There
is a real sense of the “calm before the storm” in markets
globally. Complacency reigns, despite signs that the sovereign debt crisis in
Europe is deepening and that Japanese and US bond markets also look very
vulnerable due to rising inflation, very large deficits and massive public
debt.
Gold in Japanese Yen – 6 Months (Daily)
The unfortunately named PIIGS have seen their bond yields rise sharply again
in recent days. Greek, Irish and Portuguese bonds in particular have come
under pressure on concerns of deepening economic contractions and possible
defaults.
Greek
bonds fell for a ninth day after a report showed the nation’s economy
shrank for a 10th consecutive quarter. In less than 2 weeks, the yield on the
Greek 10-year has risen sharply from 10.804% to 11.750%.
Greek 10 Year Bond Yield – 1 Year (Daily)
Irish two-year notes fell sharply this morning, pushing the yield to the
highest since the introduction of the euro in 1999. The yield increased 10
basis points to 7.26 percent in London after jumping as high as 7.56 percent.
The Irish 10-year yield rose three basis points to 9.26 percent.
Peripheral
sovereign bonds remain under pressure despite considerable support and
outright purchases by the ECB.
Ireland Government Bond 10 Year – 1 Year (Daily)
Sovereign debt issues are not confined to the eurozone and there is a real
risk of the contagion spreading to other large debtor nations, including
Japan and the US.
A
Japanese minister denied overnight that there was any chance of a Japanese
default on their massive government debt (see News). Japanese bond prices
came under selling pressure with the yield on the 10 year rising to 1.36% and
gold prices in Japanese yen rising to JPY 115,000 near the recent nominal
record of JPY 118,000 seen in December (see charts above and below).
Gold
in yen terms is still more than 25% below the nominal high of 30 years ago
which should give those calling gold a bubble pause for thought.
Gold in Japanese Yen – 40 Year (Quarterly)
US Treasuries have been sold by some of the largest investors (both private
and sovereign) in the world recently (see news). These include large creditor
nations Russia and China but also PIMCO, the largest bond fund in the world.
The
estimated cost to service the US National Debt of $14.09 trillion is $240
billion for fiscal year 2011 alone. The US national debt now equals the value
of the entire US economy in GDP terms.
This
is making investors nervous and they are rightly demanding and will continue
to demand higher interest rates for the increased risk of financing the
US’ unsustainable fiscal and monetary policies.
The
Obama administration’s budget is seen by many as being optimistic in
the extreme based as it is on the hope of rapid economic growth after two
years of sluggish growth. The unpartisan Congressional Budget Office however
does not share that optimism and thinks that the economy will continue to
struggle.
A global
sovereign debt crisis is now quite possible. At the very least, we are likely
to have a long period of rising interest rates which will depress economic
growth.
Contrary
to some misguided commentary, rising interest rates will benefit gold as was
seen when interest rates rose sharply in the 1970s. It was only towards the
end of the interest rate tightening cycle in 1980, when interest rates were
higher than inflation, that gold prices began to fall.
Gold’s
importance as financial insurance and the fact that it cannot go bankrupt or
default will also be increasingly important in the years ahead.
As
ever, it is best to be optimistic but realistic and to hope for the best but
be prepared for less benign scenarios by diversifying accordingly.
Gold
Gold
is trading at $1,372.00/oz, €1,015.62/oz and £854.62/oz.
Silver
Silver
is trading at $30.72/oz, €22.74/oz and £19.14/oz.
Platinum
Group Metals
Platinum
is trading at $1,372.00/oz, palladium at $835.00/oz and rhodium at $2,400/oz.
News
(Bloomberg)
-- Yosano Says Japan Debt Appeal Points to Zero Default
Japan’s
bond market will find support from domestic investors even as government debt
swells because they lack better alternatives, Economic and Fiscal Policy
Minister Kaoru Yosano said.
“I
see zero chance of Japanese government bonds nosediving at the moment,”
Yosano, 72, said in an interview in Tokyo today, responding to calls from
opposition lawmakers to prepare for a collapse in government finances.
“Investor still believe that the government, to a certain extent, is
pursuing fiscal discipline.”
Members
of the Liberal Democratic Party met today to discuss emergency measures the
government needs to take should the nation’s bond market collapse,
underscoring growing concern about public finances since Standard &
Poor’s downgraded Japan’s credit rating for the first time in
nine years. A former finance minister, Yosano has advocated raising taxes to
pare debt and increase the sustainability of government finances.
“Long-term
bond yields have been contained at incredibly low levels due to a lack of
promising domestic investment opportunities,” Yosano said. Investors
within the country also are able to absorb government debt, he said.
More
than 90 percent of the nation’s government debt is held domestically.
Japan accumulated a 17.1 trillion yen ($203 billion) current-account surplus
in 2010 and is also the world’s second-largest holder of foreign
reserves.
10-Month
High
Benchmark government bond yields climbed to a 10-month high last week on
expectations the economy is recovering after contracting in the fourth
quarter. Borrowing costs driven by growth would differentiate Japan’s
situation from that of Europe, where yields are rising over concern about the
region’s fiscal woes, Yosano said.
Japanese
government bonds have returned 9.8 percent in the past five years, according
to indexes compiled by Bank of America Merrill Lynch. The Nikkei 225 Stock
Average has declined more than 30 percent in the same period.
Japan’s
public debt will probably increase 5.8 percent to 997.7 trillion yen in the
year starting April 1, from a projected 943.1 trillion yen this year, the
Finance Ministry forecasts. The nation’s debt load is forecast to reach
204 percent of gross domestic product this year, compared with 99 percent in
the U.S., according to the Organization for Economic Cooperation and
Development.
Reputation
Maintained
Yosano said the nation’s sovereign reputation has been maintained
because investors see room for the government to raise its 5 percent sales
tax to bolster revenue.
“If
the government fails to undertake comprehensive tax and social welfare
reforms, that would hurt Japan’s credibility,” he said.
Prime
Minister Naoto Kan appointed Yosano last month to help lead discussions on
whether to raise Japan’s sales tax. Yosano quit on Jan. 13 as a member
of the opposition Sunrise Party, a group he formed in April after leaving the
Liberal Democratic Party, which ruled Japan for five decades until the
Democratic Party of Japan came to office in September 2009. Yosano served as
LDP Finance Minister in 2009.
Yosano
also said the Bank of Japan has made “extraordinary efforts” to
bolster the economy by pursuing unconventional measures in the past years, an
indication there isn’t much more it can do.
“Japan’s
problem isn’t monetary policy -- it’s that the country has fewer
investment opportunities that can offer a high expected rate of
return,” compared with the past, Yosano said.
The
central bank lowered its benchmark interest rate to near zero percent and
pledged to purchase financial assets including corporate bonds and
exchange-traded funds in October.
Yosano
reiterated the government’s support for the U.S. dollar as the
world’s key reserve currency. Officials of Group of 20 economies have
said they will discuss the global currency system when they gather this week
in Paris.
“It’s
very important that the value of the dollar is maintained” because
Japan has many dollar-denominated assets and is a major exporter, he said.
“The U.S. hasn’t given up on its fundamental view” that a
strong dollar is in their national interest, he said.
(Bloomberg)
-- Gold Rises to Highest in Almost Four Weeks on Inflation Concern
Gold futures
climbed to the highest in almost four weeks as rising consumer prices boosted
demand for the precious metal as a hedge against inflation.
In
January, China’s inflation accelerated as costs excluding food rose the
most in at least six years, and U.K. consumer prices rose the most in more
than two years. Billionaire investor George Soros increased his SPDR Gold
Trust holdings by 0.5 percent in the fourth quarter, and John Paulson kept
his investment unchanged.
“With
inflation concerns heating up and the metals underpinned by a mix of physical
and investment demand, it looks as if further gains are in the
pipeline,” James Moore, an analyst at TheBullionDesk.com in London,
said in a report.
Gold
futures for April delivery rose $9, or 0.7 percent, to $1,374.10 an ounce at
1:42 p.m. on the Comex in New York. Earlier, the price reached $1,377.50, the
highest since Jan. 19. The metal has climbed 26 percent in the past 12
months.
Surging
food prices have spurred protests in North Africa and the Middle East, while
Brent crude oil, a global benchmark, closed yesterday at the highest since September
2008.
“Currency
debasement and higher food and energy prices are leading to an inflation
surge in both developed and emerging markets,” Goldcore Ltd. in Dublin
said in a report.
Silver
futures for March delivery climbed 16.2 cents, or 0.5 percent, to $30.696 an
ounce.
Palladium
futures for March delivery rose $7.10, or 0.9 percent, to $839.90 an ounce on
the New York Mercantile Exchange.
Silver
and platinum have doubled in the past year.
Platinum
futures for April delivery gained $4, or 0.2 percent, to $1,831.60 an ounce
on the Nymex. The metal is up 21 percent in the past 12 months.
(Financial
Times) -- China and Russia sell US Treasuries
China has sold
billions of dollars in US Treasury bills for the second month in a row, even
as strong buying from other foreign investors countered Beijing’s move
to reduce its holdings.
A
Treasury report on Tuesday showed net foreign demand for long-term US
securities, including bonds and equities, was $41.8bn in December, versus
$64.5bn in November. Monthly net Treasury International Capital flows rose to
$48.2bn in December, up from $35.6bn in November and $17.2bn in October. The
rise was driven by private investors, while official accounts, or foreign
central banks, sold US assets for the second successive month.
Foreign
private investor demand for US long-dated government debt remained solid in
December and US Treasuries with maturities of more than a year recorded
inflows of $55bn. But, short-term bills suffered a $37bn fall, after
November’s $32bn drop.
Alan
Ruskin, strategist at Deutsche Bank, said the mixed flows reflected foreign
interest in longer-term Treasuries as yields rose. China, for example, bought
$5bn of bonds and notes in December, but sold $9bn of Treasury bills.
“The negative take for the bond market is that China reduced its
overall Treasury holdings, but they have increased their exposure to US
interest rates by buying longer-term Treasuries,” said David Ader,
strategist at CRT Capital. “It is an important distinction.”
Russia
also pared its Treasury holdings for the second month, down to $106bn from
$122bn.
But
the UK continued to drive demand for Treasuries with a rise to $541bn, up
from $512bn in November and $208bn in January last year. That increase,
according to analysts, reflected the UK’s status as a financial centre
where Treasuries are bought by investors who are not domiciled in the
country.
“Some
of China’s Treasury purchases may also be showing up in UK-sourced data
that has been consistently strong, but nonetheless, it looks like China was
more actively trying to dodge the Treasury sell-off than most,” said Mr
Ruskin.
Indeed,
when the Treasury revises its data later this year the share of UK Treasury
holdings is expected to drop sharply.
China
remained the largest foreign holder of Treasuries at $892bn in December, down
from $896bn the prior month. “According to these, admittedly
backward-looking data, there is little immediate cause for concern that
non-US investors are losing their appetite for US securities,” said Jeffrey
Young, strategist at Barclays Capital. He estimated that the December inflow
represented an annualised rate of about $575bn, enough to cover the US
current account deficit.
Caribbean
Banking Centres, a proxy for hedge funds, increased their holdings of
Treasuries to $156bn in December, up from $139bn in October. Singapore and
oil exporting countries also increased their Treasury holdings.
“This
report points to continued strong demand for US securities among foreign
investors and officials, underscoring the ease at which the Treasury is able
to fund its borrowing needs in the open market,” said Millan Mulraine
at TD Securities. Prices of US Treasuries rose slightly on Tuesday as the
Federal Reserve bought almost $6.7bn of intermediate-dated debt. The yield on
the 10-year note was 3.6 per cent.
(Financial
Times) -- China pull-back paints unsettling rate picture
It is no
secret that China’s appetite for Treasuries has been waning. Official
figures now bear out Beijing’s stated desire to diversify away from US
government debt.
The
market impact is likely to be muted for now, given the Federal
Reserve’s bond-buying under its “quantitative easing”
programme. But what happens when QE2 ends in June? Beijing’s pull-back
may then become noticeable.
The US
Treasury market occupies the centre of the global financial system. It is the
deepest and most liquid bond market in the world, and demand from central
banks and institutional investors, including private sector banks and hedge
funds, has allowed the American government to finance its multibillion-dollar
budget deficits.
Indeed,
the US is more dependent than other countries on foreign investors buying its
debt. The UK, Italy and Japan are largely funded by domestic investors. So
far, robust demand for Treasuries from the UK and, to a lesser extent, Japan
and US domestic investors has helped offset China’s waning appetite
over the past year. The Fed effect has been supportive, too. The US central
bank has become the largest single holder of Treasuries, with $1,160bn, as it
continues buying securities.
But as
Barack Obama, US president, attempts to tackle the country’s burgeoning
deficit with austere budget proposals, there are growing worries that the
cost of servicing the national debt could grow. At some stage, US interest
rates may jump sharply to keep attracting buyers of Treasury debt.
“The
low level of yields currently may not be attractive and in the future the
Treasury may need a higher real rate to attract capital,” says Gerald
Lucas, senior investment adviser at Deutsche Bank. Treasury yields, which
move inversely to bond prices, are already rising. Ten-year yields rose to
3.77 per cent last week, their highest since April, extending a three-month
bear run from about 2.5 per cent.
Among
the major foreign holders of Treasury debt, China has long been the largest
and is seen as a bellwether of foreign investor participation. China ended
2010 with $891bn in Treasuries, extending its drop from a record high of
$940bn in July 2009.
“The
upward march in Chinese reserves has been accompanied by reduced
participation in the Treasury market over the past year,” say analysts
at TD Securities. “The implications for the US are not particularly
daunting yet, but are nevertheless a bit troubling.”
US
households, hedge funds, banks and private pension funds have increased their
Treasury holdings in the past two years. But, as the economy recovers and
inflation picks up, there is a risk these investors will seek better returns
from other assets, equities for example, and not government debt.
The
significance has not escaped policymakers and key players in the bond market:
US debt servicing costs will amount to $240bn for the 2011 fiscal year,
equivalent to the entire budget deficit in 2006, according to RBS estimates.
This
month a group of bond market experts, representing some of the biggest banks
and hedge funds investing in Treasuries, voiced its concern about the
reliance on foreign buyers for purchasing a large slice of the
country’s $9,000bn in outstanding government securities.
“Foreign
ownership of Treasury debt was significant, with ownership concentrated among
a few key foreign investors,” said the minutes from a meeting of the
Treasury borrowing advisory committee. “A more diversified debt holder
base would prepare the Treasury for a potential decline in foreign
participation.”
One
proposal advocated at the meeting for diversifying the base of investors
would entail the Treasury issuing new securities, including
“callable” debt, ultra-long bonds with maturities of up to 100
years and floating rate debt, on which payments to investors would rise and
fall with inflation.
These
securities could appeal to domestic investors, particularly prospective
retirees. They could also enjoy increased demand from banks and pension funds
as a result of new international banking rules and proposed reforms to
pensions accounting. The advisory committee estimates demand for long-term US
bonds could reach $2,400bn in the next five years as these new rules take
effect. The alternative, should yields rise sharply, could be discomforting
for taxpayers.
(Financial
Times) -- Bank lays ground for interest rate rises
The Bank of
England said monetary policy would need to be tightened to bring medium-term
inflation back on track, confirming market expectations that interest rates
would start rising in May.
In a
letter to the chancellor George Osborne that was triggered by a 4 per cent
increase in consumer prices last month on the back of surging food and petrol
costs, Mervyn King said inflation was “likely” to return to the
Bank’s official 2 per cent target on “the assumption that [the]
Bank rate increases in line with market expectations”.
Mr
King’s comments confirmed investor expectations of a series of quarter-point
hikes in interest rates, beginning in May. Mortgage lenders have already
withdrawn or repriced fixed rate deals in the expectation of higher interest
rates.
Economists
rushed to predict the Bank would raise rates earlier than before and were “astonished”
at how direct the governor was in his letter. “I can’t ever
remember anything laid out quite this explicitly before,” said Peter
Westaway, chief European economist at Nomura and a former senior Bank
official, adding that the letter was a green light to a May rate rise.
Michael
Saunders of Citigroup described the governor’s letter as a
“softening up exercise”, adding “that after today or
tomorrow nobody could be surprised by a rate hike”. He thought Mr
King’s heart might not be in such a move, but “the governor is
not quite the centre of gravity of the MPC”.
Richard
Barwell of RBS, a former Bank economist, said the inflation forecasts were
now a signalling device to “pave the way for a hike in May and not
really a genuine forecast of inflation”.
The
prospect of higher interest rates sent sterling up 0.9 per cent against the
currencies of Britain’s main trading partners, reaching a level not
seen for more than five months.
Inflationary
pressures in Britain, where prices are rising almost twice as fast as in the
eurozone, stem partly from the pound’s 25 per cent depreciation since
late 2007, which has pushed up import prices.
The
Bank expects higher inflation even with the recovery held back by the weakest
household income growth since the 1920s.
Mr Osborne sought to use the deteriorating inflation outlook to criticise Ed
Balls, shadow chancellor, and those who want to slow the pace of public
spending cuts. He said any delay in deficit reduction would “risk
prompting an offsetting monetary tightening such that overall there would be
little if any net impact on demand”.
Danny
Alexander, chief secretary to the Treasury, told the cabinet on Tuesday that
the year ahead would be difficult. Treasury officials fear that although the
recovery remains fragile, faster growth would exacerbate inflation even
further.
In
response, Mr Balls said the government’s value added tax increase had
made it harder for the Bank to set interest rates. “The problem is that
if you’ve got too fast spending cuts and a VAT rise but inflation is
going up too, it really is putting the Bank in a very difficult
position,” he said.
(Bloomberg)
-- Greek, Irish Banks Force ECB to Print More Money: Euro Credit
The European
Central Bank is being forced to print money to bolster banks in bailed-out
Greece and Ireland, leaving the region’s taxpayers on the hook as the
final guarantors of those nations’ debts.
Greek
and Irish banks have issued at least 70 billion euros ($95 billion) of bonds
to create the collateral required to get cash from the ECB, according to the
International Monetary Fund and regulatory filings, a figure that may rise to
100 billion euros after Greece said Feb. 11 it may extend another 30 billion
euros of guarantees to its banks.
“What
you have here is micro-quantitative easing, or money printing,” said
Cathal O’Leary, head of fixed-income sales at NCB Stockbrokers in
Dublin. “The banks are issuing unsecured loans to themselves.”
The
ECB has vowed to eschew the type of monetary policy implemented by the
Federal Reserve, whose bond-buying to boost growth has left it owning more
Treasuries than are held by China, the biggest foreign buyer of U.S. debt. By
granting loans against bank debt, the ECB is adding to the monetary base and
would be out of pocket were the guarantors to renege.
The
yield premium investors demand to hold Irish 10-year bonds rather than German
securities is 593 basis points, up from 153 basis points a year ago. The
spread between Greek and German 10-year bonds is 852 basis points, up from
305 basis points a year ago.
‘Stressed
Market Conditions’
Ireland’s banks have issued at least 17.4 billion euros of notes backed
by government guarantees, with 9.2 billion euros going to Bank of Ireland
alone. The program amounts to 11 percent of Ireland’s 2009 gross
domestic product.
“Access
to ECB operations allows the banks in question to obtain funding that is not
currently available in the continued stressed market conditions,” the
Irish central bank said in an e-mailed response to questions.
Greece’s
current state-guaranteed liquidity program is 55 billion euros, according to
the IMF country report, equivalent to more than 20 percent of the
nation’s $330 billion output in 2009. That’s on top of the 8
billion euros of zero-coupon bonds Greece has lent to the banks and 15
billion euros of direct capital injections, according to John Raymond, an
analyst at CreditSights Inc. in London.
‘Huge
Credit Exposures’
“To a very significant extent, the ECB is taking the place of capital
markets,” said Alan Dukes, the former Irish finance minister who is now
chairman of Anglo Irish Bank Corp., which posted Ireland’s biggest-ever
loss in 2010. “The ECB is no longer in a position to pursue a clear
monetary policy because it is running huge credit exposures,” he said
in a speech last week.
Ireland
has put 46.3 billion euros into its debt-laden banks in the past two years as
property prices collapsed and loan losses soared. Irish-based lenders,
including foreign-owned banks, received 126 billion euros of ECB funding at
the end of January and as much as an additional 51.1 billion euros of
“exceptional liquidity” from the Irish central bank, figures
published on Feb. 11 show.
“The
own-bond issuances are a pragmatic response in exceptional
circumstances,” said Donal O’Mahony, global strategist at Davy
Capital Markets in Dublin. “While the notes are not backed by the
banks’ own assets, they are backed by the government guarantee, which
is an important point. State- guaranteed notes are ECB-eligible collateral.”
‘Expensive
Emergency Liquidity’
Greek banks, with 1.5 percent of European banking assets, and the Irish, with
5.5 percent, account for 17 percent and 24 percent of ECB borrowing,
according to a Feb. 7 report by Laurent Fransolet and Giuseppe Maraffino at
Barclays Capital in London.
“The
ECB accepts government-guaranteed bonds as collateral,” said Maraffino.
“The Irish banks are replacing expensive emergency liquidity with
cheaper ECB funding. It’s just the way it works.”
As the
lender of last resort, the job of the ECB is to ensure the European banking
system has the liquidity it needs to function. While the nascent European
Financial Stability Facility probably will have the task of ensuring
solvency, for the moment the ECB has that role, too.
“This
is a great example of bank risk moving to national government risk, and now
to ECB risk,” said Jean Dermine, professor of banking and finance at
INSEAD business school in Fontainebleau, France. “The ECB is increasing
the money supply and that is raising inflationary pressure. There is also
credit risk, the fact that default would lead to a loss for European
taxpayers.”
‘Difficult
to Distinguish’
Monetary growth in the euro area, as measured by M3 money supply which the
ECB uses as a gauge for future inflation, turned positive in June and reached
a 15-month high of 2.1 percent in November.
The
ECB is calling on governments to step up efforts to restore confidence, to
allow sovereigns and their banks to regain access to the capital markets.
“It’s
difficult to distinguish banking and sovereign risk,” said Nicolas
Veron, senior fellow at Bruegel, the Brussels-based economics research group.
“What happens if there’s a default? Everyone would like to avoid
testing that out in real life. Governments are really scared of the
consequences of an actual restructuring.”
Mark O’Byrne
Goldcore
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