Since the beginning days when real-interest rates turned negative coincidental to ZIRP and breakneck growth in countries with USD pegged-currencies not to mention large & reckless income tax cuts, I have toyed with the idea that, rather than thinking that credit spreads are diminishing because investors are less risk-averse, perhaps it is simply the case that the so-called risk-free benchmark is [quite plausibly] becoming, errr....ummm...more risky. Perhaps P&G's 6% of 2014 should be priced at 70bps under like-maturity US Treasury's since the cash-flow thrown off by Crest, Clairol, IAMs etc. has its sources well-diversified internationally, and is more certain than the willingness of Joe Sixpack to bear higher taxes and longer working hours in order to make good on the US's prodigious IOUs to foreigners. Perhaps the bonds of lowly leveraged prime-location REITs (Boston Props, SL Green) backed as they are by the assets themselves sitting tenants on top of copious amounts of market value of equity should be 150bps UNDER equivalent treasury's.
Call me a heretic, but with the demagoguery surrounding the politics of fiscal policy, the ignorance of the people, and the seeming near- indifference of the FRB, I do not think this hypothesis is so far-fetched....
Interesting thought. I myself have been wondering what happens when the 'unstoppable force' of unsustainable current account deficits runs into the 'immovable object' of US Treasuries as safe haven. I guess this is the fundamental point of debate between the Bretton Woods II school of thought and the Cassandra's warning of US profligacy.
Kind of you to say, but but as you rightly point out (finely illustrated, by the way), quality spreads have narrowed in the Euro-zone as well. This makes my theory more whimsical than anything else (though I must admit I amuse myself by thinking of the implications to the efficient frontier and other cornerstones of finance). As I mentioned in my April posts "BOJ's Blind Date" and in "BOJ v. MOF: FInancial Kabuki?" I think the real culprit is liquidity itself and this has no unitary source (though US Fiscal deficits, Japanse Fiiscal deficits, China's growth peg, along with ZIRP (in Japan) and near-ZIRP from 2002 to 05 in the USA, are the most guilty parties.
I take your idea one step further since I am after all Cassandra and I do DO Tokyo: what will happen to the Yen when the carry trade bursts?? In a nutshell, think 1998. I had the privilige to witness the macabre aftermath at a trading shop with an impossibly large short Yen position (not mine!!) going into the LTCM crisis, and it wasn't pretty. Yes it was bad enough seeing the move from 145 to 132 in short order, but to wake up one morning and see it move another 13 handles - mostly without a trade - THAT was absolutely astounding. After witnessing that fiirst-hand, it makes me laugh every time someone earnestly asks me if I employ VaR in my risk management arsenal....??!?! Well, It's taken 6 years to build those carry trades back-up, this but time with the blessing of both MoF and BoJ and the Fed, not to mention Congress & every restauranteur in Greenwich CT..
I still have a sneaking Tom-Clancy-like suspicion that 98 was the result of an ultimatum from the BoJ (back when they too had some integrity left) to LTCM GS Tiger & Soros to stop stealing from the Japanese people. They told them in so many words where their bid was (120), and said unwind it.....see you there. OK maybe it was just the pari passu in the market trying to squeeze out of a matchbox-sized exit but that was second only to 1987 for sheer HOLY WOW! Looking at the BOJ's enormous balance sheet, I cannot imagine it will be any different this time around...
Any thoughts from the cynic?
====
"The United States is heading for bankruptcy, according to an extraordinary paper published by one of the key members of the country's central bank.
A ballooning budget deficit and a pensions and welfare timebomb could send the economic superpower into insolvency, according to research by Professor Laurence Kotlikoff for the Federal Reserve Bank of St Louis, a leading constituent of the US Federal Reserve.
Prof Kotlikoff said that, by some measures, the US is already bankrupt. "To paraphrase the Oxford English Dictionary, is the United States at the end of its resources, exhausted, stripped bare, destitute, bereft, wanting in property, or wrecked in consequence of failure to pay its creditors," he asked. "
http://www.telegraph.co.uk/money.../14/
ixcity.html
I am no economist, but my post today discusses the impact of the 'wall of debt' created in the last 5 years in the financial markets. I think it will have a huge imapct on the carry trade as you discuss so well here and will need plenty of unwinding; necessatatin higher base rates, when the time comes.
Economists Are Destroying America
Economists, politicians, and executives from both parties have promised American families that “free” trade policies like NAFTA, CAFTA, and WTO/CHINA would accomplish three things:
• Increase wages
• Create trade surpluses (for the US)
• Reduce illegal immigration
Well, their trade policies have been in effect for about 15 years. Let’s review the results:
• Declining real wages for 80% of working Americans (while healthcare, education, and childcare costs skyrocket)
• A record-high 46 million Americans who don’t have health insurance (due in part to declining wages and benefits)
• Illegal immigration out of control
• Soaring trade deficits, much with countries that use slave and child labor
• Personal and national debt both out-of-control
• Global environments threatened by lax trade deal enforcement
Economists Keep Advocating Policies That Aren’t Working
Upon seeing incontrovertible evidence of these negative trade agreement results, economists continue with Pollyannish blather. Some say, “Cheer up! GDP is up and the stock market’s doing fine.” Others say, “Be patient. Stay the course. Free trade will raise all ships.”
Even those economists who acknowledge problems with trade agreements offer us only half-measures—adjusting exchange rates, improving safety nets, and providing better job retraining. None of these will close the wage gap in America—and economists know it.
Why Aren’t American Economists Shouting From Street Corners?
America needs trade deals that support American families and businesses in terms of wage, environmental, and intellectual property abuses. Why aren’t economists demanding renegotiation of our trade deals? There are three primary reasons:
• Economists are too beholden to corporations and special interests that provide them with research grants.
• Economists believe—but refuse to admit—that sacrificing the American middle class is necessary and appropriate to generate gains in third world economies.
• Economists refuse to admit they make mistakes.
Economic Ambulance Chasers
Now more than ever, Americans need their economists to speak truth and stand up to their big business clients. Instead, economists sound like lawyers caught chasing ambulances: they claim they’re “doing it for our benefit”.
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