Monday February 21, 2005 - 11:30:41 GMT
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Black Swan Capital - www.blackswantrading.com
Dollar yeild differential may surprise
“Traditionally, truly stalwart Fed chairmen like William McChesney Martin and Paul Volcker felt impelled to lean against the prevailing financial wind when it turned threatening. They showed no hesitation, moreover, in using every arrow in their quiver to defend or restore stability. Mr. Greenspan has never had much stomach for the political heat that invariably follows adopting necessary but unpopular measures to, say, contain a mania or even temper irrational exuberance. He'd rather be liked than right.”
Alan Abelson, Barron’s
Increasingly analysts are concluding the positive dollar yield differential over euro is already “in the market.” And it’s really not that significant anyway. Here a view that could suggest otherwise.
Eurobund prices are on a tear. And they will continue to out pace equivalent 10-year US Treasuries. And the yield differential between the US dollar and euro will continue to widen in favor of the buck, according to Morgan Stanley economist Joachim Fels. Why? Stagflation!
“Liquidity appears to spring eternal, providing euro area and global financial markets with the wherewithal to push asset prices higher still. More specifically, I see two implications. First, with the Fed raising interest rates further in the next couple of meetings and the ECB on hold, the euro carry trade should become increasingly popular. Investors and speculators will find it increasingly attractive to fund themselves in euros to invest in higher-yielding assets within or outside the euro area. As a consequence, the euro could depreciate further. Second, the transatlantic yield gap looks likely to widen further, with US Treasuries likely to underperform euro area bonds.”
Below is a weekly chart comparing 10-year Euro Bund to10-year US Treasury Note futures:
Another of our beliefs is that China has not come in for a soft landing as seems to be the consensus belief. The continuing overinvestment, or malinvestment, within the country, on top of a wretched banking system, continuing corruption, and rising social unrest indicates the chances for bust are still as great as ever. (See Crash landing coming for China for more details; it is, an article I wrote for the Asia Times last year: http://www.atimes.com/atimes/China/FK12Ad05.html . My view hasn’t changed much since then.)
In Barron’s today, you will find and excellent piece highlighting the views of Stratfor, a private intelligence service based in Austin, Texas. George Friedman is head of the firm, and he always seems to have extremely interesting, and often prescient, insights to key political and economic events. This is an excerpt from Barron’s dated today:
"’Today's China boom can only be compared to the dot-com frenzy of the late '90s in the hype and conviction that China will somehow defy all the rules of normal economic cycles,’ he [Mr. Friedman] avers. Yet many observers are still agog over China's low labor costs, the gleaming office buildings of Shanghai, the state-of-the art plants rimming its eastern cities, huge currency reserves and surging trade surpluses.
“Friedman sees growing imbalances, seething social discontent and a rotting financial structure. In fact, to Friedman, the current China exhibits unsettling similarities to Japan in the late '80s, just before the sun set on the latter economy.
“China, like Japan of yore, is experiencing an insensate real-estate boom and looming overcapacity in its industrial base.
“The financial structures of both countries suffer from the rot of loan misallocation, a shaky banking system and a huge overhang of bad debts, Friedman notes. Likewise, much of today's economic growth in China is profitless, due to both the weight of moribund state-owned enterprises in the economy and a mania for market-share growth at the expense of economic returns.”
I remember when Japan was supposed to take the baton from the US and become the world’s next great power as the Nikkei was soaring towards 35,000. In fact, I remember this quote carried in The Wall Street Journal by someone important within Japan’ foreign ministry at the time (early 80’s I think): “America will be our farm, and Europe will be our boutique.” Wrong!
Sure, the dynamics are different now. But, for all of you fretting (or wishing) and wringing you hands over the world reserve currency in jeopardy, hegemony, and all that weighty stuff, let’s not count America out just yet. For if China does “meltdown,” the weight of the US as a stabilizing force could look more important than ever. And that, net-net, would be good for the dollar.
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