Friday, November 27, 2009

Is the Dubai Debacle a Game Changer?


Here we see the falling yields on 10-year Treasury notes, as the flight to quality in the wake of Dubai default fears has driven those yields back toward October lows.

The effect of falling interest rates is to reduce the rate of return for investors seeking safe investments, as anyone shopping for certificates of deposit or short-term high quality bonds has realized for a while now.

That, in turn, pushes investors further out on the risk spectrum, seeking longer maturities and riskier asset classes. Hence, the recent outperformance of high yield bonds and both debt and equities among emerging market countries.

Most crucially, falling yields speak more to investor concerns over deflation than inflation. As long as headline inflation cannot provide political cover for the Fed, it is unlikely that there will be a change in monetary policy. That, over time, will support a managed decline in the value of the U.S. dollar, which in turn supports a transition from a consumption-based economy to an export-driven one.

At some point, that weakened dollar will exert inflationary pressures and we will have to reckon with the prospect of higher rates and a changed Fed policy. It's difficult at this moment to see that point on the immediate horizon: all of which will continue to support the dollar carry trade and the flight to risk assets despite stiff risk aversion shakeouts (such as the one we're seeing now) along the way.
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3 comments:

Matthew C. said...

Except once the dollar starts to spike and equities plunge on risk fears, there is always the looming possibility that the whole carry trade goes into super-reverse as everyone struggles to exit their positions, and it reinforces itself in a self-sustaining cascade.

Is today that day? Who knows, but seeing ES prints at -40 last night indicates that as one potential. The dip buyers (and most likely the PPT) are out there buying futures in force right now -- does this turn out to be the time they are wrong? Given the horrific imbalances in the global economy (debt levels in developed countries, an insane RE and stimulus bubble in China) it would not take much to see the Jenga blocks come tumbling down. . .

OKL said...

Oh, a phone call to Geithner/Bernanke will do the job Mr. Dubai; they can just print it.

After all, what's $80b between friends? Can't even measure up to AIG FNM/FRE or C.

Just do some deal using oil/commodities or politics to keep the economy stable; don't worry, every govt is doing that, so the people won't think there's something wrong- at least not when you announce its out of good intentions, which directly addresses their fears of losing their rights/entitlements.

It's a small affair.

Well, but please at least stop the ridiculous idea of having a man-made ski-resort in the middle of a desert.

If you haven't already realized, that palm-tree and world island idea wasn't really that great after all.

It might work if you promise Geithner/Bernanke a few houses there. Oh, don't forget about Lloyd, Vikram, Paulson, Bush, Buffett and Obama too.

*trying to be sarcastic*

GS751 said...

I am surprised people are surprised about Dubai. If building Ski resorts in the middle of the desert is not excessive I don't know what it is. It was only a matter of time before this happened

GS