Negative Yields?! Everything is possible now

This week for the first time since the depression of 1929 the yields on US Treasuries turned negative i.e., investment in such Treasuries would pay back a lower amount on maturity. The three month Treasury bills gave a return of negative 0.005 pct. As the Treasury yields plumbed new lows the credit spreads of high-investment corporate papers worsened further. Spreads have actually doubled during the last 9 to 12 months reflecting the fear factor. CDS on Sovereigns have increased 8-10 times even for G7 countries during the same period!. Net of such spreads yields have dropped to ridiculously low levels reflecting the starkness of fear which is pervading in the world today. Certain indicators such as TED spread which is now at about 2 pct and yields on 30-day Commercial paper (at below 1 pct)etc seem to suggest that the liquidity overhang was helping to bring in some relief and credits were able to access better rates. However, the negative yields on Treasuries threatens to upset the improvement in the markets.

Madness or Fear -

November saw the dividend yield on S&P Index overtake the yield on Treasuries for the first time since three decades showing up the extreme pessimism that has set into the credit markets. This week brought in negative nominal yields after almost
8 decades reflecting the extreme fear prevailing in the market.

The week also saw the evaporation of any residual hopes that Automakers in the US had of a Federal Bailout as the Senate decided that Bankruptcy was afterall not a bad option for the Big Three. The Executive Wing had to immediately step in to promise its support from the TARP in another example of the twists and turns that the programme has been subjected to. It has evolved into a programme that was targeted at purchasing trouobled assets but has actually provided capital/funding to the banking sector and is now addressing the funding constraints of the auto sector. The prospect of use of TARP funds for the Autosector has helped recovery of global markets on Friday.

This episode is the latest one in the series; there will be more to come. This episode which has taken weeks to reach the current stage, shows that governments are increasingly being forced by markets to intervene and support industries. Unfortunately, all these measures seem aimed at supporting the supply side. Markets have anyway decided that this measure is a short-term fix and has a good chance of ending in zero improvement unless the US economy stablises or the Government follows up with more wholesome measures (covering the entire economy). However, the problem is on the other side where consumers fear losing livelihood and bankruptcy (and foreclosures due to inability to service their mortgages). It will take time for the demand side to revive. Until then, pushing the supply side can only worsen the supply/demand equation and lead to pricing weakness to exacerbate.

Currencies

Finally, the week saw the EUR and GBP reverse from their lows. After straining for weeks, on Friday, the Japanese Yen managed to break through the 90 barrier against the Dollar after news of failure of Auto bailout by the Senate hit the market and reached a 13-year high of 89. The move from 91.50 was worth more than 2.50 pct but the move exhausted within the day itself. A move of 3 pct is counted as a large move in the markets. However, the reversal came not from any BOJ intervention (as many had been hoping for sometime), but by the assurances of the US Administration that it would use TARP funds to organise the bailout. The move in the Jap Yen, the mother of all carry currencies on the back of the failure of the Auto bailout as well as the reversal on news of infusion of TARP funds suggests that nerves are really frayed at this stage. But, the key input for markets was the apparently nonchalant reaction of the Japanese to the fall in USD/JPY. Does this mean that we do not have a line in sand any longer? For all those holding long USD/JPY positions on derivatives, or running Yen denominated loans nothing could be more worrisome than this. We need to watch for markets' reaction on Monday. However, if the reactions of equity markets on Friday (in London and US) are any indications, it seems that the break down of the USD/JPY may take some more time.

Meanwhile, the nice rally in EUR/USD helped pull up commodities. EURO is close to resistance zone, so this week's action is important as we run into Christmas holidays from next week. The action on emerging markets' currencies has been a little mixed with the Korean and Russian currencies showing some weakness while many other currencies have strengthened along with stock markets.

The recent moves, with small rallies adding to each other, suggest that we are in the midst of a bear market rally. Equity markets are likely to lose when the quarterly results begin to come out. With all countries (that count) effectively in recession, or suffering from big drops in GDP growth rates there is no way that a rally in equity markets can be sustained so soon. More pain is on the way.