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The $83,000bn question
Published: June 18 2010 15:36 | Last updated: June 18 2010 19:43
“Sovereign credits are vulnerable,” said Bill Gross in March. But
since then the manager of the world’s largest bond fund has been
piling into US government bonds, according to Pacific Investment
Management’s latest update.

On Friday, former Federal Reserve chairman Alan Greenspan warned that
unless countries get their fiscal houses in order, “long-term rate
increases can emerge with unexpected suddenness”. Still, 10-year
Treasury yields are at a low 3.2 per cent, down from 4 per cent in
early April.

EDITOR’S CHOICE
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Leveraged loan financing comes out of deep-freeze - Feb-02

Deflation concerns recede on inflation barometers - Jun-02

UK sees strongest demand for long bond - Jun-02

Derivatives sector wakes up to the new reality - Jun-02

OTC derivatives plan lifts shares - Jun-02

Nothing divides opinion these days more than the outlook for bonds.
The big question is how indebted governments should approach fiscal
policy. The likes of Mr Greenspan and the Organisation for Economic Co-
operation and Development believe high deficits must be tackled now.
The opposing argument is that the global recovery is still too fragile
to handle a large fiscal contraction and, besides, there is no
evidence of the danger signs of inflation or rising yields – quite the
opposite in fact. None other than the administration of the world’s
largest economy appears to hold this view.

Rubbish, reckons Mr Greenspan. Buyers of Treasuries are blinded by
basket-case Europe: just because US bonds are less bad does not make
them attractive per se. He also notes the narrowing of the 10-year
swap spread, the difference between interest rates in the private swap
market and those for Treasuries, from about 80 basis points in 2008 to
just above zero today. In other words, investors are increasingly
asking Uncle Sam to pay up relative to private parties, a worrying sign.

Unfortunately, demand will suffer whether via sharply lower government
spending or runaway interest rates. The former may well be enough to
support bonds. Equity investors, however, lose either way.