Credit Is Suspicion Asleep

By: Bob Hoye | Thu, Nov 22, 2012
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Signs of the Times

"6,125 Proposed Regulations Posted in Last 90 Days - Average 68 Per Day"

~ CNS News, November 8

Ironical, as the release came on the week when certain politicians were observing the deaths of so many soldiers - in the defense of freedom.

"Japan Plunges Into Deep Recession"

~ Financial Times, November 12

"Bank of Canada warns that 'vigilance by all parties' is essential to contain the country's household debt problem."

~ Financial Post, October 30

This seemed familiar so we checked our notes:

"The impact on the broader economy from sub-prime is likely to be contained."

~ Ben Bernanke, March 28, 2007

Using the typical timing on the end of boom, the yield curve was likely to reverse from inverted to steepening by as late as June 2007. The deadly reversal was completed by late in that fateful May.



Credit Markets

Representative sub-prime bonds soared to an outstanding high on September 14th. News that mortgage-backed securities were on the Fed's shopping list was announced the day before. The chart shows the initial sell-off was followed by a trading range below the high. It broke down this week, suggesting no lack of supply for a foolhardy bid. At 57.4 now, taking out 56.6 would extend the downtrend. Taking out 55 would ring the alarm bells.

Contrary to official plans other bond sectors showed contempt for notions about "containment".

US corporate high-yield (CYE) tested the late September high at 8.05 in late October and then plunged to 7.08. The low during the concerns of May was 6.86.

Junk (JNK) also tested its September high and has rolled over. The high was 40.53 and taking out 39.25 will set the downtrend. The low in May was 36.45.

Representing global markets, the Spanish Ten-Year reached 7.52% with concerns about default in July. Then the "risk-on" move dropped the yield to 5.34% in mid-October. The action has trended up and taking out 6.10% will start to get some attention.

As risk began to gain regard, the long bond has rallied from a key low of 144 and change on September 14th. Last week the high was 151.66 and the move is not overbought.

In shorter maturities, the Ted-Spread reached an exceptional degree of oversold at 0.203 on October 24th. It has set a brief and choppy uptrend to 0.240, which has been caused by the treasury bill rate plunging while Libor remained unchanged. It will become interesting when Libor starts to increase.


Wrap

This brief update will lead to a more extensive comment about government treasury departments issuing endless amounts of bonds as government central banks buy endless amounts of treasury issues. In case of the US it includes buying , shudder, the sub-prime.

Of course, outside investors have been playing the game, but overall it is institutionalized insanity. Where does the money come from to pay the interest? Well, it comes from issuance of yet more debt and it reminds of playing the popular game of Monopoly. Decades ago our family and friends decided to play the game with all of the money from another Monopoly set. It went on forever and there were no winners. Eventually, we quit and went back to only one set of money. Played by the rules it's a good game.

Back in the 1970s as interest rates were soaring to unprecedented levels there were some articles about the costs of compounding interest. One concept was that within a speculative rise in price the compounding cost of interest eventually limits the ability of speculators to drive prices higher. This really took effect when surging prices faltered, which was the cue for Mister Margin to come onstage.

It makes sense that this would apply at any level of interest rates. Compounding doesn't care what the rate is and even today's low coupons must be paid.

Recently this seems to have been noticed by the UK government. The request for interest payments from the Bank of England is fascinating.

Halkin's Weekly Letter includes a brief and amusing piece that starts with "Dear Mervyn":

Halkin's Weekly Letter: Dear Mervyn

 


Link to November 17 'Bob and Phil Show' on TalkDigitalNetwork.com: http://talkdigitalnetwork.com/2012/11/fiscal-cliff-with-a-creamy-filling

 


 

Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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