The Bond Bubble, PAYGO (Again), Demise of the Euro, CEO Pay and More!

by Addison Wiggin & Ian Mathias

  • Bond bubble burps again… traders finally concerned over U.S. debts, money creation
  • BRIC nations join the chorus… their clever method of ditching U.S. paper
  • “The financial crisis is not over,” declares Chris Mayer, with a compelling chart
  • Bill Jenkins on a major currency looking ripe for collapse
  • Plus, government launches executive pay regulation… a CEO shares his thoughts, below


  The bond vigilantes have spoken. They’ve cried in a powerful chorus, “Ehhh… we’re a little annoyed.”

The much hyped 10-year note auction Wednesday got a lukewarm reception from global buyers. As you can see, when the auction began at 1 p.m., investors quickly demanded a 4bps hike in the underlying yield — according to Morgan Stanley, the biggest markup at an auction’s outset since May 2003.

That helped bump the yield on the 10-year as high of 4.0%, its highest since October. Traders definitely made themselves heard — worries about debts and deficits in the U.S. are back in the spotlight. But we wouldn’t say it was in renegade vigilante fashion. 4% is a point of historic buying support for the 10-year… it’ll capture our interest again when that level is tested.

(BTW, congrats to Options Hotline and Resource Trader Alert readers. Both have bought options that rose while Treasury prices fell… OHL readers have open calls on TBT, an ETF that shorts long bonds, that are up 103% and counting. Meanwhile, RTA readers cashed in their bond puts yesterday, for 154% gains. Want to get in on the next trade? Check out Resource Trader Alert… 50% off for the next week.)

  And what a coincidence… the very day of this highly anticipated bond auction, Russia and Brazil both announced they’d soon be selling $20 billion in U.S. Treasuries in exchange for IMF bonds.

It’s a smart move… each nation gets to diversify out of the dollar (the IMF will pay these bonds back with a basket of global monies) and send a clear signal to the U.S. government. But their leaders can hide behind altruistic intentions: “This support is important to help end the international financial crisis," said Brazilian finance minister Guido Mantega. Since the money will go to the IMF’s emergency fund, Brazil and Russia get to look like generous, globally cooperatave players… even if their only intention is to get the hell out of U.S. Treasuries.

Coupled with India and China’s recent call to sell U.S. bonds for IMF paper, that’s $80 billion in U.S. debt to be sold… just what the struggling market needs.

  Look for more bond turbulence today: The Treasury will spew $11 billion in 30-year bonds, another auction likely to elicit an unpleasant response. Attentive bond observers will recall last month’s long bond auction, which was given a “dismal reception,” in Reuters’ words. Since then, yields on the 30-year bond have climbed as high as 4.83%, its highest level since October 2007.

Still… would you let this government borrow your money for 30 years at less than 5%?

  All the bond drama has the Obama administration scrambling to appear fiscally prudent. Their latest attempt: more whispers of PAYGO legislation.

“The ‘pay as you go’ principle is very simple,” said the President yesterday. “Congress can only spend a dollar if it saves a dollar elsewhere." So simple, yet somehow so impossible for Washington to employ. We applaud such spending restraint… but talk is cheap. Mr. Obama preached similar legislation in February, which never saw the light of day.

And of course, PAYGO legislation is unlikely to have any effect on 2009’s record $1.84 trillion budget deficit. Spend first, reform later…

  The Federal budget deficit rose a record $189.7 billion in May, bringing the fiscal year’s current total to $991 billion.

  Regional economies in America are “still weak,” but some are no longer in free fall, says the Fed’s latest Beige Book release. Published yesterday afternoon, the best the book could muster was that the “downward trend is showing signs of moderating,” in five of the 12 regions.

In the 2,243-word executive “summary,” the word “inflation” was not mentioned once.

  “The financial crisis is not over,” declares Chris Mayer. “The mortgage bubble infected a number of areas beyond just subprime. The subprime crisis was the first to drop, like a marathon dancer that falls to the floor exhausted. But there are still other dancers on the floor ready to topple over too.

“Take a look at this next chart, which has gained some currency in the worried circles of financial people. It’s worth a bit of study. It shows you the other dancers on the floor.

“Subprime is only one slice of low-grade bologna. It sits at the bottom. Alt-A is the next riskiest slice of mortgages above subprime. Alt-A are mortgages to people who are better credit risks than subprime, but still not prime. Documentation is still spotty as far as verifying income, and loan to values are high. Plus, about a quarter of these mortgages went to nonowner-occupied homes — which were subject to even greater speculation.

“The scary thing is that this mortgage market is 50-100% bigger than subprime.

“Unlike subprime, Alt-A loans typically have five-year resets — meaning, the interest rates adjust to higher rates. The Alt-A reset surge doesn’t really get started until 2010! It continues through 2012. You’ll also see something called ‘option ARMs’ on that chart. These loans usually have ultra-low teaser rates and often were interest only. Again, the reset surge for these loans only starts in 2010.”

Factor in scary-large “jumbos,” many near-worthless lines of home equity, the injured credit card and auto loan market, commercial loans for the leagues of ailing businesses… still seems awfully dark out there. If you’d like some help navigating your way through this mess, check out Mayer’s Special Situations. We’re currently offering one-month trials for just $1. Details here.

  Despite all the U.S.’ woes, the dollar is holding pretty steady. The dollar index is just a hair lower than yesterday, now at 79.8. Thus, the dollar’s major competitors are just a few cents off recent 2009 highs… euro: $1.40, pound: $1.64, yen: 97.

Interestingly, the pound is currently at a 2009 high versus the euro, at 85 pence. Trader fears are mysteriously shifting out of the U.K. and into Europe, where the “one currency fits all” model is again in question.


  “It only makes sense,” writes our currency trader Bill Jenkins, “that given the present situation, a country like Ireland should not be able to borrow at the same rate as a country like Germany. Yet that has been the very working policy of the ECB. One size fits all. Everybody borrows at the same rate, so theoretically, as they put that money to work, they all profit at the same rate. It supposedly provides some synchronicity to the economies. The only problem is, it doesn’t.

“Germany is putting the squeeze on other members. The more trouble the PIGS (Portugal, Ireland, Greece and Spain) are in financially, the worse they feel the squeeze of Germany’s unrelenting and strong fiscal discipline. And it provides yet another reason for Germany to exit the Union. Simply staying on just to feed the PIGS isn’t going to do it.

“At the same time, the incentive for the PIGS to join the Union in the first place was to piggyback on the strength of the Germans — it offered them lower rates at which to borrow. Now they are seeing rising rates, as they are forced to borrow outside the ECB. Rising rates with a stable currency they cannot control forces them to lower wages on their citizens as the only outlet for financial pressures. No politician wants falling wages on his term record!

“In short, I don’t think the euro has any lasting strength in the years ahead.” Interested in profiting from this trend? Look no further than Bill’s Master FX Options Trader.

  While volatile, the stock market has been pretty boring this week. Yesterday’s early gains courtesy of Chinese growth were erased by fears surrounding the bond mess. Indexes ended flat for their third day in a row.

  China isn’t looking as hot today as it did Wednesday. Exports fell there by a record 26.4% from May 2008-May 2009, says the Chinese customs bureau today. While we were dazzled by their auto and property sales numbers yesterday, without overseas sales, recovery for the world’s second largest exporter seems quite tricky… to say the least.

  Commodities are on the rise again today. Oil’s up nearly a dollar, to another 2009 high of $72 a barrel. Base metals like copper, aluminum, lead and nickel are at YTD highs, too. Gold’s holding steady around $955.

  Two items in the data cupboard today, both seemingly positive, but not really:

Retail sales rose in May by 0.5%, the second month in a row and their best since January… Hooray! Oh, but the rise in sales was lower than expected and almost entirely attributed to higher gas prices… bummer.

And initial claims for unemployment fell by 24,000 last week to 601,000. Good news: That’s the fourth week in a row and the four-week moving average of claims (621,750) is at its lowest level since February. Bad news: there are still 6.8 million Americans filing for unemployment, a record high. Last week’s streak-breaking drop in continuing claims was revised to another gain, so this is the 19th week in a row of record-high claims for unemployment benefits.

  Last today, the Obama administration has officially embarked on a campaign to control CEO compensation. The Treasury announced yesterday it will oversee CEO pay at seven of the world’s most hated companies: AIG, Citi, Bank of America, GM, Chrysler and both the automakers’ financing arms. In a twisted way, we suppose it’s “fair,” as the government is the largest shareholder in each of these companies. And we’re glad the Treasury has limited themselves to just these organizations. But oh, my… what a slippery slope.

The Treasury Department is also calling for legislation that would give shareholders a more direct say in CEO pay and board member elections. Like PAYGO… sounds good, but as of now, it’s all talk

  “I can’t take the whining any longer, and I just had to respond,” writes a reader, responding to our ongoing debate on government regulation of CEO pay.

“As CEO, board member and secretary of the corporation for an eight-year-old company, I am required to give to any shareholder a number of items upon request within several weeks, as mandated by State statute. I have not once been asked for any board meeting minutes, articles of incorporation, bylaws, current financials, etc., by any shareholders, even though they have the legal right to obtain these. Any shareholder can request a complete shareholder list with names and addresses, as well as stock ledgers to foment insurrection in whatever area he or she chooses to do so, including trying to call a dissident shareholder meeting. This is where CEO pay can be addressed.

“The shareholders have more rights than they realize or choose to exercise. The main reason is people are lazy about their investments. I also invest in other penny stock companies, but I always do my own due diligence. In my penny stock companies, I know all the officers, including home phone numbers, and personally call the companies once every few months. I have never missed a shareholder meeting, to include flying across the country for these. I visit these companies at least once a year. I try every means to legally obtain information about these publicly traded companies, as there is little public information available.

“Investing takes hard work and risk capital, and most people are too lazy to do this. I am sorry for the long diatribe, but uninformed shareholders grate on me. Keep up the good work. The 5 rules.”

Our pleasure,

Ian Mathias

The 5 Min. Forecast



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