We’ve had a remarkable run in US notes and bonds over the past several weeks. The economically-sensitive 10-year note briefly yielded more than 4% in mid April. After an astounding rally yesterday, buying in the 10-year continues this morning, and its yield is down to 3.57 as I write.
I’m at a loss to convey the magnitude of this move in such a short time. Unless you’re a capital-markets obsessive like me, it’s hard to sense how big this is. Coming at a time when the euro is widely expected to drop sharply in value and Asian markets appear to be very overextended, the rally in Treasury debt has to be interpreted as a broad turn away from risk.
Why? The news stories are unanimous in blaming the ongoing and very serious situation in Greece. I’ve been sounding the alarm in this space about the weakness of Greek debt for months now. The underlying problem there is worse than elsewhere, and there are somewhat different drivers for it, but it still is a widespread problem: too much deficit spending by governments. To state the problem even more broadly: too much spending by governments, period.
In Greece, ridiculously overpaid public-sector workers are now going on strike. The country’s high earners (who illegally avoid paying most of their taxes) aren’t on strike but are almost certainly looking for ways to get their money out of the country. (Short-sellers love the smell of capital flight in the morning.) And in the last few days, the mobs have started throwing cobblestones and Molotov cocktails, and the police are responding with tear gas. Not a good situation.
And yet, I’m seeing contrary indicators. The great fear in the finance world is that Greece, even with the 110-billion euro bailout package from the EU and the IMF, will end up defaulting on sovereign debt. Greece has been spending far beyond its means, and that simply must stop in order to avoid a default. Have you ever tried to tell a spoiled child to eat his spinach or he won’t get his dessert, and had the child respond by throwing flaming gasoline at you? If so, then you know quite literally how the Greek prime minister feels.
Ultimately, this problem can and will be solved with massive transfers from the wealthy states to the heavily-indebted ones. In a way, the Germans have been collecting a rainy-day fund for decades, and it just started raining. Combine this with the fact that the European Central Bank, to its evident displeasure, has now committed to accept any Greek sovereign debt security as collateral in term repo for an indefinite period of time, a guarantee they will not be able to avoid extending to other states as well.
The result is that the fiscal profligacy of Greece and other states will be covered by the savings of others. (Now if you’re the type of person who saves carefully and never runs a credit-card balance, don’t you feel a little stupid?)
But you see, that’s why I’m seeing a contrary indicator here. I don’t expect to see a massive financial crisis, as many fear. (And those fears are being fanned by some German officials, who need to justify a deeply-distasteful diversion of taxpayer funds right ahead of a major election in Nordrhein-Westfalen.) And the Molotov cocktails and tear gas will stop flying after the Greek authorities complete their upcoming debt rollover, wait a few more weeks to make it look good, and then accede to the protesters’ demands.
But where does that leave the capital markets? There still are lingering questions about the sustainability of the economic recovery, which is being driven by Asia. And as I mentioned, Asian markets are seriously overextended and in need of a correction. And then there is the prospect of higher policy interest rates in the US, which I believe (contrary to many others) will not happen this year.
But the biggest contrary indicator of all is the sudden emergence of people making extremely bearish, even apocalyptic predictions, now that (admittedly strong) headwinds have appeared in markets. The old cliche is true in this case: markets climb a wall of worry.
The standard rule is that euphoria is contagious and resilient. Markets are currently in a bull cycle, with most participants expecting that the nascent global recovery is robust and sustainable. At times like this, declines often provide buying opportunities. Over the next few months, the euphoria should return, even though (as I’ve said elsewhere) a 5% correction or more in US stocks wouldn’t be a surprise.
This story first appeared at The New Ledger.