The biggest sovereign bond bubble of all time could soon pop, so bondholders better give up their "implausible assumption" that foreign investors will continue to furnish the capital that keeps the U.S. and Europe afloat, warns financial columnist Ambrose Evans-Pritchard.
"It is lazy to think that China, Japan, the petro-powers, and the surplus states of emerging Asia will continue to amass foreign reserves, recycling their treasure into the U.S. and European bond markets," writes Evans-Pritchard in The Telegraph.
"These countries are themselves bleeding as exports collapse. Most face capital flight. The whole process that fed the bond boom from 2003 to 2008 is now going into reverse."
Woe to investors who misjudge the outcome of this strategic shift, Evans-Pritchard says.
Russia has lost 27 percent of its $600 billion in reserves since August. The oil and metals market collapse has left the oligarchs prone. China's reserves dropped $15 billion in October.
"Beijing has begun to fret about an exodus of hot money," Evans-Pritchard says.
Remember, China's $1.9 trillion cache of foreign bonds is a by-product of holding down the yuan to boost exports.
That mercantilist technique is no longer required, as the currency is declining. Beijing needs the money at home in any case to uphold the Chinese economy. Even Japan has slipped into trade deficit.
There may be better uses for that money at home, foreign investors are starting to say.
James Montier of Societe Generale in Paris has examined U.S. bonds back to 1798. Yields have only been this low under war controls in the 1940s when the price was set by dictate. Yields on 10-year US Treasuries have fallen to 2.4 percent. Rather than risk-free returns, this is “return-free risk,” Evans-Pritchard said.
"The U.S. and European governments cannot rely on Asia to plug the $3,500 billion hole in their budgets this year," said Evans-Pritchard."Asians are just as likely to be net sellers of their bonds. Which implies that central banks may have to monetize our deficits."
The upside of all this is that Europe and the United States may already be so far into debt deflation that bonds will rally. New data suggest that Japan's economy contracted at a 12 percent annual rate in the fourth quarter of 2008. The United States, Germany, and France shrank at a 6 percent rate, and Britain shrank at 5 percent
These statistics are worse than 1930, though not as bad as the killer year of 1931, said Evans-Pritchard.
Most interestingly, some sophisticated investors — institutions and individuals — are increasingly eyeing riskier bonds as a way to boost their return. The need for a solid yield is driving investors despite the economic slump.
"There are a lot of folks doing the math and asking 'What would have to happen for this investment to be bad? The world would have to be horrific'," Jason Brady, a money manager at Thornburg Investment Management, told Reuters.
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