Blood In The Markets

Blood In The Markets "Blood on the streets Runs a river of sadness. Blood in the streets, It's up to my thighs." ~ The Doors

www.mksense.blogspot.com Today there was blood in the markets. That is because that there was blood in the streets in the city of Athens, blood in the streets in the city of Lisbon. There may soon be blood in the streets in the city of Madrid. The bond vigilantes were put in force and the are seeing the Greece bailout measures for what they are, insufficient thus far. The concerns pervading the capital markets are that 1) Austerity measures may not be enough and debt restructuring may be necessary. 2) Greece may have to leave the Euro to devalue its way out of its troubles. 3) The contagion spreads beyond Greece to Portugal, Spain and to other European nations fracturing the confederation, rendering impotent as an economic bloc. Small investors have been expecting too big to fail to rule as it has since 2008 (unless you were Lehman or WaMu. Bond vigilantes think otherwise. The problems in Europe are severe. We are not talking about dubious assets with mark to myth valuations. We are talking about nations which are borderline (if not actually) insolvent. It is going to take more than restricting civil service pensions and benefits to pay for the kind of assistance Greece requires. Typically a nation, such as the U.S. can print money and issue debt to finance its deficits. The attractiveness of buying sovereign debt is that the issuing nation can usually make good on the return of your principal, albeit in a devalued state. EU members cannot issue currency on their own. They are like U.S. states without the cultural bonds and sense of common cause. The troubles in Greece have sent investors scurrying from the Euro into the dollar. This has sent both long-term U.S. interest rates and U.S. equity prices plummeting. Interest rates fell on strong demand for safe assets (obviously) and U.S. equities fell due to the strong dollar which affects price valuations and makes U.S. goods more expensive overseas, potentially damaging the manufacturing-led recovery. The question remains: Will this flight to safety push long-term rates even lower? Some experts, such as economists Goldman Sachs believe that the yield of the 10-year treasury is heading toward the low 3.00% area. The folks on Morgan Stanley's institutional department are of the opinion that the 10-year yield is heading into the mid 5.00% range by the end of this year. Although either scenario can play out, I don't think either will. For the Goldman scenario to play out, investors would have to become frightened to the point where they abandon foreign treasuries and credit products and plow money into U.S. treasuries. This is what has started recently, but with the U.S. also borrowing its way out of an economic hole (you didn't think the recovery was this strong on its own, did you?) so, other than central banks, their appetite for U.S. treasuries will have its limits. Gold could be the choice of non central bank investors looking for safety. Central bank and other investors needing safe income (pensions, insurance companies, etc.) will continue to purchase U.S. treasuries keeping yields in the mid to high 3,00% area for the foreseeable future. Even when it rises, mid to high 4.00% is about all we may see during this cycle. The Fed will see to that by removing stimulus and taking a modest tightening bias. It will only take a mild tightening to keep the economy from over heating. If the European contagion spreads, reigning in the economy will be the least of the Fed's problems. Those expecting TIPS and floaters to yield windfalls are likely to be disappointed. They should only be used as hedges to protect against higher inflation and a flatter yield curve, respectively and then only as a part of a laddered and diversified portfolio. Laddering 2-years to 10-years using a variety of products such as CDs, agencies and corporates, overweighting the belly of the curve, 5 to 7 years, may be the best way to approach the coming years. Tell your friends. I am looking for more subscribers.