Mish's Global Economic Trend Analysis

Bond Market Anticipates Greek Default; New Highs in Greek, Irish, Portuguese Bond Yields; Spain Downgraded on $21 Billion Bank Capitalization Concern
State of Denial on Municipal Bonds; Are Munis the New Subprime?
Pimco Dumps All Remaining Treasuries in Total Return Fund; Six Reasons to Fade Bill Gross
Unexpected Trade Deficit in China; Chinese Importers Caught in a Squeeze; Global Macro Picture Weakens

Bond Market Anticipates Greek Default; New Highs in Greek, Irish, Portuguese Bond Yields; Spain Downgraded on $21 Billion Bank Capitalization Concern

Posted: 10 Mar 2011 05:51 PM PST

I sit dazzled at the idea the ECB is going to hike three times smack in the face of a renewed sovereign debt crisis in Europe.

Greek, Portuguese, and Irish government bond yields are at fresh highs and Spanish government yields are flirting with new highs. Topping off recent action, Moody's downgraded Spanish government debt on bank capitalization concerns and the market once again anticipates a Greek default in spite of a $153 billion bailout.

Let's take a look at some of the stories making those headlines.

Bond Market Anticipates Greek Default

Bloomberg reports Bond Market Anticipates Greece Defaulting as EU Leaders Meet

Greek 10-year bond yields rose to a record this week and it costs more than ever to insure against a default, even though the nation received a 110 billion euro ($153 billion) bailout from the EU and the International Monetary Fund last year. Two- year yields exceed 10-year levels, suggesting a restructuring may come before the three-year aid program expires.

"The onus is on EU officials to dissuade the market from the notion that a debt restructuring is inevitable," said Robin Marshall, director of fixed-income at London-based Smith & Williamson Investment Management, which oversees $20 billion. "They've lost investor confidence in any resolution that doesn't involve some form of restructuring."

EU leaders gather today in Brussels, aiming to agree to a blueprint to improve competitiveness, a plan Germany demanded as a condition for expanding the bailout effort. Investors will also be looking for signs that differences over how to solve the debt crisis are narrowing ahead of a second meeting on March 24-25 that German Chancellor Angela Merkel has said will produce a comprehensive package of measures.

Greek securities plunged this week after Moody's Investors Service cut the nation's rating, already at junk, by an additional three levels, saying the probability of default had increased due to "implementation risks" in the budget cuts it is making as a condition of receiving aid.

Yields on the bonds of the euro region's most indebted nations have jumped in the last two months as Germany, Finland and Austria rebuffed calls from Greece and Ireland to lower the interest rates on rescue loans. Disagreements also persist over the remit of the 440 billion-euro European Financial Stability Facility, which provided loans to Ireland, including whether it should be allowed to buy euro-region government bonds.

Leaders will today debate a proposed pact that Merkel and her French counterpart Nicolas Sarkozy want as part of any reinforced plan to support cash-strapped nations. The bloc's economically weaker countries have criticized the plan as an attack on their sovereignty.

Portuguese 10-year bond yields reached 7.70 percent on March 9, the highest since at least 1997, when Bloomberg began collecting the data. On the same day, equivalent-maturity Italian yields climbed above 5 percent for the first time since November 2008, while Irish 10-year yields touched the most since February 1993.

"It doesn't seem like a solution or compromise is around the corner," said Orlando Green, assistant director of capital markets strategy at Credit Agricole SA in London. "We could see more spread widening if they are slow in coming up with a plan. It's not all priced in yet."

Spanish Banks Need to Plug $21 Billion Capital Hole

Please consider Spanish Banks Begin Search for Investors to Plug $21 Billion Capital Hole

Spanish banks that together need as much as 15.2 billion euros ($21 billion) to meet minimum capital levels now must persuade investors that their battered balance sheets offer the potential return to match the risk.

Bank of Spain's estimates of how much capital the banks need fully reflect losses hidden on balance sheets, putting the onus on them find investors quickly, said Inigo Lecubarri, a fund manager at Abaco Financials Fund in London.

"At this stage, I don't think anyone will be really convinced by anything," said Lecubarri, who helps manage about $200 million at Abaco. "People will only be convinced when someone credible comes and puts some money on the table to invest."

Spain Irate Over Debt Downgrade

Forbes reports Moody's Downgrades Spain's Credit Rating As Recapitalization Could Cost €50B

Spain saw its sovereign debt rating slashed by one notch to Aa2 on Tuesday, as Moody's, the credit rating agency, cited higher than expected recapitalization costs for the country's savings banks or cajas, and the central government's inability to enforce ambitious budget deficit targets, set at 1.3% of GDP throughout the 19 autonomous communities. Spanish officials were enraged, starting with finance Minister Elena Salgado, who disagreed with Moody's decision to release the figures hours ahead of the Bank of Spain's official estimates of restructuring costs.

The country's benchmark index, the IBEX 35, dropped 1.17% through the session, while Spanish government bond spreads over German bunds hit 225 basis points, as yields rose to 5.53%.

Moody's downgraded its rating on Spanish government bonds to the second highest notch on fears that the the cost of re capitalizing the country's many cajas would probably reach €40 to €50 billion (about $55 to $69 billion). That would be far more than the €20 billion ($28 billion)estimated by the office of President Jose Luis Rodriguez Zapatero and would substantially increase Spain's public debt ratio.

Spanish officials were infuriated that Moody's chose to release these numbers only hours ahead of the Bank of Spain's official estimates, which put banks and cajas' recapitalization needs at €15.2 billion (about $20.1 billion).

Expect Greece, Ireland Default

At a minimum, Greece and Ireland are going to default. Spain and Portugal are on deck.

ECB Rate hikes penciled in by the market will bring those defaults sooner rather than later. There is merit in defaults sooner because the quicker the defaults, the quicker the recovery. However, the ECB sure does not see it that way.

Thus, things in Europe are about to get interesting even though I rather doubt we see three hikes by the ECB by December.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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State of Denial on Municipal Bonds; Are Munis the New Subprime?

Posted: 10 Mar 2011 10:06 AM PST

Municipal bonds show signs of trouble despite the stock market's rally says Jeffrey Gundlach, DoubleLine Capital CEO in a CNBC interview regarding the Muni Bond Market.

Bond king Jeff Gundlach likened municipal bonds to subprime mortgage bonds on CNBC's Strategy Session on Wednesday.

"You've got a history of low defaults, which is comforting. But that kind of sounds like what subprime sounded like back in 2006," Gundlach said.

Gundlach said the markets for subprime bonds and municipal bonds are similar because the buyers are similar. Muni bond buyers aren't seeking fundamentally good credit stories—they are buying for "technical reasons," Gundlach said. This is exactly what happened with subprime

With subprime bonds, buyers were seeking highly-rated credit with very low default histories in order to satisfy regulatory bank capital requirements. They largely ignored deteriorating fundamentals, and continued to buy subprime mortgage-backed securities at a rapid clip even when the problems with the market were becoming apparent in the first half of 2007.

Muni bonds are bought for a different "technical reason"—the tax benefit—and buyers are once again ignoring deteriorating fundamentals. So are munis going the way of subprime?

"If by that you mean, lower, then yes. If you mean crashing, I'm agnostic on that," he told David Faber.

Gundlach pointed out that even if defaults do not ultimately climb as high as critics like Meredith Whitney have warned, muni bonds will likely trade much lower.

"Between here and the end game, lies the valley. And the valley is full of fear. I think the muni market is going to go down by at least, on the long end, something like 15 and 20 percent," he said.

I like his rationale. It's not so much the volume of munis that may default, but rather the market's likely reaction when those defaults do happen.

It's a good interview. If you are interested in munis, please play it.

Better buying opportunities await those willing to sit in cash, not just in munis, but in equities, junk bonds, emerging markets, and commodities.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Pimco Dumps All Remaining Treasuries in Total Return Fund; Six Reasons to Fade Bill Gross

Posted: 10 Mar 2011 08:49 AM PST

Pimco's Bill Gross has been dumping US government debt in favor of other alternatives including emerging-market opportunities. Looking ahead, I think it's more likely to be a bullish setup for treasuries than not.

First, please consider the news.

Bloomberg reports Pimco's Gross Eliminates Government Debt From Total Return Fund

Bill Gross, who runs the world's biggest bond fund at Pacific Investment Management Co., eliminated government-related debt from his flagship fund last month as the U.S. projected record budget deficits.

Pimco's $237 billion Total Return Fund last held zero government-related debt in January 2009. Gross had cut the holdings to 12 percent of assets in January, according to the Newport Beach, California-based company's website. The fund's net cash-and-equivalent position surged from 5 percent to 23 percent in February, the highest since May 2008.

Yields on Treasuries may be too low to sustain demand for U.S. government debt as the Federal Reserve approaches the end of its second round of quantitative easing, Gross wrote in a monthly investment outlook posted on Pimco's website on March 2. Gross mentioned that Pimco may be a buyer of Treasuries if yields rise to attractive levels.

Treasury yields are about 150 basis points too low when viewed on a historical context and when compared with expected nominal gross domestic product growth of 5 percent, he wrote in the commentary. The Fed is scheduled to complete purchases of $600 billion of Treasuries in June.

Gross in his February commentary urged investors to reduce holdings of Treasuries and U.K. gilts and buy higher-returning securities such as debt from emerging-market nations. "Old- fashioned gilts and Treasury bonds may need to be 'exorcised' from model portfolios and replaced with more attractive alternatives both from a risk and a reward standpoint," Gross wrote.

Gross last month increased holdings of emerging-market debt to 10 percent, the highest since October, from 9 percent in January. He cut holdings of mortgage securities to 34 percent from 42 percent in January.

Six Reasons to Fade Pimco

I view this setup as favorable for US Government bonds. For starters there is no Pimco selling pressure, only potential buying pressure when Gross changes his mind.

Second, everyone seems to think the end of QE II will be the death of treasuries. While that could be the case, sentiment is so one-sided that I rather doubt it, especially is the global recovery stalls.

Third, the US dollar is towards the bottom of a broad range and any bounce could easily wipe out gains in higher yielding emerging-market debt.

Fourth, the global macro picture is weakening considerably with overheating in China, state government austerity measures in the US, and a renewed sovereign debt crisis in Europe on top of a supply shock in oil. Emerging markets are unlikely the place to be in such a setup.

Fifth, chasing yield means chasing risk, and that is on top of currency risk. Chasing risk is highly likely to fail again at some point, the only question is when.

Sixth, several interest rate hikes are priced in by the the ECB this year. Will all those hikes come? I rather doubt it, and if the ECB doesn't hike, look for the US dollar to rally, perhaps significantly.

Relative Value Traps

The alleged "relative value" of emerging markets may turn out to be nothing but an "absolute value" trap. Admittedly there is not much to like on a long-term basis about US treasuries either.

Should treasuries continue to sell off, it may very well be the case there are no hiding places at all, except for the universally despised US dollar.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Unexpected Trade Deficit in China; Chinese Importers Caught in a Squeeze; Global Macro Picture Weakens

Posted: 09 Mar 2011 11:38 PM PST

Equity futures are in the red across the board late Wednesday evening in light of an unexpected trade deficit in China.

Some reports suggest not reading too much into the deficit because February trade numbers are distorted following the Chinese Lunar New Year holiday. However, even the two-month total is negative, so the holiday excuse is a pretty weak one.

Please consider China Reports Unexpected Trade Deficit as Export Growth Cools

China reported an unexpected $7.3 billion trade deficit, the nation's biggest in seven years, in February after a Lunar New Year holiday disrupted exports.

Outbound shipments rose an annual 2.4 percent, the slowest pace since November 2009, and imports climbed 19.4 percent, according to a report on the customs bureau website today.

Yuan forwards weakened after the announcement, which may deflect international pressure for China to strengthen its currency to redress global economic imbalances. Commerce Minister Chen Deming said March 7 that it's "totally unreasonable" to say the yuan is undervalued after U.S. Treasury Secretary Timothy Geithner repeated calls for a faster pace of appreciation.

Economists combine Chinese data for the first two months of the year to eliminate distortions caused by the annual holiday. On that basis, the nation had a deficit of about $890 million, compared with a surplus of about $22 billion a year earlier.

Global Macro Picture Worsens

Two months do not a trend make, but a couple more would do it.

As a side note, people frequently write wondering why China does mot buy more commodities with its US dollar reserve. There are a several reasons, one of which should be obvious from the above article.

China's manufacturers are already squeezed, unable to pass on rising import costs.
Accumulating commodities is pro-cyclical. China is overheating already.
Any commodities not bought directly from US suppliers (for example copper from Australia) increases trade distortions elsewhere.
Thanks to loose economic policy globally, commodity speculation is running rampant already. No importers want to add fuel to that fire.

China is overheating, and the global macro picture, especially from a Chinese perspective is far worse than that.

The world may not have noticed yet, but Europe is in trouble. The PIIGS are imploding under austerity measures and the most of the rest of Europe except perhaps Germany does not look very good.

Europe is China's largest trading partner.

Factor in the situation in Libya, rising oil prices, an ECB that seems hell-bent on hiking rates (I bet they back off after at most one hike), state budgets under attack in the US (thankfully), and the whole idea that Chinese growth is going to save the world is Fantasyland material.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Thursday, March 10, 2011

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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