C.M.O. 6.29.2009
Credit Market Overview
June 29, 2009
“This time it’s different.” That phrase usually marks the peak of “irrational exuberance” and is what investors tell themselves as they play another round of the game known as the “greater fool”. In the end it always is the same and the lesson that it was not “different” comes very painfully to some.
But even if where you get to is the same, the route taken invariably is different. It is like that in the Treasury market at the moment; getting to the same place differently. The last time there was profligate spending by the government, financed through debt issuance; Edward Yardeni coined the phrase “Bond Vigilante” to describe the bond market participants who forced yields higher to protest President Clinton’s fiscal irresponsibility.
The markets were more parochial back then and the vigilantes were mostly a domestic breed. The vigilantes are back again but this time they live in a land far to the East and their leader is Zhou Xiachuan the governor of the People’s Bank of China. ZX, if you remember, called for the expanded use of the IMF’s Special Drawing Rights in an essay posted on the PBoC’s website back in march. SDR’s are a basket of major currencies, USD, EUR, JPY and GBP that to date have mostly been used by the IMF to make loans.
Mr. X is pushing to have the SDR become the world’s reserve currency displacing the USD in that current role. He would also like to see the Yuan added as the 5th currency in the SDR but that’s a story for a different day. Putting their money where their mouth is, China recently said it would buy up to $50BN in IMF bonds as part of a deal made by the world’s major economies earlier this year to boost the resources of the IMF in its effort to combat the global financial crisis.
Borrowing a phrase from the “Donald”: “If you owe the bank $1, the bank owns you, but if you owe the bank $1BN, you own the bank.” With China as a major creditor to the U.S. they might not own us but they are not be ignored either.
Earlier this month Liu Mingkang, chairman of the China Banking Regulatory Commission said that “Toxic assets must be immediately resolved worldwide”. He added that while “measures taken so far to support the financial sector have helped ease the panic in the markets, they are ‘not enough’”.
Treasuries rallied this past week with renewed risk aversion being given the credit for the decrease in yields. The 10-year note hit 4% on June 10th but was trading back at 3.50% by Friday’s close. Spreads aren’t playing as nicely though as the price of Merrill Lynch’s High Yield Master Index II has fallen 1.97% since June 16th which works out to a widening of about 69bps over Treasuries. To put this in perspective that move was bigger than the corrections that came after the rally that followed the 1991 collapse of Drexel Burnham Lambert and the snap back from the WorldCom/Enron/tech-telecom implosion in 2002-03. Martin Fridson of Fridson Investment Advisors told Barron’s he observed a $110MM outflow from high-yield mutual funds last week.
It is too early to know if the most recent moves in the credit markets portend a deliberate move away from risky assets or just normal ebbs and flow slightly exaggerated by summer volume, or the lack thereof.
What we should hope for, however, is the return to fiscal responsibility the vigilantes brought their first time around. Hopefully, it won’t be different at all this time.
Enjoy the short week,
Jim Delaney
