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Thursday, June 02, 2005

Bonding Together

Stephen Roach has been having a rethink on bonds:

"When I first wrote of an interest rate conundrum in January, little did I know how deeply this concept was about to become ingrained in the heart and soul of central banks and financial markets......But conundrum it is, as real rates remain at unbelievably low levels at the short and long end alike -- in the US, Europe, Japan, and even emerging markets. Given my concerns over the US current account deficit, I have long in the bearish camp with respect to the US bond market outlook. A rethinking is now in order. The likelihood of a China-led slowing of Asia has prompted me to change my view. I now suspect bond yields will stay low for the foreseeable future, and I wouldn’t rule out the possibility that they might even drift lower".

This was written on Monday. Short term confirmation of what he 'wouldn't rule out' wasn't long in coming: on Tuesday the 3 1/4 percent German bund due in July 2015 fell to an all time record low yield of 3.22%. This left a gap of 1.22% with the ECB base rate, the narrowest gap since the last time the Frankfurt-based central bank cut interest rates in June 2003. This may indicate that Trichet's room to *not* cut rates is reducing.

Meanwhile yesterday in the US ten-year yields closed below 4 percent on consecutive days for the first time since October.

Also it is significant to note that eurozone government bond yields no longer automatically move in the same direction: whilst the yield on the Germnan 10 year bund rose 1 base point to 3.24 percent, the yield on France's 3 1/2 percent bond due April 2015 was little changed at 3.25 percent, and the yield on the Italian 10-year bond rose 1 base point to 3.45 percent.

The impact all these low yields and the economic uncertainty are having in the US? Well, as I suggested here at Bonobo recently, they are really reducing Greenspans 'room to manoeuvre' down at the Fed. This reality was floated yesterday in a speech from Dallas Fed President Richard Fisher (in a move where he is widely interpreted as acting as Greenspan's emmisary), suggesing that the 'tightening' process may be nearing its end. Which brings us back to Stephen Roach: interest rates may be in the process of stabilising on the downside, and we are maybe near the peak of the tightening process.

With the ECB stuck at 2%, the BoJ at 0%, and the Fed at 3.5%, that speaks volumes for the depth of the global liquidity markets these days.


Fred C. Dobbs said...

Why is it assumed that Fisher is doing Greenspan's bidding? Is that why a Fed spokeswoman took the unusual step of explicitly saying in front of the camera that Fisher was not speaking for the FOMC?
It's much more likely that Fisher is a loose cannon.
Wait for June 9 to hear what Greenspan REALLY thinks (or what he REALLY wants us to think he thinks). I'm betting he won't back up Fisher.
Fed speakers, except for Fisher, have been pretty clear that they don't think the U.S. economy is softening and that inflation remains a greater threat than slow growth.
Someone is in for a rude awakening.

Edward Hugh said...

"Why is it assumed that Fisher is doing Greenspan's bidding?"

Fair comment Fred, I have no way of knowing.

But statements by people associated with central banks are difficult to read, in principle. Look at the debate we are having about Trichet yesterday.

So the question is really whether you expect rates in the US to rise or not.

You don't, so you take the 'rookie' line. I do, so I think this has been okeyed with Greenspan.

Why do I think this: because rates will come down in Europe, and this makes it impossible for G to keep raising *and* ,maintain open trade with China.