Loads of Debt: A Global Ailment With Few Cures

30 Jun 2015 | Author: | No comments yet »

As a currency, the euro started Monday by losing ground to the dollar. But the euro had actually appreciated by the end of the day. The market’s message: A departure by Greece from the EU wouldn’t be such a bad thing over time..

That gargantuan sum of money is what central banks around the world have spent in recent years as they have tried to stimulate their economies and fight financial crises. After a long spell of tranquility, investors in the United States and most other developed countries are suddenly dealing with a heavy dose of uncertainty.Haven demand sparked by the crisis in Greece isn’t proving enough to prevent Treasuries from slumping toward a first quarterly loss since 2013, as yields climb with the Federal Reserve set to raise interest rates this year.Treasury yields tumbled Monday, recording their largest one-day yield decline since November 2011, as the latest escalation in the Greek saga, with the introduction of capital controls and an upcoming referendum, fueled flight-to-safety flows into U.S.

The rise in bond yields is worrying the central government as its cost of borrowing has shot up by 20 basis points across tenures over the last three months. U.S. sovereign debt dropped for a third straight month as a rebound in the world’s biggest economy from a winter freeze buoyed prospects for the Fed to lift borrowing costs as early as September.

The concern of the government was evident from the Reserve Bank of India’s move to reject all bids it received for three bonds at last week’s auction. Ten-year Treasury yields slid the most since 2013 on Monday after Greek Prime Minister Alexis Tsipras unexpectedly abandoned talks with creditors. “I really don’t think the situation in Greece will affect the Fed too much,” said Kei Katayama, who trades bonds at Daiwa SB Investments in Tokyo. The buying rally in Treasurys started in Asian markets and continued in New York, as investors braced for heightened volatility in a holiday-shortened week that will end with the closely watched U.S. jobs report on Thursday.

Treasuries look “a little overbought, but in this kind of flight-to-quality situation, the actual level is not so meaningful.” Ten-year yields were little changed at 2.31 percent as of 11:46 a.m. in Tokyo, according to Bloomberg Bond Trader data. Greek banks will be closed until July 6, to prevent capital flight as Greece prepares for a July 5 referendum that will determine whether it will accept reform measures demanded by its creditors.

The government has borrowed Rs 1.80 lakh crore during April-June by reissuing bonds across tenures and the cutoff yield set at auctions has been edging up at every successive sale. As European stock markets fell sharply and U.S. stocks also took a hit, government bond prices rose, as bonds are considered safe-haven assets at times of financial turmoil. Greece’s government has repeatedly called for relief from some of its debt obligations, and Puerto Rico’s governor said on Sunday that its debt was “not payable.” Both borrowers are extreme cases, but high borrowing, either by corporations or governments, is also bogging down the globally significant economies of Brazil, Turkey, Italy and China. Greece has shuttered its banks and its stock market ahead of a referendum next Sunday that will let voters decide whether they prefer to stick to more creditor-mandated austerity in return for access to more money or just say no and live with the consequences — which could mean an exit from the European Union and a return to the country’s own currency.

The yield on the 10-year Treasury TMUBMUSD10Y, -0.46% fell 14.7 basis point to 2.333%, according to Tradeweb, after gaining 21.1 basis points last week, the largest weekly gain in the month of June. Adding to the turmoil were expectations that the Greek government would not make a debt repayment to the International Monetary Fund that is due on Tuesday.

But a Greek departure from the group of 28 European countries — once so feared as an economic calamity — wouldn’t be such a big deal now beyond the borders of Greece itself. The Dow Jones industrial average sank 350.33 points, or 1.95 percent, while the benchmark index for investors, the Standard & Poor’s 500-stock index tumbled 2.09 percent, erasing its gain for the year. Conversely, yields on bonds in the so-called eurozone periphery, most notably in Spain, Portugal and Italy, were all up between 23 to 34 basis points.

Bloomberg’s U.S. economic surprise index, which measures the extent to which the data are above or below analyst estimates, rose to minus 0.46 on Monday, the highest since Feb. 27. Direct exposure to Greece beyond the official sector — or other European countries and institutions such as the IMF — is minimal, as European banks have only €5 billion ($5.56 billion) exposure to Greece, in the context of €32 trillion ($35.6 trillion) balance sheet, a J.P. Fed funds futures show there’s close to 30 percent odds the Fed will increase its benchmark rate from near zero in September, and a better than 60 percent chance by December, according to data compiled by Bloomberg. The RBI slashed its repo rate by 25 bps in its bi-monthly policy review on June 2 but said it has front-loaded rate cuts, indicating more rate cuts would be hard to come.

In fact, lower interest rates can persuade some borrowers to take on more debt. “Rather than just reflecting the current weakness, low rates may in part have contributed to it by fueling costly financial booms and busts,” the Bank for International Settlements, an organization whose members are the world’s central banks, wrote in a recent analysis of the global economy. The interest rates on short-term debt issued by those other countries, generally below 3 percent, suggest no one is worrying now about dominos falling in Europe. A further rise in the government bond yields of Spain and Italy could cause a contraction in the fiscal policy of those countries, noted Alberto Gallo, head of macro credit research at the Royal Bank of Scotland. They say the gains certainly weren’t triggered by evidence of robust economic growth and the pricking of the stock bubble doesn’t signal a dire turn for China’s economy beyond the slowdown that was clearly underway. Even worse, the island’s weak economy is actually contracting. “Puerto Rico is a very specific situation,” said Ken Taubes, chief US investment officer at Pioneer Investment Management in Boston. “It’s hard to sustain debt when you’re shrinking.” Puerto Rico’s bonds are widely owned by US municipal bond mutual funds, which owned the debt for its relatively high yield.

The Fed could move as soon as September to begin raising rates. “The Greek situation, if it got really, really bad, or if China had a really hard [economic] landing, could affect the Fed’s timing,” said Eric Stein, codirector of fixed income at Eaton Vance Corp. in Boston. “The US is not insulated from the rest of the world, but I tend to be a believer in the US economy.” Ukraine is moving closer to default after creditors continued lending to the country despite zero growth and a corrupt and opaque political and economic system.

Now, some of those creditors, including Franklin Templeton, an American investment firm, have resisted Ukraine’s demand they take a loss on their principal investment, preferring instead to extend the repayment period.

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