Apr

24

 I have been asked if a lower yield after seemingly bad news like the S&P downgrade is bullish for bonds. A lower yield than before happens often. Is it bullish or bearish? If you specify the time and the magnitude and the other conditions it can be tested. Such tests must be made conditional on the time of the day. As a hint, such tests as of the end of the day do not support anecdotal assertions being made here about qualitative factors, and sensible sounding technical shibboleths. The problem with qualitative analysis is that there are so infinitely many smart people constantly tinkering to get the right price, that the right price is the result of so many people like Paul DeRosa and the palindrome, the former of whom is completely sagacious and knowledgeable, and the latter of whom takes along with him trillions of fellow travelers that are part of the affinity group, as well as the wisdom of all the flexions that rely on such as the upside down man and he for guidance as to what they should do to finesse their positions along. Furthermore the wisdom and the access to such info from all these types is always varying, and depends on the ethos with which they look at things, which is often right during bad economic times for example for the Man of Many Books. Sometimes they're good and sometimes bad. So it's hard to follow a qualitative guru, and even more difficult to find a qualitative divergence. Certainly impossible is to make money following a shibboleth that hasn't been tested, and to extent it has, one wouldn't be writing that it's worthless unless it were truly wrong.

Rocky Humbert responds:

Here are some stats:

1. Japanese National Debt/GDP = 228%. Yet their currency is very strong; and their yields remain near record lows.
2. Italy Natioanl Debt/GDP = 115%. Their yield is 120 bp over bunds.
3. US National Debt/GDP = 97% (if you include social security etc); 60% if you don't. Yields at 10 bp over bunds.

Although academics try, it's clearly impossible to draw a straight line between National Debt/GDP and nominal sovereign debt yields.

Furthermore, and more on point, last week Gallup (and Google Trends) showed the US Budget Deficit had risen to be the "Nation's Most Important Problem." This story moved to the front of the pack — displacing job; war; healthcare; and Charlie Sheen.

That Obama gave a speech on this and that S&P issued their non-news is simply a mirror of the established public mood. Therefore, definitionally, it's in the price.

One more thing: Normally, a company PAYS MONEY to S&P to get a credit rating. That's not the case with S&P's rating of US Government debt. Hence I think we taxpayers should all thank S&P for their incredible generosity — providing their useful, cerebral and predictive analysis of the United States of America — totally free of charge. (Either that, or you get what you pay for.) 

Ken Drees writes:

Looking for the next trend or meme– could this all be a preamble to QE3 in June or the no mas to GE? So it's a battle stations type of market that comes to us this summer with much more volatility then we have been conditioned for? I wish I could quantify the persistence of trend beyond the rational into some type of indicative feature. Financial alchemy– chasing that idea.

Gary Rogan comments:

How high the debt to GDP needs to be before a country goes kaput is clearly numerically an unsolvable problem, especially for sovereign money printers like US and Japan. If the bond market keeps buying the debt this can go on essentially forever. If the economy is barely making it but trending upwards there doesn't even have to be any appreciable inflation for an unknowable period of time. Therefore it's not clear what the rational approach should be to evaluating the situation, and then people focus on the differences like the Japanese debt being owned so much by the internal population, and that population being so thrifty. Clearly part of the reason that the debt has risen in importance is not the absolute level but the seemingly uncontrollable actions of those who are creating this debt while paying lip service to "living within our means". People don't like it because to them this symbolizes irresponsible behavior, because they know that their neighbors or relatives who do that get in trouble, so then there are political consequences to this behavior and the opposition party makes even a bigger issue, and so it goes and goes. This is totally different from the bond market making a judgment about the country in question defaulting. I personally think its the ridiculous that the main generator of this debt has just made a speech in which he proclaimed that we can't spend more than we take in, and have heard it compared to Colonel Sanders making a speech declaring that we can't just go on killing chickens this way. And yet I don't know where it's all going any more than the next guy.
 


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  1. Brendan Dornan on April 25, 2011 1:18 pm

    Studies show ratings companies lag, so companies like Pimco make a good deal of their money by front running the upgrades and downgrades of the ratings agencies.

    Default risk is only one type of risk to bonds, and that includes sovereign bonds. They are subject to inflation risk, interest rate risk, repayment risk, liquidity risk, etc. Shouldn’t these be apply to sovereign bond ratings? And by those measures, is any of the G4 really a AAA rating? If the US is a AAA credit rating on the basis of a printing press, then all any developing or developed country is a AAA as well.

    http://bonds.about.com/od/bonds101/a/bondrisk.htm

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