Lend me your fears
At least government bond markets are working beautifully. All other asset and credit markets remain in various funks but government bonds are flying despite the prospect of a massive increase in supply around the world.
In fact they are showing all the signs of a bubble. In the US the 10-year treasuries yield is down to 2.33 per cent – lower even than during the Great Depression; 5-year at 1.47 per cent. This is despite the trillion-dollar bond-selling program outlined by the US Congressional Budget Office last week.
In Australia it is a similar story, except with a B, not a T, as in billions not trillions. The 10-year bond is yielding 4.1 per cent, and falling, yet a $20 billion budget deficit is in prospect in 2010 and the Rudd Cabinet will go from wondering how to spend the surpluses to issuing bonds like confetti.
So far the market’s attitude to this is: no problem – bring it on.
The estimate of $20 billion for the 2010 deficit comes from Joshua Williamson at TD Securities, who says there will be an expansionary budget in May accompanied by weaker tax receipts because of lower company profits and a weaker labour market reducing personal income tax.
In addition unemployment benefits will rise and the impact of the bear market on superannuation balances has shredded Australia’s vaunted retirement incomes policy based on mandatory personal super. As a result, new government pensions have increased by 50 per cent since October.
So Australia will soon join the global rush of bond issuance by governments to pay for fiscal stimulus and to meet tax revenue shortfalls as demand for welfare support rises.
Nevertheless, demand for bonds remains incredibly strong as investors flee volatile and dangerous risk asset markets looking for safety; in particular, prices have soared and yields have plunged since the Lehman Brothers calamity in September/October.
Bonds globally look very expensive. As Bill Gross of Pimco pithily put it in a Barron’s magazine roundtable the other day: “At today’s yields, don’t touch them.” And another Barron’s article on the bond bubble last week was headed: "Get Out Now!"
As with many bubbles, it is a brave investor who bets against the trend.
TJ Marta of Royal Bank of Canada argues that it’s not a bubble about to pop because: “There will be a considerable period before the ‘animal spirits’ return – rabbits come out of holes much more slowly than they jump into them.”
Moreover he reckons that US treasuries are not necessarily overvalued because of the disinflationary forces that have been unleashed by the “massive deleveraging impetus from collapsing derivative and credit markets".
But while US long bond yields certainly don’t seem to have much room to go any lower unless the Federal Reserve starts buying them as well (which is distinctly possible), the spread between them and Australian yields could certainly contract this year.
That’s because local super funds really want to buy Aussie bonds. The funds generally are focused on Australian assets and are looking to maintain, or increase, local currency defensive asset allocations as contributions continue to come in.
In other words, while the dreadful performance of the equity market over the past 12 months has thrown many retirees back onto the old-age pension and helped move the Federal Budget into deficit, the pensions will be paid for by the same super funds buying government debt.
