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Michael Baxter

Bull and bear:Markets buy debt, regardless

Written by: Michael Baxter on April 23rd 2013

Category: Bull & Bear, News

Safe Debt, government debt, corporate debt, pertaining to companies with the best credit ratings: it’s in vogue.  It matters not what the fundamentals say, the markets want it and they want some more. Despite a week of awful news on the UK economy, the yield on UK government bonds is playing with a nine month low. The news out of Italy transcends awful and yet the yield on its bonds fall to an all-time low. The US money supply is crawling along in the slow lane. Bill Gross has called for an end to Austerity. The world has gone upside down, and it is all because of the investor’s thirst for safe debt.

Italy goes against the comedian but who will have the last laugh?

There was time when being over 80 was considered to be quite old. Not so anymore. There is the sprightly Bruce Forsyth (85), Alan Greenspan (87), or young whipper snappers such as Warren Buffett who, at 82, can barely claim to be an octogenarian. Of course, if you sit up in the higher echelons of the Catholic Church being 80 means you are only just old enough (by five years) to be considered wise enough to vote for a new Pope.

Even so, 87 seems a tad old to be elected as president or, to be more precise, re-elected as president. But that is what Italy has done. Or actually that is what Pier Luigi Bersani, the leader of Italy’s centre-left Democratic Party, (super) Mario Draghi and dear old Silvio Berlusconi have done. They got together and agreed that the 87 year old Giorgio Napolitano should have another term as Italian president.

Mr Napolitano had previously said he didn’t want the job. You can’t blame him; 87 is rather old to be trying to create order from the chaos that is Italian politics.

So while Mr Napolitano might have been greeting the news of his re-appointment with a grimace, perhaps muttering something about poisoned chalices under his breath, the markets beamed. They went out and bought Italian bonds, forcing the yield on two year bonds to just 1.2 per cent, an all-time low.

It is hard to see why the markets are so happy. Recent data shows government debt is worse than expected, and heading for 130 per cent of GDP. The IMF has revised this year’s projections for Italy’s growth downwards from minus 1.2 to minus 1.5 per cent. Last year, when the economic prospects appeared to be better than this, , the markets didn’t want to touch Italian debt and bond yields surged.

But then again, markets are not behaving in a predictable way at the moment. QE and ECB measures may lie behind the fall in Italian bonds. But then why has gold performed so oddly?

Has Italy become a safe haven?

There must be a joke on there somewhere. Maybe Italian comedian and now powerful opposition politician Beppe Grillo can draw our attention to it. Mr Grillo is not a fan of corruption, and wants to see a break with the past.

He sees Mr Napolitano as a symbol of the Italian system that has created such a mess. So he was against his reappointment. Can’t think why…

UK and US bonds fall again

Meanwhile as the news out of the UK takes a turn for the worse, and another credit ratings agency decides the UK is not all that safe, the markets flock to these shores for the safety of government bonds.

At the time of writing, the yield on ten year government bonds is 1.6476, which is close to a nine month low.

The yield on US bonds is flirting with a 2013 low.

It is odd though. If the markets are so keen to put their money into safe assets, why aren’t they buying gold?

Anticipation of QE may not provide the answer. You can see why markets concluded that another bout of central bank easing was on its way, when two months ago Mervyn King – along with two others members of the MPC – voted for more QE. But there have been two meetings of the MPC since, and the voting pattern has not changed. If anything, QE is less likely now than two months ago when bond yields were higher.

As for the US, the Fed is making noises about the end of QE.

Maybe the truth is that markets don’t care about debt anymore. That the creed we call austerity is dead.

Gross calls for less austerity

Bill Gross, the most important and influential bond investor in the world, has called for less austerity.

He joins the IMF in going distinctly un-austerity-ish of late.

And he seems to be going with the shift in the wind in the world of academia.  Fans of austerity have been unmoved by all the recent critics of the Reinhart and Rogoff model; the one that said when government debts rise above 90 per cent of GDP, growth falls. Now new research has said there were data errors in the Reinhart and Rogoff theory, and in the process critics claim their conclusions are wrong. See Bull and bear: Gaping deficit found in the theory of austerity economics  The Austerians have responded by saying: “So what?” or words to that effect.

Sorry, but the Austerians are grasping at straws. The Reinhart and Rogoff model is just about the only model that provides evidence to support austerity. Now, the case for cuts has been severely weakened.

As for Bill Gross, he told the ‘FT’: “The UK and almost all of Europe have erred in terms of believing that austerity, fiscal austerity in the short term, is the way to produce real growth.” Or so he told the ‘FT’. He added: “You’ve got to spend money”.

Maybe markets are buying government debt as government debt rises, because they have decided that it doesn’t matter any more.

US money supply grows at just about the right pace

New data analysis from Capital Economics may suggest the US money supply is growing at just about the right pace.

How can that be, you might ask? And indeed if you look at the headlines, your question has merit. In 2008, the US money base (or M0) was worth around $800; now it is worth around $3 trillion. That is quite a hike. No wonder many say QE makes runaway inflation unavoidable.

But the broad US money supply or M3, which uses a much more realistic definition of the money supply, has seen much more gradual growth. From 2008 the M3 money supply was around $8 trillion; now it is around $15 trillion. That is still growth, for sure, but actually, if you look backwards over the last 15 years, the growth in M3 is consistent with US inflation of about 2 per cent.

The truth is that broad money is dependent on banks lending and the recipients of that lending spending or investing. And that ain’t happening.

And that, by the way, is why government bond yields are so low. The less companies and households spend, the more their money sloshes around the system and end up in government bonds.

To achieve growth, either we must see a surge in confidence that leads to more spending, or the government must take the money no one else wants to spend, and spend it on our behalf.

China slows Eurozone stuck in slow lane

Today was flash composite PMI day.

You may recall that Purchasing Managers’ Indices (PMIs) come in lots of shapes and forms. Today saw an early estimate (that’s the flash bit) of both manufacturing and services (hence composite) across the Eurozone and China.

Recall also that any score over 50 is meant to correspond with growth. A score of less than 50 corresponds with contraction, supposedly.

The flash PMI for China fell to 50.5 in April from 51.5 in March. Qinwei Wang, China Economist from Capital Economics, stuck a surprisingly bullish note, however, saying: These readings point to economic weakness. Nonetheless we believe that growth is not far below the current sustainable rate. There have been few reports recently of large-scale job losses, which implies there is little to be gained from stimulus. Indeed, local employment bureaus reported that the excess of job openings relative to job seekers in Q1 was wider than ever before.”

As for Europe, the composite PMI is stuck at 46.5, which is the same as last month.

Markit, which compiled the data (although it did so in conjunction with HSBC in China), tells an interesting tale.

It says the Eurozone contracted by 0.6 per cent at the end of last year; that PMIs suggest a less extreme contraction of 0.3 per cent in Q1, but that in April the economy of the euro was contracting at a 0.4 per cent pace.

Markit said: “While France saw the rates of decline in both business activity and new business ease sharply to the slowest for four and eight months respectively, Germany saw both activity and new business fall at the steepest rates for six months. The drop in German activity was also notable in being the first since last November.”

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: Beppe Grillo, Bill Gross austerity, Giorgio Napolitano, Italian bonds, PMI China Eurozone, UK bonds, US money supply grows

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