Yesterday was a day in which it looked as if equity markets were going to fall heavily but in fact recovered with the Dow Jones Industrial Average dropping nearly 150 points during the day but only closing some 43 lower at 11,126. However government bond markets took centre stage around the world as yields generally rose and prices fell. In the United States there were better than expected economic figures for example the Durable good orders figure for September was up 3.3%, although one always needs caution with this figure and to highlight this a lot of the rise was aircraft orders for Boeing which rose from ten to over one hundred. Aircraft orders are erratic and often influence this figure. However the day was influenced by yet more rumours over what the FOMC will do on November 3rd and the debate is not over if it will expand its balance sheet but by how much. So we are back to “front-running” central banks again.
What is now expected from the FOMC in terms of the size of QE2?
Market expectations had been rising for the amount of asset purchases or expansion of its balance sheet that the FOMC will undertake on November 3rd. Indeed as an example that even the Bank of Japan feels that it is a done deal, it has moved its next meeting forwards by ten days to November 4/5 presumably so it can respond if necessary (for example to intervene against a rise in the Yen). In terms of size of intervention then Goldman Sachs had been suggesting policy measures of the size of US $3 trillion to US$4trillion so the size of expected measures was increasing almost day by day. I also note the enormous scale of the gap between 3 and 4 trillion which suddenly appeared to be treated as chump change!
However a writer for the Wall Street Journal who has a reputation for being well-informed and something of an insider then reduced the scale of expected intervention. Now we got a suggestion that the FOMC would indicate an initial intervention of some US $500 million which would be spent at say US $100 million a month. Also new intervention would be announced at future meetings if the economy should weaken. So a lighter but more flexible response.
In the front-running investing atmosphere of these times it is not a surprise that such a (possibly well-informed suggestion) led to US government bond prices falling and yields rising. The ten-year benchmark saw yields rise from 2.63% to 2.71% for example. Also the US dollar continued its recent rebound which is consistent with lower expectations of action from the FOMC with the dollar index creeping above 78.
The dangers illustrated by the most recent suggestion
Having looked at an analysis of these moves it would appear that the FOMC has changed it mind again! In the fevered front-running atmosphere of these times this is not far from outright negligence in my view as it makes me wonder if the FOMC actually knows what it wants to do and if we keep getting new “guidance” markets will be volatile and destabilised. I wrote an article a few months ago about how difficult it is for an ordinary investor in these times and would like to add that this is a situation that central banks have made worse by their actions.
The latest move has involved the FOMC going to primary dealers in US government bonds and asking them how central bank purchases will influence government bond yields. Apart from the initial thought which is , how about looking at the purchases already made and using that as a guide? I am left surprised at the lack of thought behind this action as the primary dealers are likely to give a response which benefits themselves. Markets have given their own interpretation of this as government bond prices are rising again.
Moral hazards abound all over the place here. I find myself discussing a situation where the FOMC has asked a group of people who are the last group I would ask. Front-running of expected central bank actions seems to have taken over markets and yet central bankers are people who usually base their votes and policies on models where you look for an equilibrium. The same equilibrium that their moves are probably preventing. You could not make it up.
Also in this frenzied atmosphere may I ask for the clock to be stopped briefly and some thought to take place. Many times I have suggested that an exit strategy for QE is as important as its composition and introduction but I have heard no mention of any exit strategy at all….At times like that I truly wonder if the lunatics have taken over the asylum.
Other Government Bond Markets
As I stated earlier these in general fell and if we take Germany as a benchmark yields on her ten-year bund rose by 0.05% to 2.57%. I have a chartist friend who considers these levels to be significant for the next trend but of course the next front-running surge depends mostly on central bankers whims and not strategy or charts.
Here we saw another day of poor performance and another example of markets reacting to expected central bank moves. The follow-on effects of the good GDP or economic growth figures for the UK saw her ten-year gilt yield rise by 0.09 to 3.15%, because they made more asset purchases less likely. So the world trend with a little extra. Our longest dated gilt which matures in 2060 fell by just over two points.
I wrote yesterday that it was illogical for index-linked gilts to fall on good economic growth figures and hold to that view but on the day I would have lost some 2 points on our longest dated index-linked gilt which fell to 121.79. So they too had been buoyed up by hopes of Bank of England purchases.
The Peripheral Euro zone countries
Here was some real action and it was yet again rising yields as economic and political news added to a general rising of government bond yields.
Portugal looks likely to fail to get her austerity budget through her parliament
Portugal’s government had proposed a new austerity bill to get her public finances on track. I have written many times on Portugal’s economic difficulties and I analysed the economic situation of Portugal in articles on the 24th June,14th May, and 5th May amongst others. The theme is sadly of poor growth in the good times which immediately poses the question what happens in the bad? This was added to in my article of last Friday which pointed out the inconvenient truth that rather than reducing, Portugal’s fiscal deficit was in fact rising. This is unfortunate to say the least when you have claimed that your plan is front-loaded.
However the new austerity plan which had already helped reduce Portuguese government bond yields by some 1% was hit by trouble in by the Portuguese parliament yesterday. The opposition Social Democrats (PSD), who hold the balance in power in parliament, called a halt to five days of negotiations, accusing the minority government of being inflexible. The vote is on November 3rd and if the PSD votes no then the government will fall. The problem is that due to a presidential election being due in January Portugal would not have a new government until after that as its constitution would force a delay.
Such political uncertainty and grandstanding did not go down well with financial markets who raised the yield on Portuguese ten-year government bonds by over 0.2% to 5.92%.
Ireland’s continuing woes
The problems with Ireland’s banking and property systems never seem to go away. I discussed yesterday her proposed four-year plan for fiscal stability which has all sorts of risks and implications. Her ten-year government bond fell in price terms by just under one point and now yields some 6.61% which puts her firmly back in the danger zone and she must be grateful that she does not have to issue any more bonds in 2010.
There have been two developments today and neither are good. Firstly it would appear that some of the bondholders will reject the terms recently offered for some of Anglo-Irish’s debt. There are lots of implications from this one is obviously increased uncertainty, another is whether this will help trigger payments from Credit-Default Swaps or CDS’s. Another is that Bank of Ireland has issued Euro 750 millions of 2 and a half-year borrowing, on the face of it this sounds good and maybe you will find some journalists who say this. However if you stop and think that this money has been borrowed at 5.9% you then get two very worrying thoughts.
1. Exactly where is Bank of Ireland going to be able to lend this money out at a profit when interest-rates are so low? In case you are wondering its standard rate for mortgages in Ireland is 3.4%. So any new mortgage business is at a margin of -2.5%.
2. Bank of Ireland has a state-guarantee so the fact that it has had to pay 5.9% for relatively short-dated borrowing is worrying for the sovereign nation too.
Greece and her continuing financial woes
After discussing the recent report from her central bank yesterday I failed to add the political element in her current issues. She has elections soon and as part of the campaign her Prime Minister has threatened to call a more general election if things do not go his way. The combination of this and continuing poor fiscal and economic news led to yields on her government bonds jumping sharply yesterday. The ten-year yield rose by nearly three-quarters of a point to 10.44% and her three-year now yields some 10.83%. So much for plans to return to bond markets.
It is the shorter-dated yield which troubles me the most. If you look at Greece ten-years ahead then there are so many alternatives it is likely to make your head spin. But with the likelihood of the EU aid being extended and increased and the fact you can earn over 10% a year should lead to there being buyers in a world where other yields are low. I think that the lack of buyers is rather eloquent on Greece and indeed on EU credibility.
A Playlist for the FOMC meeting
Thank you to those who made suggestions. Many were excellent and left me wondering why I had not thought of them! Please keep them coming.