Buy Spain sell US no thank you!

Wednesday saw the release of the Beige book. The Beige book is a US economic report published 8 times per year. It is a compilation of anecdotal information from each of the 12 Federal Reserve Banks on current economic conditions in each of its respective districts. The reports come from Bank and Branch directors and interviews from a variety of business sources. Without going into Wednesday’s commentary in great detail, the general conclusion to the report is that the US economy continues to plod along at a satisfactory pace. The overall assessment was that the report is likely to confirm the Federal Reserve will end its bond-buying program in the 4th quarter of 2014. Probably the most encouraging sign was that labor conditions were reported as generally strengthening. The hawks looking for signs of future inflationary pressures will highlight that seven districts reported wage increases.

US treasuries paid little attention to this report, after the sharp jump in yields on Tuesday, 10-year US treasury yields stabalised at 2.6% on Wednesday. The difference between the yield on the Spanish 10-year bond and the 10-year US treasury is now just 0.28 of one percent. For those traders who were brave enough a year ago to buy Spanish bonds and sell US treasuries, they would have done well. We would imagine those traders were few and far between, and those risk managers who would have agreed to the idea even fewer.

We often talk about how bond yields impact equity valuations; today BCA research amply demonstrated this point. They believe if short-term rates go back to a historic average of 2%, then equities are on the expensive side. On the other hand if the real interest rate is half that at 1% over the next 20 years, then the present value of expected cash flows is 30% higher.

Tomorrow is a big day for the ECB; we would hope Mr. Draghi gets a good nights rest, as once again the eyes of the financial world in particular will be on him. The reaction of Spanish, Italian and German bonds will be where the equity markets will take their lead. It Is hard to see how peripheral yields can fall much further what ever the ECB does. For the German bund even at the current yield of 1.43%, that we would suggest is not necessarily the case.


Posted on June 5, 2014 .