Mish's Global Economic Trend Analysis

Trichet Reiterates Austerity Message; Germany Plans More Borrowing Cuts; Will the Treasury Rally Last?

Posted: 04 Jul 2010 10:44 AM PDT

Once again and with greater force, Europe has snubbed its nose (and rightfully so) the Keynesian clowns in US academia and the Obama administration.

Bloomberg reports Trichet Calls on EU Governments to Reduce Budget Deficits to Boost Growth.

European Central Bank President Jean- Claude Trichet pressed governments to trim their budget deficits, saying such action would boost economic growth by improving confidence of consumers and investors.

"We are in a period where we have to manage budgets very tightly," Trichet told journalists in Aix-en-Provence, France. "I have no problem with austerity, rigor. I call this good budgetary management."

Trichet said today that deficit reduction won't choke growth and a failure to stem budget gaps would be equally risky for the recovery.

"Confidence is key for growth, and if you cannot have confidence in the sustainability of the fiscal policies then you have no growth because you have no confidence," he said. "The two things are complimentary."

Germany to Reduce Deficit by 80 billion euros ($100 billion) over five years

Reuters reports Germany plans to cut new borrowing in savings drive

Germany plans to cut net new borrowing by some 80 billion euros ($100 billion) over five years, reducing supply of Europe's benchmark debt and adding pressure on other euro zone members to tighten their own public finances.

The draft budget for 2011, which the cabinet plans to approve on Wednesday for ratification in parliament in November, will anchor a 34 billion euro reduction in new issuance over the next two years compared to earlier plans.

The federal government also aims to cut spending to 307.4 billion euros next year, a 3.8-percent decrease from plans made before a "debt brake" law was passed in 2009, details of the draft made available to Reuters on Sunday showed.

The budget is the latest chapter in Germany's drive to consolidate public finances, a move that has drawn criticism from some other large countries that say it is too early to withdraw support enacted during the financial crisis.

Unions have promised stiff resistance and industrial action looks likely -- a threat that could rise as cuts in social services deepen and health care costs rise as planned.

In addition, some politicians from within Merkel's ruling coalition say the measures are unfairly aimed at the poor, whose benefit cuts make up the largest part of the savings planned through 2014.

Besides the spending cuts, the budget's planned reduction in new borrowing to 65.2 billion euros this year and 57.5 billion euros in 2011 will put the onus on other countries that share the euro currency to follow suit.

Can the Bond Rally Last?

MarketWatch says Bond rally reflects gloom - but don't bet on it lasting

The recent steep rally in U.S. Treasury bonds, helped by investor jitters over European debt and weakening U.S. economic data, isn't likely to last, say some bond investors and strategists.

They expect longer-term rates to rise in coming months as investors pull back from bonds -- whose prices rise when their yields fall -- because growth turns out to be better than markets anticipate. This shift should support the stock market.

Short-term Treasury yields dropped to a new record low in recent sessions as bad news piled up about consumer confidence, manufacturing and the job market. In the six months ended Wednesday, an index of Treasury debt had the biggest half-year gains since 1995. Some strategists, however, are betting that these clouds will clear in the second half, and that yields are on their way back up.
"Staying in safe haven assets right now might feel like the best thing to do, but that's wrong," said Jim Caron, head of global interest-rate strategy at Morgan Stanley. "The second half of the year is going to surprise most people as we get the growth that will lead to higher yields."

"Ultimately, we think equity markets do come back and rally," he said.

The appropriate questions at this point are

1. What does ultimately mean?
2. Equity markets will "come back" from what level?
3. Since when has Morgan Stanley ever been right?

Let's address that last question.

Morgan Stanley expects 10-year yields to rise 220 bps in 2010

Let's flashback to November 20, 2009: Morgan Stanley expects 10-year yields to rise 220 bps in 2010

Our forecasts look for bond yields to rise in 2010: Our US economics team expects bond yields to rise to 5.5% by the end of 2010 – an increase of 220bp that outstrips the 137bp increase in the fed funds rate expected over the same horizon

That was a pretty pathetic forecast by Morgan Stanley on both counts.

Now Morgan Stanley is back at it, preaching a rally in equities and a bond selloff. I believe they are wrong on both counts. Of course they did say "Ultimately" although I might point out Japan is still waiting for "ultimately" as well.

Morgan Stanley is seriously underestimating the upcoming weakness in Europe, China, and the US in my opinion.

I am sticking to what I said in Factory Orders Fall More Than Expected; Recovery Withers on the Vine

The Price We Pay For Budgetary Murder

How Policy Errors Cause Depressions (and how "in isolation" some things Krugman says make sense)

This recovery is over, and it wasn't much of one to begin with. Indeed, there is a decent chance we do not have a double-dip recession for the simple reason the NBER may not call the end of the first one.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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