UAE. The bond bears are wrong again. Three months into another round of improbable reasons why yields now have to normalize, the yield on the US 10 year government bond hit another all-time low on Friday.
Currently the ten-year bond is yielding 1.4820%, almost 0.8% below where it stood just two months ago. Another bad set of US employment data, and the on-going slide in commodities, have demolished any credible fears of inflation.
Fears of deflation are the market drivers. Bond yields across the safe-haven nations have plummeted to such an extent that Switzerland is now threatening capital controls. Investors now have to pay the Swiss and German governments to lend them two year funding.
I have spent most of the last twenty years covering Asian markets and watching Japan deal with debt-deflation. Japan was never this bad. At least when the Japanese realized their policy mistakes they then quickly reversed course.
Bank Of Japan governor Hayami had good reasons to resist calls for quantitative easing at the turn of the millennium, but European policy making has become little more than a giant game of chicken between the south and Berlin, with the ECB seemingly unwilling to do anything beyond mumbling price stability; it is possible that it will cut rates this week, but unless the cut is in excess of half of one percent, it will be clear there still is no resolve to move away from the hair-shirt status quo.
Japan was never locked into a currency union from which there was only one permissible exit route – massive debt-deflation. Yen depreciation was always an option. For Europe, this option isn’t available to individual members of the eurozone. The only option is increasingly looking like financial chaos. Followers of Emerging Markets will have noticed the sharp falls in Eastern European FX in recent weeks – cross-border exposure to Western European banks is substantial.
Last week, the ECB released the latest set of deposit data for Europe. Greek deposit growth, excluding financial institutions and those of government entities, declined 15.6%y/y. Peak to trough Greek deposits have dropped by 30% since September 2009.
In Spain, deposits declined 6%y/y in April. And for the first time, Portuguese depositors have entrusted fewer of their savings to national institutions than they did a year ago. Deposits dropped 0.7%y/y. What these will look like when the next data set for May is released at the end of June and the effects of Greece’s recent election are priced in is anyone’s guess. But the trend is clearly towards declining confidence in Europe’s banks.
Meanwhile the euro has finally succumbed; it has fallen from 1.3250 at the end of April to the current 1.2413. That it hasn’t fallen by more is mostly likely down to net short euro positions being at historical highs, USD swap lines and the increasing perception that poor US jobs data will force the US Federal Reserve into engaging in an additional bond buying programme ahead of November’s presidential elections.
Matters for European markets have been complicated by weekend comments from Prime Minister Rajoy of Spain and ex-PM Berlusconi of Italy. Snr Rajoy appears to be edging towards the suggestion that Spain refuse a bailout from the EU and opt instead for the exit.
Clearly his intended audience is in Berlin rather than Madrid. With the bailout of Spain’s third largest lender, Bankia, having been received badly by markets last week, and estimates of Spanish banking bailout needs creeping past EUR400bn, Spain’s political leverage is gaining. Similarly, ex-Italian PM Berlusconi’s balloon that Italy should start using its own central bank printing presses to mint euros is a clear statement that the single currency is on very weak ground if Greece’s electorate appears close to voting against austerity again on 17 June.
From a tactical perspective we therefore continue to view US exposure as preferable to European and Japanese – until we get nearer the US elections in November. Outside the G7, calling Emerging Markets has become tougher but we retain our preference for short-dated hard currency debt and with country bets on Russia and China.
Measures of growth in BRICs countries have slid since March, but as a region, commodity poor Asian equities have proven more resilient quarter–to-date, largely because they benefit from lower commodity prices – Indonesia being the most obvious exception. Non-Japan Asia’s quarter-to-date performance is no worse than the G7 at -11%y/y; Latin America is down 19% and Eastern Europe by 24% (MSCI indexes and USD terms).
Growth-wise, Brazil has cut its policy interest rate by 350bps since mid-2011 and growth measured only 0.8%y/y in Q1. Russian asset prices have been hit by lower commodity prices, but GDP growth is still robust at 4.9%y/y. India’s policy-making machine has undermined international confidence in itself.
India’s large 3.5% of GDP current account deficit makes it vulnerable to further INR declines. China’s latest data points have caused, as usual, a lot of hand-wringing. To be sure China’s export sector is leveraged to European trade, but there is still ample room for the People’s Bank to loosen policy. Russia and China easily appear the pick of the four. China’s relatively closed capital markets add to its appeal.
Outside the usual asset classes, gold and gold mining stocks have become active again. In the last week it appears that gold has begun to trade as a risk-averse hedge against deflation and inflation. Un-hedged gold mining stocks have gained in contrast to the rest of the commodity bloc.
Gold spot gained almost USD 80/oz on Friday at the time the US reported only 69,000 new jobs in May and April’s figures were revised down. The NYSE Arca Gold Bugs Index of mining stocks gapped almost 7% on Friday – in contrast to the GSCO commodity index which fell 2.7%.
Gold’s rise alongside the USD index is the first indication from the market that gold’s double failure to break USD1,540/oz in May might indicate the market is beginning to form a bottom.