Market Musings Blog

Remember the dance called the Twist? Basically the twist is done swiveling around one’s hips, with feet pointing one way and shoulders the other. Watching the Euro zone action has been like watching a twist competition. One part of the Euro-body is moving towards a semi solution that the markets seem to like one day, while another part moves towards newly dismaying outcomes. “Hard” countries such as Austria are having trouble borrowing – a new development – and Spain is about to hit the magic 7% rate for government debt that signifies the beginning of the march towards a bailout. On the other hand, Greece and Italy have new governments, which the markets read as a positive sign.

New hopes rest with the European Central Bank, as investors and politicians have decided that it’s up to the ECB to save Europe by buying massive quantities of troubled country debt. But the ECB has other ideas, and those entail sticking to its edict to control inflation. We’ll see how long that lasts.

In the meantime, here are a couple of facts to chew on about Greece:

• The first recorded default dates to the fourth century BC, when ten Greek municipalities in the Attic Maritime Association defaulted on loans from the Delos Temple.
• In the last two hundred years, Greek has defaulted 51% of the time on its sovereign debt.

Makes you wonder why anyone would ever lend Greece money, eh?

For several years leading up to 2011, investors were assuming that inflation would carry interest rates in the US sky high as our government dealt with the credit crisis. The Fed’s “open spigot” strategy, keeping the money taps flowing, and the administration’s fiscal stimulus – surely all that money sloshing around would create substantial inflation. We were long on the other side of this argument (see Slow and Low, in Resources, for our article in the Portland Business Journal on the topic), believing that inflation wouldn’t translate to high interest rates any time soon.

Now, investors have swung the other way, worrying that the US is in for a long period of slow growth, just like Japan, with potentially permanently low interest rates. But the link between being like Japan growth-wise, and having a bond market like Japan’s is not so clear. Japan’s own citizens buy its bonds and for many, those bonds are the only available investment alternative for income; the US must rely on the largesse of foreigners to fund its debt. Thus, Treasuries compete with many other investment alternatives, which we think will prevent low rates forever. We still don’t think big rate hikes are anywhere on the horizon, but assuming that low growth will always mean a yield under 2% on the ten year Treasury could prove unrealistic.

The latest news from the Euro zone shows some slow progress towards the most critical aspect of the whole Greek tragedy: stemming contagion from big write offs at Euro banks. As the Euro zone accepts that Greece must default in one way, shape, or form, banks are expected to take it on the chin. Containing that damage is crucial for the world economy. As we write this, Euro zone leaders are at a working dinner, attempting to find grounds for agreement. The dinner guests probably don’t include the two Italian lawmakers that went to blows yesterday on the Parliament floor over the generous pension system in Italy.

With every step towards a resolution, the US stock market shows some underlying bullishness. Today’s rally was goosed by good earnings, but the backdrop of progress in the Euro zone, however slender, certainly helped. Also contributing to the ebullient mood were signals from China and India that their monetary tightening policies may be near an end. Of course, what’s good for stocks is not so good for Treasuries, which declined in price today. The month of October has been a rough one for Treasury owners, as that market has racked up losses from the very low interest rates that prevailed in September.