rot is covered by the government. On Monday, his "conservatorship" (i.e. seizures of Fannie and Freddie, the "two Fs") triggered one of the biggest defaults in the history of the US credit derivatives market. This is because in credit derivatives markets, "conservatorship" equates to "bankruptcy". Meeting actual claims following such a technical default will remain subdued: the actual value of the two Fs' debt remains high, precisely because the US Government stepped-in to back it. However, the key issue has to be: what about the health of America's "other" mortgage debt - namely, all of those mortgages that are
- total mortgage debt totals $12,080 bn;
- of this, $5,200 bn - or, 43% of total mortgage debt, is guaranteed by the two Fs, so
- this has to mean that $6,880 bn, or 57% of all US mortgage debt outstanding, is not guaranteed by the two Fs, i.e. now explicitly by the U.S. government. Step in sub-prime mortgages and the credit default swaps backing this junk...
No Hank Paulson can step in here and exercise "conservatorship". The upshot: once America's Economic Clock™ ticks badly yet again, watch these other $7 trillion dollar snakes appear and rattle markets. That rattling will be all the worse precisely because no government can step in ... Thus, investors willl demand a higher risk premium, as in: higher yields.
- The two Fs now are embedded in America's national debt. On Tuesday, the non-partisan Congressional Budget Office (CBO) announced that the two Fs' operations now have to be included in the the government's operations. After all, through Secretary Paulson's "conservatorship", the US Government has taken over guaranteeing these agencies' debts.Not that this has driven US yields up. But, things stack up. Get some more of those $7 trillion dollars worth of snakes, the ones mentioned above, slithering around, coupled with a rising US surplus and the result: America's sovereign debt starts getting downgraded. Not good for yields: investors will expect a premium.
- Banks won't want to lend. If the government has had to step in to rescue two government corporations, and if American growth remains tepid, then expect banks' aversion to risk to keep rising. So they will keep lending less and less - if for no other reason that they cannot raise capital in order to maintain regulators' ratios. And if they do lend, they will command a risk premium...
2. Why America's Economic Time™ must worsen
Back to The Economic Clock™. Subscribers know that it has a "monetary" and a "real" arm. In normal circumstances, the monetary arm is run solely by the Central Bank. But this time things really are different: whilst Hank Paulson is becoming the socialist of the American century, bailing out Bear, two government agencies, Lehmans and others going forward, it is the private banks that are pullling in their liquidity this time around: they don't want to lend.
Thus, in the jargon of The Economic Clock, America is undergoing an
- excess demand for money: banks don't want to lend/cannot lend for regulatory reasons, and thus
- excess supply of goods. We all know about how Americans are consuming less.
If our view of higher US yields prevails, then look for even less lending by banks. That represents an intensified excess demand for money, driving yields up further. No matter how much longer the Fed keeps Fed Funds on hold, mortgage rates will stay stuck at the 6%+ ceiling - until confidence returns. According to more recent surveys of American and European executives, this looks like next summer. Oh oh, that means another 12 months of gloom - so how can corporate profits rise? As one executive pointed-out recently: towards the end of each profits cycle, accountants run out of tricks by which to boost profits.
Looks like accountants as well as the US Government, alias Hank Paulson, are starting to scrape the bottom of the barrel when it comes to credible profit-boosters/bail-outs....
3. How to Save Money Off This Idea
- Always consult your financial adviser first.
- Stay in cash, or in strongly-rated short term instruments.
- Avoid long-dated debt instruments, on account of higher yields.
- Stay away from stock markets.
