Back from a day in the trenches doing research on gas-bearing shale formations in Australia, your editor rejoins the action in the stock market and the wider war between inflation and deflation. And what do we notice upon our return? There are winners and losers and lots of confusion.
Earlier in the week we noted that the action in the U.S. bond market was the prime mover for stock and commodity prices. Thursday trading in the States confirmed that. For the first time in five days, U.S. bond prices rose and yields fell. The spread between two-year U.S. government notes and 10-year notes had blown out 276 basis points as investors gagged on the amount of debt being auctioned by the Treasury Department this week (over $100 billion).
But Thursday's auction of $27 billion in seven-year notes seemed to go off without too much trouble. The market swallowed the new debt and did not chuck it back up. It's a little nauseating when you realise that U.S. debt outstanding is $11.2 trillion, or 76% of GDP.
Our guess is that it's going to be 100% of GDP by the halfway point of Obama's term as President. For this week, however, the new wave of Treasuries sent in to battle deflation, recession, and capitalism itself seem to have stemmed the advance of bond yields. Victory! Viva Obama! Viva Bernanke! Viva la deficit! Viva el dollar!
Still, there are other forces that threaten to overrun the Fed's efforts to keep the U.S. mortgage market from further imploding. Eight percent of U.S. homeowners were late on their mortgage payments in the first quarter, according to the Mortgage Bankers Association. The delinquency numbers tend to track unemployment, and unemployment is rising.
What's worse, with prices still falling, more and more mortgages are going under water, where the mortgage exceeds the current market value of the house. After that, foreclosure isn't far behind. And in the States, a record 3.85% of mortgages are in the process of foreclosure. When you add the delinquency and foreclosure figures together, you find that 12% of U.S. mortgage holders are either late on their mortgage payments or already in foreclosure.
That is a nightmare for the Fed. And if 10-year bond yields resume their march higher next week, they will take 30-year mortgage rates with them, killing off for this year (and probably next) any hope from a rally in U.S. house prices. Our guess? Home sales will pick up at these levels but prices will keep falling.
And what does this mean for the rest of the world? U.S. bond prices are in full retreat. The Fed is covering that retreat, turning around long enough to fire more money into the market and slow the advance of the bond vigilantes. But as money flees the sovereign bond market, it will seek refuge in tangible assets and non-debtor economies with more stable currencies and less net debt.
In midst of all this broken recordism, oil prices are climbing higher. OPEC met in Vienna and decided to keep its production levels stable. The group also said it expects world oil demand to rebound later this year, led by Asia. Crude futures are currently trading above $65.00. The energy sector was up on Wall Street and will probably be up for the week here in Australia.
Hey here's some good news for the next one hundred years. "Among advanced economies, Australia is the most integrated with Brazil, Russia, India, China and South Africa, according to a new index from Maplecroft, a U.K.- based global risk analysis firm," reports Bloomberg. Australia is first, followed by Finland, Japan, and the United States.
Jim O'Neill, the chief economist at Goldman Sachs, says "As the economies of the U.S. and Europe struggle to recover, those of the BRICs will prove to be more robust, and will be instrumental in pulling the world out of recession." So it will be prosperity by association if the Maplecroft index is correct.
Whether or not it the BRICS will pull the world out of a recession this year, or next year, or the year after that, we can't say. But the world economic order is definitely changing and the change-what we've called the Money Migration from the West to the East-favours Australia...in the long run. And in the short run? More on that next week!
Dan Denning
for The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
Related Articles:
- Another Big Wave of Foreclosures
- Avoid Bank Stocks
- The Case for Higher Treasury Yields…and Lower REIT Prices
- BRIC – Brazil, Russia, India and China Suffer High Rates of Inflation
- The Investor in Indian Bonds has Ben Bernanke on His Side
About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Nick Grealy on 30 May 2009:
Dan: Care to give us an idea about Oz Shale Gas? Visit my web site and check the topics of shale gas and you'll see we've been fans for almost a year about shale gas. It will be massive! But the UK energy "experts" don't even see it coming, it really is a case of whingeing poms. Shale gas has an automatic bad press since it's considered "unconventional" , which is a kiss of death for English people. ( I'm a Yank in the UK, who loves them when I don't want to hit them.)
CBM in Oz is obviously big, but I haven't heard about shale gas. Yet. Any thing you want to add is welcome..
Comment by GaryB on 30 May 2009:
".. the U.S. bond market was the prime mover for stock and commodity prices. Thursday trading in the States confirmed that. For the first time in five days, U.S. bond prices rose and yields fell." Yeah, but who's the buying US bonds? The US Govt? Isn't this just QE at work? They must be pissing themselves with glee, manipulating both the bond market and the stock market at the same time - double the bang for your counterfeit buck.
Comment by Ross on 30 May 2009:
I hate to be a product of the times and be cornered in tethe negative. Does any body else out there feel like that. Geeees .... doesn't that sound like that repulsive talk over advertising?
Anyway I wouldlike to congratulate those far seeing Aussies who have put their efforts into the x-cultural studies like uni of Western Sydney's on Australia-Mexico-Brazil. Hats off to them and let us value people ahead of their times.
Comment by Fred on 31 May 2009:
Aussie 2y, 5y, 10y treasury bond yields also on the rise:
http://www.rba.gov.au/Statistics/interest_rates_yields.html
Helps to chart the numbers in Excel. Hmmm...looks to me like those bond yields precede the 30,90 & 180 day bank accepted bill yield action, and all that precedes the RBA's 'headline' cash rate changes. Hmmm... me thinks home & other loan rates will soon head back up. The b.a. bill yield action also appears to explain why banks did not "pass on" the RBA's April 09 'headline' rate cut.
Comment by Greg Atkinson on 1 June 2009:
Fred..I would guess that just as the RBA probably went to far raising rates they now have probably gone too far cutting rates. I cannot see how all the money being splashed around the world is going to do anything else but push up inflation for a while anyway. But if housing prices do fall after the current first home buyers mania then things could get very interesting.
Comment by Biker Pete on 2 June 2009:
Property will lead us out of the recession, Greg. Can't see history changing in that respect. Already the new super limits are having the anticipated effect. Phone calls are increasing for our (private sale) properties. We expect to sell one (at a modest 10% profit) later this week... .
Comment by Greg Atkinson on 2 June 2009:
Biker Pete the only area that worries me a little is the first home buyers market, but having said that I would guess we ain't going to see those nationwide falls of 40% that people were talking about. I wonder how much of an impact If any) the cut in immigration numbers will have on housing prices?
Comment by dan on 2 June 2009:
Hi Greg. At the moment you might be right and previous fears are proving unfounded - given the current information. If the situation didn't alter greatly with respect to the world economy, the housing market in Australia is unlikely to move downwards dramatically (since the government has declared itself on the superannuation side of things). But with the information coming out on the US economy day after day over the past few weeks, I would still consider all bets to be off. Some people out there are probably faster at digesting the info (and time proves everything), but to me it looks like the the US is on the edge of a financial, social and political cliff. I don't think the Fed even knows what it all means - or they are bluffing.
If the US goes under water, where will that leave Australia? We need to keep this in the back of our minds, because in many respects, current Government decision making appears to be taking this into account (even though they might not be the right decisions).
I am personally going to wait before dipping into the real estate game again - at least another 12 months, and also I still think it's wise for people to consolidate and get out of debt as soon as possible - be as free as possible, as the banks are likely to move the goal posts as things get hotter (and they will), to the customer's disadvantage. On the other hand, since even mainstream newspapers are harping on about gold, I think we can already say that the next rally is under way and will have a shiny yellow glint to it. I don't trust mainstream newspapers, so that makes me nervous about gold. How's that for paranoia!
Comment by Greg Atkinson on 2 June 2009:
Hi Dan, when it comes to the U.S. everything scares me. I do not think the nation would handle a long downturn very well and Obama is going to have to make some deep spending cuts to balance the books at some stage. (and keep the Chinese happy)
But where will he cut? How far will he raise taxes? How with this affect Oz?
Comment by Gerry on 2 June 2009:
Yeah Greg..Some reasons for controlled concern I'd say....Military machines take a lot of funding. It is the big area of expenditure and it keeps increasing with proportional sofistication of weapons. They never can cut without playing second fiddle, and like the soviet union go under economically first. As china, North Korea, Iran and good old Russia (building up again), flex their muscles in the face of economic weakness in the USA it will take some constraint to reduce recurrent expenditure. It will need a new acceptance of place in the world which will be hard to come by.It is not in the psyche etc. It will give us all here in australia and elsewhere reasons for concern going forward, as we hope for brave difficult and sensible decisions.
The US supposedly was compared to GM in the past....up and down and successful together etc.. Well the U.S may have to swallow hard too and to quote the spin of the GM chief executive look forward to a "defining moment in the reinvention of"..the US.
Comment by Ross on 2 June 2009:
Gerry, you can't compare the rise of anyone soon in the world as a challenge to the USA on military hardware except for the odd rogue ballistic missile or the unlikely insanity of a MAD stink erupting with the Russians over western encroachment into central asia. Russia has one operating aircraft carrier that hardly ever puts to sea and it has half the capability of any of the US ones, and the US has a main fleet of 11 of them plus extras with VTOL/jump ramp capability that smaller nations sometimes label as carriers. Obama is only committing to stand down one of his which is the oddball in the otherwise homogenous fleet. That is more than 3 times the aircraft carrier striking capacity of the rest of the world combined. And you don't think aircraft carrier in the normal sense because the US carriers themselves have no defences at all and must sail in a large battle group.
But just like you and Greg I fear that US economy going backwards. Like CA says it is hard to imagine a hyper inflationary wage price spiral breaking out in the US when wages there adjust to burger flipping levels in the real economy so quickly. But they either cut costs like you say or something almighty or at the extreme end of expectations must give that spills over to staples and energy.
Comment by Biker Pete on 3 June 2009:
I'd have to agree that the claims of 50% falls in realty and 90% falls in rents appear quite far-fetched, even given widespread concerns about the world's economies, Greg. Frankly, the future doesn't look too good in the US... and Bill was probably wise to set up a few offshore bases, as have some of our US friends. Not a bad idea to have a safehouse outside the US turmoil these days!
Despite the apparent upturn in building starts and sales up to $500K, we aren't expecting anything but modest gains on our house sales. Rents are different. We're continually advised that we're asking too little... yet we're making great returns, certainly enough to be very comfortably well-off.
In terms of warfare, the US is more likely to be dragged into more unwinnable war zones than challenged directly. While these allow the US to demonstrate superiority technologically, such wars are costly, not just politically but in real dollar terms. How many more wars can a seriously depleted US conduct abroad these days?
Comment by Biker Pete on 3 June 2009:
Missed your note on immigration, Greg. It does not seemed to have slowed one iota here. That may mean we're investing in the right locations. There still seem to be a lot of new arrivals. Recent rental enquiries include IT, Technical Engineer, two teachers, mining engineer, dentist. With the exception of the teachers (both wives), the others are on high incomes. All expect to stay. All are happy to pay rents around $400 - $450 per week. One family commenced paying two months before moving in; another three months in advance! We were pleasantly surprised... . We suspect that immigration in specialist fields deemed critical may mean a continued influx of well-heeled tenants and future home purchasers.
These folk appear most concerned about good security, good schools, air-conditioning, and proximity to ocean. Super-fast optic-fibre for Foxtel and internet also appear to influence demand... .
Comment by Lachlan on 3 June 2009:
Can the US keep borrowing money to fight wars,forever? If not, then what happens next?
Comment by Greg Atkinson on 3 June 2009:
Biker Pete - cheers thanks for the reply.
Regarding the U.S I guess it is the same old story. The bigger you get the more people you bump into who want to take you down. This has happened to everyone from the Greeks, Romans (and before) right up to the British Empire and now the U.S. You then get caught into a cycle of having too many fronts to watch and your resources are slowly wasted away maintaining a large military and fighting endless wars.
Comment by Dan on 3 June 2009:
Lachlan: Military infrastructure is separate from the economy. If a country has food and access to resources, it can and will fund a military. The money is beside the point, ultimately, except that it may restrict a country's access to those resources. Is this likely to happen to the US? I don't think anyone is going to put sanctions on them in the foreseeable future, or kick them out of the territories they are currently milking for resources - unless there is a regime change and countries decide the U.S. is to be treated the same as Iran, or (historically) Iraq and South Africa, where it is bled dry and forced to pull back. That would take years to accomplish, even if everyone ganged up on them.
Comment by Ross on 3 June 2009:
Dan, Reagan's effort says that military spending isn't separated from the US economy. He ran up virtually the same debt to GDP ratio as GW Bush but his spending was on the govt tick and heavily military biased. Reagan left G (HW)Bush holding the can and gave Clinton his "its the economy stupid" election win despite HW winning the first Iraqi campaign more cleanly than any other foreign expedition in US history. The difference between the current debt and the Reagan debt is the exponential increase in the services economy contribution to GDP which was underpinned by both the foreign debt and the funny money releveraging of it and US domestic assets.
Comment by rick e on 3 June 2009:
Two things
1 if the USA needs more bonds sold then they will ask overseas governments to buy them i.e. Australia, Japan, South Korea etc (like the mafia protection money)?
2 if and when the USA dollar collapses would that cause the stock market to fall and cause the next bear market around the world ?.
It might pay for the world to bail out the USA?
Maybe that’s what is happening now? And on and on?
You’d think something has got to give? May be we all are …… (cash)?
Comment by Biker Pete on 3 June 2009:
Hard to know, isn't it? We imagined we were decoupled from the US, but China's reliance on US consumption of her exports has meant we resource exporters are (all) shackled to US consumption. Has China's resource stockpiling loosened that shackle somewhat? Is it a critical component of our relative immunity so far... ? If so, what's the longer term prospect once The Giant, employing these reserves, is self-reliant for much longer periods? How might we weather that export drought for any extended period?!
Comment by Coffee Addict on 3 June 2009:
rick e : Yes to both of your questions but No it won't, on balance , pay for the rest of the world to bail out the USA. Other G20 countries have their own financial crises to manage for the moment.
Once the USD gives - and this will probably only happen after deleveraging ebbs off - a good chunk of the US debt will disappear into thin air.
And yes, debtor country governments, including the Australian Government have made periodic comments along the lines that cash is actually quite risky.
Comment by Gerry on 3 June 2009:
Dan..You say "military infrastructure is separate from the economy". I am perhaps a little slow today and need that one run past me again. when a country has trillion dollar defecits,and runs the best military machine, how is increased spending on weapons, military infrastructure, star wars, defence shieds etc not part of the economy and budgetary process.Why is the money spent beside the point?.How can you suggest it is not a critical issue and area of expenditure to examine if you want to turn around your financial position.I realise they quarantine their military expenditure and it is somewhat sacrosanct but someone has to pay the piper eventually and it is the taxpayer. Why not NASA budgets etc being beside the point too. Where does the money the govt spends and gives to the weapons manufacturers come from? if not the taxpayers. The US companies overseas who may be doing the milking of resources you refer to sure don't appear to give it back to the government coffers,and not many pay much tax.
Comment by Lachlan on 3 June 2009:
Thanks replies.
What a funny ol world it is. Take our own nation. K.Rudd says we need to ramp up our defense forces because our neighbours are becoming more powerful. These neighbours include China. This costs a lot of money we dont have so bonds are issued to raise the capital required. Inevitably China etc invest in Aussie bonds therebye subsidising armed forces which may later be used to counter their own.
Money talks I suppose.
And does Kevin really lose sleep at night over China? I doubt it.
Comment by Dan on 3 June 2009:
Gerry: I probably put it a bit poorly. If you separate money from the real economy (the flow of objects around society and people doing things) then clearly the US is not starving - it has food and energy and the means to get raw materials. While these exist, it can support its military. The numbers don't mean a thing ultimately (especially in a fiat currency) - it's the failure of an essential component (such as food) that can sink a nation.
Comment by Greg Atkinson on 3 June 2009:
Dan the U.S needs to import oil, so it actually cannot support the needs of it's military by using the resources within it's borders. So I think Gerry's comment is pretty valid.
Comment by Dan on 4 June 2009:
Greg: It has to import a lot of things, but while it _can_ import oil and other things, it can support its military infrastructure. That could have something to do with why it invaded Iraq (if they were so genuine about regime change why did they destroy Iraq's national infrastructure except for its oil production facilities). Yes, the spending on military by the US has been wasteful (in my opinion), and would have been better spent on domestic matters, particularly supporting the manufacturing sector. And yes, the ridiculous state of affairs of US finances is dangerous, especially for American people who will probably suffer a big drop in living standards as a result. But as you say, IF the US loses access to its oil (eg: a in conflict with Iran gone horribly wrong), or to other raw materials, then things suddenly begin to look rather bleak - or bright, depending whose side you're on.
Comment by Gerry on 4 June 2009:
Thanks Dan ....comments I made were in the context of the whole military spend inside and outside the country,military bases,new weapons etc.and that this area of the budget has to be a major player with any serious budgetary "razor gang" looking at recurrent expenditure otherwise it will drag down the bottom line further, which is what is probably the most perilous issue facing the US currency etc at present.I Only mentioned the military initially as a major budget item example rather than other implications. Bernanke has had a big spend too, but realises cuts to recurrent expenditure are needed going forward as part of any way out as no one seems to want to raise taxes on the other side of the ledger (like california)even in good times.I appreciate that the Gov't can(and will)support the military machine as good as anything else when viewed in isolation and its own operating environment, and was not predicting its demise, far from it.It would be the "last man" standing.The military also has a positive economic role to play and cuts would have to be carefully targeted. I really want to see this large economy pick up its game and move forward. Thanks for the responses Dan which are appreciated.