Tags: Treasury | yield | ECB | rate

No Good Alternative to the US

Tuesday, 09 Jul 2013 02:54 PM

By Hans Parisis

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For understandable reasons, long-term investors seem to be impatiently waiting for what Federal Reserve Chairman Ben Bernanke could say this week on Wednesday afternoon when he gives a speech at the National Bureau of Economic Research (NBER) Summer Institute in Boston on the history of Fed policy. Bernanke rocked, certainly unwillingly, the markets when he said on June 19 the Fed will likely slow its bond buying program "this year(!)" because the U.S. economy is strengthening and then end the program in 2014 for the same reason.

That said, I wouldn't be surprised if we have to wait to find out more about the so-called "tapering exercise" until July 17 and 18, when Bernanke is set to testify before the House Financial Services Committee and the Senate Banking Committee.

In the meantime, the Organization for Economic Co-operation and Development (OECD)'s composite leading indicators (CLIs) for its 34 member states shows that of all the "big" economies, only the United States and Japan continue to point to "firming" economic growth. In May, the CLI was 101 for the United States (it has been above 100 since January 2012) and 101.3 for Japan (above 100 since January 2013). A CLI of 100 represents average growth

At the same time, we also see the CLIs for the eurozone indicate growth is timidly coming slightly back, with only France not moving at all, which could mean trouble in the making for the eurozone.

Also interesting is the fact that neither of the CLIs for China (99.5) and Brazil (99.1) provide any encouraging signs that growth is coming back within the next six months.

The Producer Price Index in China was -2.7 percent year-over-year, compared with a -2.9 percent in May, which confirms its 16th consecutive month of "deflation" and underlines continuous overcapacity problems that, in turn, cuts any sound growth prospects for the Chinese economy in the foreseeable future.

Yes, the U.S. growth pace continues to get better bit by bit and shows further signs of firming over the next six months, and in case that's confirmed, normalization of interest rates is on its way.

This should mean that slowly rising interest rates in the United States should not be considered as a low probability from here on.

In this context and considering the possibilities of where U.S. interest rates should be headed, I've thought the following exercise could be of interest to long-term investors. for having a somewhat better idea of the direction and values of where U.S. yields could be in the near-term by knowing what some really "big" players expect on where (the zone) the benchmark U.S. 10-year Treasury yields could be in the near-term.

On Monday UBS, recommended shorting the 10-year U.S. Treasury Note Futures contract for September 2013 at 125.10 (implied yield, 3.0735 percent) with a target of 123.04 (implied yield, 3.2701 percent) and a stop at 126.04 (implied yield, 2.9623 percent). In understandable English, this means UBS expects yields of the 10-year U.S. Treasury note to rise above 3 percent in the near term.

As always, only time will tell if they're right or not and nothing is written in stone.

As a long-term investor, one should never negate the possibility that during the summer and into the fall, broad-based risk aversion could come back completely "out of the blue" for many reasons, such as geopolitical reasons related to what is going on in Egypt and Syria and the Japan-China tensions over the Senkaku islands (as Japan call them)/Diaoyu islands (as China calls them) that cover no more than 1,700 acres and are composed of five islands and three rocks.

The Japanese Defense Ministry's white paper for 2013 states its concerns about "China's potentially dangerous maritime activities" and how it wants "Beijing to abide by international rules rather than engage in forceful actions." This demonstrates very well the far-from-comfortable tensions that are in place over these disputed islands in the Pacific Ocean. That China disagrees shouldn't come as a surprise to anybody.

So, we certainly can't pretend we are back in one of those "best of times."

Also, in Europe, the crisis remains alive, notwithstanding Eurogroup approved the latest aid installment for Greece, albeit with a number of stipulations and with "staggered" payments. As Greece never didn't comply fully with whatever was agreed on with its Troika creditors before, it now "must" by July 19 show its creditors that it is serious about cutting 4,000 public-sector jobs by the end of the year and that it is moving to modernize its tax code.

From my side, I'd like to say I'll believe it when I see it. A Greek widely respected think tank revised its growth forecast for the Greek economy down to -4.8 to -5 percent in 2013, from -4.6 previously, and expects unemployment to hit 27.8 percent.

Also, I still can't see any real serious EU political cohesion surfacing. Last week, it wasn't headline news but it's important enough to mention that European Central Bank (ECB) members clashed over an interest rate cut of 0.25 basis points that was proposed by Belgian council member Peter Praet at the ECB policy meeting and that was dismissed by the core "North" council members. Ultimately the ECB policy meeting concluded with all the members' unanimously agreeing "not" to cut. Yes, the "North" had pushed through its will, but this could spell trouble in the future.

No, Greece and certainly the eurozone aren't out of the woods yet. Problems could still be postponed until after the summer. Maybe we'll have to wait until the German elections in September are over for tensions in the eurozone to come back to the forefront.

Finally, I still expect a correction. I also expect yields of U.S. Treasurys as well as junk bonds to continue on their upward path and overall "liquidity" to diminish.

Remember that when yields go up, prices go down. So, I don't have any problem preferring cash equivalents, with very-short U.S. Treasurys remaining my top preference.

In case this situation is confirmed, that won't bode well for emerging markets, and in clear English that would mean we haven't seen the bottom there yet.

So far, I can't see any real good alternative to the United States as a whole, and I still expect the U.S. dollar to continue on its upward path.

For long-term investors who already own gold, I would start considering buying some more especially physical gold once we arrive in the $1,100 per ounce zone, but only after having had a good look at the situation at that time. Yes, I'd try to buy below the actual production cost price.

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