Credit Reversal

Its a fact that news in credit takes much longer to seep into the equity markets and while we did see markets continue to remain positive, the real news was not GMs long expected bankruptcy, but the back up in long end rates. While the fact that 10 year US treasury yield at 3.5% (rather than mid-March 2.5%) may well reflect a an economy on the mend (everyone knows the old wives tale about inverse yield curve reflecting recession, positive yield curve evidence of  healthy growth). But the worrying news is the effect this has had on mortgage rates in the States, with 30 yr fixed mortgages rising to 5.8% (4.5% in the last month or two). This scuppers plans for a quick turn around for the US housing market, with delinquencies on the rise, home owners can no longer expect to be able to refinance cheaper and its becoming more and more likely that the Fed is going to have to intervene in the market to prop up mortgage bonds (duration on these products will now also get much higher, since prepayment speeds will drop). In fact letting the situation linger on is most likely going to undo much of the Quantitative Easing measures; the US Government must feel a bit like Sisyphus, every time they roll the stone up the hill (read taking steps to ensure economic recovery), they only ever watch it roll back down…

More than anything sentiment has been the primary driver in the return to recovery, which brings into questions whether a broader economic pick-up is required before the next bull market. With US housing data coming in strong yesterday (substantial price drop but home sales increased - albeit on foreclosed stock); the economic mood is taking on an additional vibrancy. In today’s economic data an improvement in durable goods sold would confirm this emerging trend of an economic pick-up. 

Throughout this rally my only question has been what conceivable factor could hamper it and now it actually will be the role of rating agencies in how they treat national debt. The spectre of GM’s default and one of the Generals going down; could ultimately lead to a contagion effect for the corporate economy. Nevertheless sovereign risk is now more of an issue and with the month of May coming to an end it does lead to the question perhaps this rally can be sustained? I’m trying very hard to refute this talk of recovery, I’m not a fan of premature optimism, but even the credit market now seems to be getting on the act with the Mortgage-Tsy the tightest its ever been.

I’m getting a positive tone from the market despite my best efforts to remain a skeptic. However I don’t see gold climbing up as confidently as before, particularly in a recovery scenario, and as for oil I find it odd that an asset can be rangebound between $30 and $140 per barrel. Valuations in that commodity are just not credible particularly with the spectre of an inept Cartel trying to micro-manage its prices through supply chokes.