Wednesday, November 10, 2010

US Bonds: Waiting for the First Rat

US 10yr Notes have had a tough few days with yields rising some 15bp.  Irish Bond traders might be wondering, if a few days yield rise of 15bp can be described as “tough” what word would one choose to describe government debt trading in Ireland lately.  Yields on Irish 10yr government debt rose by more than 60bp today, making the total yield gain since May more than 400bp.  I think “crisis” seems most apt.

What’s the difference between Irish Debt and US Debt trading besides currency denomination?  That is, why are Irish yields rising dramatically and US yields not?  After all, both nations have a large stock of government debt, a not insignificant portion of which was necessitated by bail-outs of highly leveraged banks and are running substantial continued deficits (admittedly the expected Irish deficit is roughly 3 times the US relative to GDP).  Why are Irish yields so sensitive to news of additional deficits while US yields remain stable?

The French refer to this conundrum as the “exorbitant privilege” of the US.  If Ireland were to announce a policy of Irish Central Bank monetization of the next 9 months of debt issues, Irish Debt would, I suspect, crash more severely than it has.  Yet, this is just what the Fed announced last week.  It’s good, it seems, to issue the world’s reserve currency.

Press coverage of Irish debt trading speaks of investors demanding ever-higher yields as risk compensation given Ireland’s fiscal woes, while the fear in the US is just the opposite, i.e. of another asset bubble being created, despite, it seems, the US’ fiscal woes. 

Perhaps the answer to the query, “what’s the difference between Irish and US debt trading?” is simply time.

At some point in all markets, the metaphoric rats leave the sinking ship.  In the Irish 10yr, it seems 6% was the yield of no return.  Leveraged owners of the debt started to flee (sell) while Ireland’s financial needs grew (due to, if for no other reason, higher borrowing costs) and debt sales begat more debt sales. 

To repeat, at some point in all markets, the metaphoric rats leave the sinking ship, even, I believe, US debt markets. 

Of course, when the feasting has been very good for a long time and when a rat might fear repercussions from leaving early, a wise rat might wait until other rats left safely before leaving himself.  A wise bond trading rat might watch US yields and flee when they rose above some level, say 4% in the US 10yr.  An even wiser rat, having decided the meal was not to his liking (or so I understand the debt rating downgrade from a Chinese rating agency), might sell while the selling was good, say while the ship’s owner (the US) was buying.

I’m most curious to watch US debt trading in the coming months as Treasury data on foreign inflows details the movement of the rats off the ship.  Once the other rats know that many are leaving the exodus will become a stampede (lots more leveraged longs in US debt markets than in Irish debt). 

Who knows, in the not too distant future the press might speak of US Bond investors demanding ever higher yields.  

Disclosure: No positions in US Treasuries (yet)