The Badger is home alone this week as the girls are on holiday with mum; Ellie dog is here moulting like crazy and with the epic amount of hair loss it’s not clear why she’s not completely bald but hey ho, tidy and clean remains the dream!
What’s been happening?
The markets have had a really strong last two weeks as tensions in Gaza and Ukraine have eased.
The meeting last week of central bankers at Jackson Hole in the US was interesting in that the three main central bank chiefs spoke to their domestic economy (ies) and the future.
Yelland (US) said “rates to rise slowly but not yet”.
Draghi (EU) said “more can and will be done to prevent deflation and to stimulate consumption” but did not specify what.
Koroda (Japan) that he thinks things will get better but if not he is ready to ease monetary policy further.
It’s all about interest rates
One of the stranger situations currently is the comparison of interest rates for Sovereign Debt.
The US 10 year yield is currently around 2.5% which is similar to the UK.
Yields for Emerging Economies are much higher (reflecting higher interest rates):
South Africa 8.0%
So the yield on Indian debt is 300% higher than the UK which seems very high, but there are some genuine concerns in emerging economies such as higher inflation, political instability and weaker economic fundamentals.
But this is where it gets VERY odd.
The yields on EU members debt is artificially low because of the perceived backing by Germany, these rates are:
Greece 5.8% (same as Mexico but it has oil and is booming)
Portugal 3.3% (massive debts)
Italy 2.4% (same as the US which has massive oil reserves, and is a leader in both Biotech and technology – Italy doesn’t and isn’t)
Spain 2.25% (over 25% unemployment for under 25’s and been in recession for the last 5 years)
Ireland 1.79% (still recovering from a massive banking / property crash)
France 1.3% (can’t keep a functioning government and won’t enact labour market reforms which are desperately needed, same goes for Italy)
And finally the strangest ones of all.
Investors are buying 10 year bonds from two countries paying the below inflation princely sums of 0.95% and 0.5% respectively.
The yield on the German 10 year Bund is indeed 0.95% and the Japanese JGB IS 0.5%.
Why and what does it mean?
Plainly the yield on a Portuguese or French bond does not make sense when compared to a US, UK or even the Mexican yield if the economics of the Countries as stand-alone entities are compared (the yields / interest rates should be higher).
The comparison in the markets is not however direct, it’s viewed in the case of the EU countries through the prism of Germany.
Any and all EU wide economic actions in reality have to receive the tacit approval of the Germans before they can be undertaken, which means because the Germans are hyper conservative economically that no one expects the ECB to be allowed to do anything radical.
Now this German EU over lordship might strike some as sinister, but the Euro countries (as can be seen above by the low yields they are paying) benefit hugely from this perception. The flip side of the German coin is that when DRAGHI famously said that he and the ECB stood ready to do anything it took to keep the Union together, everyone knew this meant the Germans would back it up.
So the cost of serving the national debt in Portugal, Greece or even France is a fraction of what it would be outside the EU or if Germany were not perceived as guarantor.
The Euro is plainly a flawed concept in that it’s like being half pregnant or having an open marriage. All member states share the same currency but they all issue individual bonds (not a centralised single debt obligation raised and underwritten by the European Central Bank then distributed out to member States). This individual debt should mean that markets simply treat the individual nations bonds like a currency and value it (charge an appropriate interest rate) relative to the economics of the Country. They would if it weren’t for Germany.
Of course the strength of the Euro currency is a negative for the likes of Greece and Portugal; if they were individually floating they would have devalued enormously but this argument is now really mute as the majority of their debts are Euro denominated. To go back to their own currency and see it devalue makes their debt percentage quantumly worse, as it would still be Euro denominated so that boat has sailed.
As to what all this wonkery means it’s simply that rates in Europe and Japan will stay very low for a long time and that the yields on US treasuries will get dragged lower, because the market is attracted to buy them for the extra interest even though it’s barely above inflation.
The US and UK Central Banks know that putting up domestic interest rates will strengthen their currencies and weaken the Euro (good for European business) which is another reason that Anglo rates may well be slower to rise than many expect.
Which all brings us to T.I.N.A
“There Is No Alternative”
This is the growing belief of markets in relation to the comparative attraction of equity investment.
If you can get an average and growing 3% dividend yield from a basket of high quality stocks why on earth would you buy bonds with an average 10 year fixed yield of around 2% unless you absolutely had to?
Answers on a postcard please……because I can’t think of any.
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.