Your editor departs for Wellington for five days today to meet with an old friend about publishing his newsletter. His letter is a top-down, geopolitical, macro-economic report grounded in an exceptional knowledge of the credit cycle and history in general. We’ll keep you posted.
But there are some strange and perplexing crumbs to collect from news reports this morning. Yesterday we learned that for the first time in 70 years, yields on 90-day U.S. government securities were briefly negative. Investors – if you can call them that – were happy to loan money to the U.S. government for 90 days – and lose money.
Normally, the only thing that could explain such an unusual preference for liquidity at the expense of return is abject terror of equities. But stocks have been moving on up nicely. The plunge in short-term yields can’t be explained in terms of “risk aversion.” So what’s behind it?
It’s a pretty interesting question if you simply phrase it: what kind of investor is happy to lose money over 90 days? Is the move to the short-end of the U.S. yield curve part of a broader shift out of longer-dated maturities (10 year notes and 30-year bonds).
Even the New York Times is starting to freak out about the amount of U.S. debt that must be rolled over in the next four years. The times article points out what we pointed out at the beginning of the month: U.S. debt is far more interest rate sensitive than ever before, which makes it potentially far more expensive to service if interest rates spike.
But that doesn’t get us any closer to explaining the near-zero short-term yields. Granted, they were low to begin with. Maybe they are only unusual because they descended from such a low base to begin with. But is there another explanation that sheds light on what’s going on in the markets?
One possibility, and we admit we are speculating here, is that banks are beefing up on liquid assets to bolster their capital positions. Whether this action corresponds with the end of the year or some other force, well, we have no idea. But without a corresponding fall in some other asset, the fall in short-term bond yields must represent a preference by institutions for T-bills and notes right now.
Our colleague Kris Sayce thinks institutions might be using T-Bills as collateral for other loans, pyramiding their way up to new balance sheet growth. It’s possible. It’s also possible that banks are buffering their capital positions in anticipation of…turbulence.
In today’s Age, Eric Johnston begins his story with the headline, “Australian banks fail new capital test.” Gee, that sounds familiar! “Ratings agency Standard & Poor’s has warned that nearly all the world’s big banks – including Australia’s major lenders – have insufficient funds to cover their lending exposures and risk a ratings downgrade unless they move to bolster their balance sheets over the next 18 months.’
That might sound odd, considering that Aussie banks tapped equity markets for $20 billion in new equity last year. But did the new money actually bolster the balance sheet? Johnston reports that, “While Australian banks benefited from having a large exposure to low-risk residential mortgages, S&P said a narrow geographic and business base counted as a negative. It also noted that the capital raisings by the local banks had been used mainly to fund acquisitions or balance sheet growth.”
More home lending baby!
It’s probably a stretch – given we have no evidence whatsoever – to suggest that global banks (Australia’s included) are bolstering capital by moving into short-term U.S. debt. It’s also arguable that U.S. debt – even short-term near cash bills and notes – are a quality asset to be adding to your capital mix. But it’s a lead and we’re chasing it down.
Why does it matter? Well, the last time yields went negative like this was in 1938. That preceded a collapse in the stock market and the onset of the “Great” part of the U.S. Depression. Of course in 1938 the Fed began tightening up monetary policy again (prematurely, some argue). It won’t do that today.
Meanwhile, some other troubling pieces of information from the bond market. Bloomberg reports that Telstra, “scrapped a domestic bond sale plan after it couldn’t reach an agreement with investors on the terms of the securities. ” Apparently bondholders “wanted the 10-year debt to include assurances compensating them if Telstra’s credit rating gets downgraded.”
Geez. Creditors are getting pretty choosy these days, aren’t they?
There are other stories we’d like to have a closer look at today. For instance, a Brazilian steel-maker has plans to buy 16.5% of coal explorer Riversdale Mining for $190 million. This fits the pattern we described earlier this week of major international companies seeking to buy independent junior miners in order to guarantee resource supply. We’ll have to ask Dr. Cowie what he thinks.
Time to board the plane now and cross the Tasman. We’ll report tomorrow from the east coast of the North Island. Until then.
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