Friday, March 26, 2010

And so it begins... (the interest rate climb)

"Selling the "less poor" investment hardly makes the U.S. Treasury's job any easier. A sign that buyers may be turning wary came Wednesday, in a weak auction of 5-year Treasury notes. Indirect bidders, considered a gauge of foreign demand, took 39.7% of the notes, the lowest portion since July, according to Miller Tabak. Treasury bonds have already had a rough week, with the benchmark 10-year yield climbing from 3.68% to 3.82% since Monday. "
Post health-bill passage, plus real-world signs that profligate spending actually can systemically crater an economy (in addition to Dubai and Greece, Portugal has now been downgraded and is teetering on the brink), 10-year yields skyrocketed this week.
I'm not a big believer in short term fluctuations, but the big difference here is that if Coca-Cola plummets today, I look at it and think "Nothing's going to happen to Coca-Cola, this just makes it a better value", and eventually the price gets pushed back up again. If the US debt outlook plummets (which the passage of the healthcare bill absolutely pushed us towards, and Portugal is another indicator of how much trouble we're going to be in), then interest rates rise... but that should only spur more investment if people DON'T use price as an indicator of quality. If people see treasury bond yields rising, and take it to mean that the US is a riskier investment and get out, then bond yields will rise even higher, stifling the economy further and making the US less creditworthy, leading to higher rates - in effect, an interest rate spiral. This type of momentum absolutely happens in currency and sovereign bond investing (George Soros made billions on it), and in the case of treasuries, they can be self-fulfilling (unlike Coke, which doesn't need to raise capital beyond operational cashflow, so any bubble or trench is by definition temporary).
This means that for a country like the US with structural deficits, a point-in-time perception of weakness can lead to actual weakness; there's plenty of evidence for that. If Moody's, Fitch and S&P decided to downgrade US debt, the downgrade would likely make the US debt less creditworthy. They seem to understand that, which is one reason among many, I think, that they haven't pulled the trigger (another is that they would receive SUBSTANTIAL media, social and political pressure from all sides by "proud Americans" who want to stifle their warnings).
Thus, short-term movements actually do matter. And in this case, they're justified and have a readily determinable cause - government spending - verified by the low percentage of indirect bidders. This should be a warning, but of course nobody will take it as one.

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