US Bonds Ride Euro’s Demise

The Dying Days of Fiat Money…

Your editor has the same feeling this morning as he did on Monday, May 16th. That was the day the Space Shuttle Endeavour blasted off for the last time. Your editor stood on the causeway in Titusville, Florida and watched the shuttle ride into the sky on a plume of fire, just like clockwork.

The financial markets have the same sense of counting down to the inevitable at the moment. Only instead of blasting off, they feel like they’re about to blow up. Markets are contending with the super failure of the so-called “Super Committee” in the US Congress to agree on a plan. This failure was consistent with the quality of US political leadership for the last 30 years. But it’s not even close to being the biggest problem in the world right now.

That distinction belongs to Europe. The looming breakdown of the Euro is a massively deflationary event for stock and commodity prices (although not US bonds, as you’ll see in a moment). It’s going to dominate the news until the moment reaches its crisis. And the crisis may be at hand.

The core of Europe’s credit quality is now under scrutiny. The ratings agency Moody’s said that higher interest rates in France could threaten the country’s credit rating. It’s on the edge. And Credit Suisse was even more succinct in a note to clients. The note concluded:

We seem to have entered the last days of the euro as we currently know it. That doesn’t make a break-up very likely, but it does mean some extraordinary things will almost certainly need to happen – probably by mid-January – to prevent the progressive closure of all the euro zone sovereign bond markets, potentially accompanied by escalating runs on even the strongest banks.

European Bond Market Mark-Down

You can take it to the bank that if the bond market in Europe closes, the banks will be soon to follow. The banks are full of government bonds. And you can’t have a crisis in the former without a disaster in the latter. That disaster is rapidly approaching.

This seeming inevitability is what drove down the S&P 500 by nearly 2% overnight. Imagine what would happen if the US or France was suddenly downgraded again by the ratings agencies. You’d see the same nasty cycle of asset sales to raise cash that you saw in 2009, only a LOT worse.

But we are in the zone where strange things happen that don’t make a lot of sense at first glance. For example, check out the chart below of 10-year US Treasury note prices. They are rising. As bond prices move inversely to yields, this means that 10-year interest rates in the US are falling even as they are moving higher in Europe. The flight to US bonds is nearing 2009 levels. But what does it mean?

10-year US Treasury Note Price Index
Click here to enlarge

Are US Bonds a Safer Bet?

The move into cash and US bonds isn’t a contrarian trade. No one is buying the US because they think things have gotten as bad as they’re going to get. They’re buying US bonds because it seems safer than staying in European government bonds. Or because it’s what people have done for the last 50 years when they think the world is full of risk with no good place to put cash to work.

Now we’re not a chartist. But we do have a fondness for looking at the relative strength index (RSI) on a chart. When the RSI trends above 70, a stock or security tends to be overbought. When it trends below 30, a stock or security tends to be oversold. Based on that crude analysis, we’d say the 10-year note rally will make new highs this week and yields will go to record lows as Europe’s contagion spreads panic among bond markets.

But wait!

Short of shutting down the ratings agencies and declaring a bank holiday, Europe’s interventionists have only one realistic option to get ahead of the decision cycle of markets and “reset” investor psychology. The European Central Bank will have to intervene on a gargantuan scale to guarantee European government debt. It will have to travel down the quantitative easing path of the Fed.

So there is your four-day forecast for the rest of the week, dear reader. Partly cloudy with a 90% chance of another 5-7% fall in equity markets. Gold and silver and oil will sell off too as markets deleverage. $2000 gold by December 25th is a real possibility. An Aussie dollar at 90 cents to the USD is too. And US Treasury yields will plummet to record lows. And then…

Strap yourself in for blast off. The firing of the European printing press is going to send precious metals to the moon. You may even get a Santa Claus rally in stocks. But it looks more and more likely that between now and the end of the year the ECB is going to have to do something BIG or be overtaken by market forces. Collapse or intervention, which do you reckon? Until tomorrow…

Dan Denning,
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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4 Comments on "US Bonds Ride Euro’s Demise"

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Ned S

“Collapse or intervention, which do you reckon?”

Can I have an Oz peso on both please sir … As in intervention followed by collapse? Or collapse followed by intervention. :)

IMO they flee to the USD because it is the liquidity engine of last resort. It supposedly makes bad good again at Stiglitz cheap rates (because socialist executive government and promise of future taxes on the goy is the socialist version of classical/feudal precious metal money). When we don’t believe the USD can make good, then all speculative leveraged positions collapse. Commodities will be central to that deflationary collapse as they were in 1840 and the 1890’s before later coming back at whatever physcial demand after the discretionary-less services/consumption economy commands. Precious metals could be worth herd/panic values, or else… Read more »
Ned S

Ross: “When we don’t believe the USD can make good, then all speculative leveraged positions collapse”

Yes, it’s getting fugly alright. (Glad I don’t have any debts. Though I’ve started thinking about getting a job.)


When’s this fall in house prices coming to Darwin, when prices drop won’t it be almost immpossible to loan from the bank, will places like Darwin drop in price with all the gas pipe line and gas hub work going on, Will Darwin maintain it’s price or drop to a more real price.

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