Market Anomaly: Bunds Yield Less than USTs, Short Bund Long UST trade?

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Market Anomaly: Bunds Yield Less than USTs, Short Bund Long UST trade?
The current conditions are so tough in Spain that it made ex-Prime Minister, Felipe Gongalez say, “we’re in a situation of total emergency, the worst crisis we have ever lived through”.  This comes after Spanish bond yields rose to 6.7%, only .3% away from “default risk”.  In addition, the IBEX index of Spanish stocks fell 2.6% and is at its lowest point since 2003.

The 23.5 billion euro rescue of one of the country’s top lenders, Bankia has had some backlash as the central bank governor, Miguel Angel Fernandez was forced to resign for not sharing his knowledge of the possible failure of the bank.  As of right now, no one has shorts on Spanish government debt.  The reason being is that these were the levels that we saw last year when the ECB came in and gave out loans to help stabilize the markets.  However, if the ECB comes out and says that it has exhausted its resources to help lend, it will seem as though all European assets fell off a cliff.

Currently, Spain and the rest of Europe are going through a difficult time that resembles much of what 2008 looked like for the US.  The possible Greek departure doesn’t do any favors and policymakers are already setting up emergency measures to implement if Greece does end up leaving the euro. However, that won’t stop a broad sell off and the possibility of the euro going to $1.15.

Right now, the markets need something positive.  There is simply just too much bad news in the region and it seems as though nothing is working in Europe.  Unfortunately, I do not see this mess turning around so smoothly.  Europe could see another tough recession coming its way very soon as debt cripples the region.

It should be noted that the German 10 Year Bund is currently yielding 1.37%, less than the US Treasury 10 Year yield of 1.63%.  The inflation rate is about the same in the US and Germany and so is the domestic financial strength of both countries.  Certainly we both are facing some tough times but it shows that the “classic safe havens” , may not be so safe anymore.  Why would you hold a 10 Year note from Germany when you can buy US treasuries with a better yield.

Furthermore, Germany cannot print euros, but the US can print dollars. The US can print and print, Germany cannot. Germany can therefore default on its debt, whereas the US cannot since it issues US denominated debt and the Federal Reserve can buy unlimited amounts of it. The market seems irrational in this regard. A possible trade would be to go long US treasuries and short German bunds, and assume the market will correct this anomaly. As always, this is not formal investment advice.

The bottom line here is that Europe has a tough summer ahead of it.  Spain appears to be the new poster child of the debt crisis and there is little appeal to European assets right now.  As European woes continue to hurt US markets, safety and defensive stocks are going to be the only way through this with the less risk.

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