Monday, June 11, 2007

Once, Twice, 3 X A Lady

Yes, I am still talking about bond yields going past 5% in the states. The chart showed that even the more super-charged internet bull run in 1999/2000 was eventually decimated by continuous rate hike. I believe the 99/2000 bull run was a few notches stronger than the current bull run, and may take less than 6.5% to reduce the run to a trot. I think my really danger level to get all out of equities is when yields reach 5.5%. Last week it hit 5.14% which was a relatively big jump aove the 5% threshold.

The chart also showed that one rate hike is not sufficient to puncture a bull. It has to be followed by successive hikes. As mentioned before, globally every country/zone that matter are about to raise rates even higher in the forseeable future: UK, euro zone, China, HK and Japan. In fact I don't see any major country contemplating NOT hiking rates for the rest of the year.

This bull is harder to be pricked because its a money supply growth driven rally. What that means is a lot of liquidity chasing after a reducing pile of assets and alternatives. I have been bullish since 2005 and have maintained that stance till now. I am still bullish but the signs are there that we are moving into the last stage of a 4 stage bull run which began in 2005.

In the US, a government report released last Thursday said labor costs are up more than anticipated, making it more likely that companies will raise prices and fuel inflation. Options traders raised the odds of a boost to 5.5% in the fed funds rate to nearly 41%. A month ago, the odds were zero. Those are big danger signals. Plus, any rate hikes by Japan, China or euro zone will immediately put very strong downward pressure on USD thus forcing the Federal Reserve's hand to raise rates in order to keep people holding USD.

If you were to look at the unbelievable NZ dollar, you will know that sensibility boundaries are being tested currently. NZD surged to a 22 year high early last week to 76.3 US cents. However late in the week, it had a minor collapse, dropping nearly 1.5% in value. NZD has been a big beneficiary of carry trades as investors borrow in yen and bought the kiwi dollar as it is now carrying 8% in interest rates. For a small economy such as NZ, 8% will stifle much of the economy, but it has to do that to keep the NZD steady. NZ's interest rates is the highest among all 30 OECD nations. Interest rates has to be high as there is ample liquidity coming in, and high rates are needed to stem inflationary pressures, currently running at 3% p.a. and pushing up. Billions of dollars worth of Uridashi bonds - issued to Japanese investors who borrow cheaply in yen, receive the bonds denominated in Kiwi dollars and earn New Zealand interest rates - have helped prop up the Kiwi dollar. Even the RBNZ was quoted as saying it regarded current levels of the exchange rate as exceptional and unjustified. The fact that te NZD has just broken a 22 year high at levels that their own reserve bank don't think is equitable should indicate troubling waters ahead.

Many factors could unravel the NZD: a) higher rates offered by other currencies relative to fundamentals (e.g. another hike by ECB may make holding the euro highly attractive relative to NZD as euro zone may have more stability and economic sustainability); b) yen carry trade holders panic and start getting out, prompting a rush for exit doors (as it is, NZD could easily go back to 68 US cents and still be considered fairly valued.) I have chosen to highlight the NZD as its the most visible for now, and an implosion in NZD could have some ramifications on global markets, especially emerging ones.

Why do I see rising rates as a determining factor? Because low bond yields and interest rates have been largely responsible for the two major factors which have been driving up markets over the past 2 years: a) private equity funding; and b) companies buying back shares. Higher bond yields and interest rates would make it much harder for PE firms to leverage and turn around companies (and PE firms feed on debt to enlarge returns and reduce capital commitments.) Higher yields and interest rates would narrow the gap between stock yields and risk-free yields, which will start to reduce the amount of share buybacks eventually.


boyplunger said...

What cause the yields to rise in the first place?in this case in the US?

Anonymous said...

A wave in motion can keep going until the tide turns. How long? Trillion dollars question now.

Since NZD is being single out, we can also look at others JPY crosses in order of yield differential.(central bank rates)

NZD/JPY 8-0.5=7.5
AUD/JPY 6.25-0.5=5.75
GBP/JPY 5.5-0.5=5
USD/JPY 5.25-0.5=4.75
CAD/JPY 3.75 (NET)

Now if you look at the monthly price chart of the above:
NZ is all time high level.
OZ is all time high.
GPB is 8 years high. (on the verge of breaking out a big base)
USD is at 5 years high.

what can keep the motion going?
As long as the big gap of yield dirrential exists.

How can the tide turn?and When?
Narrowing of yield dirrential.
When you see that, pls give me a ring at gmail, my name is price chart....haha.

Yesterday, the AUD/JPY went back up to high point and NZD recovered from the sell down.CAD/JPY is going strong while USD GBP and EUR is maintain against JPY.

BTW, some other countries that have equal or higher rates than NZD:
Brazil 12.5
Turkey 17.5
Iceland 14.25
Hungary 8.0
South Africa 9.0
Egypt 8.75

Well, the trillion dollar "yen" question!!!

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