Expect gilts to plummet
Jan 15, 2010
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So far, markets have been happy to finance Western economies' growing deficits, says Jeremy Warner in The Daily Telegraph. But now it seems they're "losing their appetite" and demanding higher interest rates to hold expensive state debt. American ten-year government bond yields have risen sharply (reflecting falling prices) in recent weeks, as have ten-year gilt yields – now at 4%, up from 3.6% in early December. Ten-year gilt prices have now fallen over 7% in the past year and are set to slide further.
British government debt looks like "an accident waiting to happen", says Simon Marsh of Killick & Co. The Bank of England is set to end its quantitative easing programme of bond purchases funded by printed money in February. By then it will have spent £200bn hoovering up 23% of the outstanding stock of gilts.
So soon we'll be "at the mercy of genuine investors", as Liam Halligan puts it in The Sunday Telegraph. And they see that we have a 13% budget deficit and are heading for an overall debt load of more than 90% by 2013. At that level debt begins to crimp growth, according to the IMF. The sheer scale of quantitative easing fuelled fears of inflation, while the credit-starved economy looks likely to struggle to hit the government's optimistic growth targets for 2010 and 2011. That implies yet more borrowing.
But the most immediate problem is political risk. Neither main party has produced specific ideas for tackling the deficit. The worry is that a hung parliament would stymie a clear deficit reduction plan. And if we don't "properly deal with the deficit" after the election, a debt downgrade is a "near certainty", says Invesco Perpetual's Neil Woodford. Investors will demand higher returns for holding UK debt, meaning lower gilt prices. Once Britain's debt rating comes under threat, yields will rise sharply, agrees Michael Hart of Citibank. This scenario implies further woe for sterling. Hart reckons it could fall back to parity with the euro in six months.
A rise in bond yields raises the prospect of an economic relapse. A trend of rising yields presents a headwind for equity valuations because it makes bonds more appealing. Using data going back to the 1930s, Morgan Stanley notes that each time a trough in bond yields has ended, the FTSE All-Share has corrected by 13% on average in the next few months.
The big picture: China becomes world's top exporter
China's exports fell for the first time in 25 years in 2009. But other countries' foreign sales slumped by even more, leaving China's total of $1.2trn last year ahead of Germany's forecast $1.17trn.
China is now the world's top exporter and its share of the global total has jumped to 10%, after growing by an annual average of 23% in dollar terms over the ten years to 2008, says The Economist. Indeed, according to the IMF, it will account for 12% of world exports by 2014.
China also became the world's biggest car market in 2009 – yet another illustration of the country's growing global economic clout.
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