Monday, May 21, 2007

The Conundrum Unwinds / Richard Berner

should be no surprise... us stocks get pushed on a daily basis from strong foreign markets. should be the same for us bonds.....this are not good news for us stocks in general. a slowing domestic economy and tightening around the world. on top of this more and more countries are diversifying ( kuwait) away from the greenback.

sollte keinen überraschen...waru sollten für anleihen nicht die gleichen gesetze wie für aktien gelten. das sind spezeill für den us aktienmarkt keine guten neuigkeiten. eine lahmende heimische wirtschaft und gleichzeitig weltweit erhöhende notenbanken. obendrein immer mehr länder die sich sinnvollerweise vom $ lösen.

Despite slowing US growth, declining core inflation and a steady Fed, US real yields are on the rise again. US real growth has decelerated to 2.1% over the past year and to only about 1% in the first quarter, from 3.1% in 2005 and 2006, and significant headwinds for growth persist.

Yet US real 10-year yields have risen by 30 basis points (bp) in the past two months to 2.45% — a level close to the upper end of the range prevailing over the past two years. That has pushed nominal 10-year yields to 4.8% — the highest level since February. Is the bond-market “conundrum” of 2004-05 finally unwinding? And if so, why?


I think the conundrum is unwinding, although the yield curve is likely to remain relatively flat. The main culprits for this increase in US yields, as I see it, are more global than domestic: Strong global growth — manifest not just in GDP or industrial output but also in domestic demand outside the US — is one key factor. The improvement in non-US domestic demand implies that the strength of global growth is not entirely dependent on US developments.

Concurrently, therefore, global real yields are rising; for example, yields on 10-year index-linked UK gilts have jumped by 35 bp in the past two months — and twice that amount since December 2006. In turn, the global domestic demand improvement likely means that the world’s saving-investment balance is tipping away from support for US bond prices. With those overseas trends sustainable, in my view, global real yields seem likely to put a floor under those in the US. Details follow.

It’s always difficult to disentangle the forces acting on yields, and this time is no different. For example, at the start of the year, I expected that a combination of five forces would lift real US yields: US ‘core’ inflation would peak and move lower; US growth would rebound towards trend; and US saving imbalances would shrink — the last two courtesy in part of strong growth abroad. In addition, I thought liquidity would dwindle, and term premiums and volatility would rise slightly

Those forces now all seem to be in play. But two of the factors that I think are important drivers of US real yields originate abroad, and they are right now making the difference. First, strong growth combined with upside risks to inflation abroad have promoted monetary tightening in several economies and increased the likelihood of further policy actions. For example, European growth has consistently turned out to be stronger than expected. ..... As a result, central banks are acting or talking hawkishly in many of these theatres, and markets are pricing in the likelihood of more rate hikes.

A second important global factor is also tipping away from support for US yields, namely the global saving-investment balance. Three or four years ago, that balance, coupled with slower global growth, may have contributed to lower global and US real yields. True, global growth was beginning to improve significantly, but it was largely the product of strong US demand and Chinese production. US monetary tightening encouraged the recycling of the resulting surplus saving from abroad into strong US capital inflows from both official and private sources, a stronger dollar, and healthy demand for US yields.

That was then. Today, the balance is shifting in the context of strong global growth. More of the income generated from strong growth in output abroad and from the favorable “terms of trade” in commodity-producing economies is showing up in overseas final demand. For example, in both Latin America and Asia excluding Japan and China, strong growth has encouraged booming capital inflows and currency appreciation. With many global yields close to or even above those in the US, and global investors looking abroad for investment opportunities, it’s hardly a stretch to think that rising global yields will put a floor under those back home.

Put differently, these shifts mean that some of the flow of saving from abroad that has so far helped to finance the US current account deficit on attractive terms will now be diverted to finance demand growth in many of our overseas trading partners — and in this context, that may contribute to somewhat higher US real interest rates.

>and on top of this more and more us investors "diversifying" out of the $

>dazu kommt das immer mehr us investoren ihr glück ausserhalb des $ suchen.

Reinforcing that tendency, if Asian and Middle Eastern central banks allow their currencies to appreciate against the dollar at a faster pace, or de-peg them from the dollar, they will accumulate dollar-denominated reserves more slowly. That now seems to be happening, because rising inflation pressures are forcing them to abandon their exchange-rate policies, as in Kuwait . And China’s latest move to raise rates and broaden the trading band for the yuan is also a step in that direction. Indeed, the gradual diversification of global foreign exchange reserves away from the dollar and liquid fixed-income securities through the growth of Sovereign Wealth Funds seems likely to boost US real rates. ...

To be sure, domestic US factors are also important. US real rates are getting a lift from an evident pickup in second-quarter US growth, which precludes Fed ease for now. Indeed, we believe that the first quarter likely marked the trough for US growth at just under 1% annualized, and estimate that the second quarter pace may rebound close to the 3% trend........ Certainly, it’s too soon to say that this rebound is sustainable, but it is occurring in the face of significant headwinds to growth from rising gasoline quotes and the ongoing housing recession...

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