“You will always be a child of two worlds, and fully capable of deciding your own destiny,” Spock’s father Sarek tells him in the latest Star Trek movie. Which brings us to Australia’s place in this emerging new world order. Which place will it be? De-industrialised deadbeat debtor or something else?
The place NOT to be is choking on debt, trapped in the tar baby that is the unfolding Anglo-Saxon bond crisis. The bid by the U.S. and the U.K. to auction off hundreds of billions of dollars and pounds worth of bonds this year is already forcing interest rates up in those countries.
Bear with us, if you would. We know. There are few things in the world more arcane and less interesting than interest rates. But right now, we believe the action in the bond market is the key to understanding the move in commodity and stock prices. What you see in the charts below is the widest spread between ten-year and two-year notes since 2003.
Ten-year yields spike as the short-end of the curve gets trendy
Source: Wall Street Journal
The yield curve is getting steeper. Ten-year yields closed above 3.5% while two-year yields look pretty range bound. Investors are charging the U.S. more to loan to it long-term while they seem to be happy to park cash in shorter-term maturities, even if the real yield (adjusted for inflation) is negligible (or negative).
The current spread between ten-years and two-years is 263 basis points (2.63%). It blew out to 274 basis points in 2003. That was about the same time that Alan Greenspan’s Fed slashed rates to one percent and kept them there to kick off the leveraged bull market in all asset classes across the globe. Global synchronised boom.
The Fed doesn’t have that flexibility today, of course. U.S. short-term rates (the Fed funds rate) are already being held in a range between zero and 0.25%. If the central bank wants to try and bring ten-year rates down, it’s going to have to buy more bonds directly. And if it does so by creating more money, we reckon it puts more bullish pressure under gold, oil, and copper prices. We’ll get to that in a minute too.
By the way, keep an eye on the auction of US$35 billion in five-year notes tomorrow and US$20 billion in seven-year notes later in the week. If we’re right and non-U.S. investors are suspicious of the value of U.S. long-term bonds, these auctions will be a lot more difficult than the US$40 billion two-year note auction this week, which showed plenty of strong demand from non-U.S. buyers.
If the Fed loses control of ten-year and thirty-year U.S. interest rates, look for the ratings agencies to put the U.S. in the same company as the U.K. when it comes to credit quality. If you finance deficits and borrowing with outright monetisation, it kicks of a crisis of confidence in your currency and your outstanding debt. In the U.S., foreigners hold some $6.35 trillion in debt. They’d be very worried indeed the more the Fed monetises new debt issues.
Either way, the Anglo-Saxon bond crisis is here. Higher interest rates retard economic growth, make credit more expensive, and debt more costly to service. They will also drive investors further into tangible assets. Why? Well, investors may simply turn their back on sovereign debt and invest in exchange traded commodity funds or publicly listed resource producers.
for Markets and Money