Wednesday, May 29, 2013

Sovereign Debt Irrational Exuberance

Let us all be glad and happy that the masters of the universe have the entire financial game figured out. Sure, they get to keep plenty of the revenue, but we do get cheap plastic toys, iPhones and plasma tvs. It's a fair trade. Maybe we should caution them though because some things are popping up that are weird. The FED keeps printing and sucking up US debt obligations, so where is the regular investment community going to put their cash, especially those funds that have fixed return targets? The latest and greatest market bound to blow up in the face of the investment community is frontier sovereign debt. Frontier market debt reaching generational if not lowest of all time yields is a sign of a hyper-blown up bubble in bonds.

Frontier market debt is debt from countries that are on the fringe of emerging markets. Bolivia, Paraguay, Honduras and even Rwanda have all performed recent auctions. This won't end badly. Paraguay auctioned off 10 year bonds at 4.625%, yielding less than General Electric's 10 year bonds. Who do you bet on paying you back? GE or Paraguay. One has a track record of paying back money and can help buy the US presidency. One is a developing nation with a presidential election ahead of it. To put this in perspective, US 10 year bonds had yields around 4.625% in 2007. Rwanda sold debt at 6.635%, which is interesting considering we westerners can still watch documentaries and dramatic films based on the recent genocide of millions and its aftermath. That's a great risk! Sign me up.

Particularly smart yet stupid at the same time is a set of quotes later in the article:

Jan Dehn, co-head of research at emerging market specialist firm Ashmore Investment Management, which owns $78 billion in emerging and frontier market assets, said: "There is a bubble in fixed income, but it is found in the heavily indebted developed countries, not the frontier markets." 
Dehn contends U.S. government bonds are riskier than frontier markets, saying a U.S. 10-year Treasury Note that yields around 1.65 percent provides inadequate compensation for inflationary risks he sees as likely to emerge.

Very good points. The developed countries are in a debt bubble. Inflation upticks of small amounts can wipe out the return of 10 years USTs. The entire sovereign debt market is in a bubble. These piss ant countries do not have their debt in their currency but in other currencies like the dollar or euro. They can't print out of their debts.

Anything part of the dollar bloc will suffer in a dollar crisis as well. I'd ask Mr. Dehn if the UST market at low rates is poor protection in a rising inflation/rate market, then how do bonds with a slim risk premium over the USTs protect one more in a rising risk environment? Getting 4.625% from Paraguay in a rising inflationary environment isn't going to cut it, and no, you will not reach the exit quicker than everyone else. A rising interest rate environment is painful for all risk assets, especially the wildest of frontier markets. While the US is the center for idiotic behavior, it is not the only stage.

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