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US Treasury Yields Going Up and US Dollar Fall-VRK100-30052009

US Treasury Yields Going Up and US Dollar Fall-VRK100-30052009

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The article penned by Rama Krishna Vadlamudi, MUMBAI, INDIA (vrk_100@yahoo.co.in) described the impact of US Treasury yields on the economies and financial markets around the world.

The document discusses the impact of rising US Treasury yields and discusses the political impact of currency movements and oil price fluctuations.

It narrates the close interdependence between the US and China as Chinese forex surplus feeds the US bond market, whereas US consumption feeds the export surpluses of China. As such, both are Siamese twins in this regard.

The article details the important questions investors have to ask at this point of time.
The article penned by Rama Krishna Vadlamudi, MUMBAI, INDIA (vrk_100@yahoo.co.in) described the impact of US Treasury yields on the economies and financial markets around the world.

The document discusses the impact of rising US Treasury yields and discusses the political impact of currency movements and oil price fluctuations.

It narrates the close interdependence between the US and China as Chinese forex surplus feeds the US bond market, whereas US consumption feeds the export surpluses of China. As such, both are Siamese twins in this regard.

The article details the important questions investors have to ask at this point of time.

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Published by: RamaKrishna Vadlamudi on Oct 08, 2009
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10/07/2009

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Rising US Treasury Yields and Falling Dollar

Rama Krishna Vadlamudi
MUMBAI May 30th, 2009 vrk_100@yahoo.co.in

It is getting curiouser and curiouser to use a phrase from “Alice in Wonderland.” While US Treasury yields are rising, the US dollar is falling day by day. And commodities also appear to be bullish, with crude oil touching more than USD 66 a barrel and gold touching USD 980 an ounce this week. Even as dollar is on a downward spiral, the US stock markets are still in the most resurgent mood. While Dow Jones is hovering at 8,500; the S&P 500 broader index is well above 900 levels. The US dollar index (a measure of US dollar versus six other major currencies) has reached a level of 79.22, though much above its one-year low of 71.72 attained in July 2008 (its year-high was 89.29 – March 2009). What is the real connection between all these different markets and reference points? What are the inter-linkages that keep them move in directions sometimes divergently and another time in the same directions? According to EPFR Global, the Emerging Market equity funds have attracted a total inflows of USD 21 billion in the past 11 weeks; whereas, the US, Europe and Japan have seen outflows of USD 14 billion. The biggest beneficiaries of these global fund inflows are China, Brazil, India and Taiwan. Obviously, investors are pulling out their money from Europe, Japan and the US as these countries are sliding into a recession (some are already in recession), though some market men believe that there are some signs of economic recovery in these countries.

US Bond yields on the ascendant:
Risk appetite for equities has gone up in the last three months the world over. As such, it appears that money has moved from the so-called safe instruments, like, government bonds into riskier categories, like, equities and commodities and this is showing in higher levels of stock and commodity indices. As the prices of US Treasury notes are falling, the yields are touching multimonth highs (bond prices and yields move in opposite direction). The yield on benchmark 10-year Treasury note has risen from a level of 2.08 per cent (December 2008) to the present level of 3.67 per cent, an increase of more than 150 basis points in less than six months, which is quite unusual in the US markets. The massive US government bailout programmes and the accompanying fiscal deficits have been bothering the financial markets and as such US bond prices are falling; and moreover, all these developments have put tremendous on the US dollar, which has lost more than 10 per cent against major currencies since March 2009.

PARTICULARS Latest All-time high All-time low

US TREASURY 10-year yield % 3.67 15.84 2.08

US TREASURY 30-year yield % 4.54 15.21 2.53

REMARKS As on May 28, 2009 On Sep 30, 1981 & Sep 26, 1981 On Dec 18, 2008

Note: Data for 10-year yield available since 1962 and for 30-year since 1977. (Date source: US Fed)

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Parallel with the early 1980s US economy? As the table given above indicates, the US in the early 1980s was in the throes of rising unemployment, skyrocketing inflation and record high level of bond yields. In fact, the 10-year bond yield touched an all-time high (since 1962) of 15.84% in September 1981. Commercial interest rates in the US had jumped to more than 20% in the early 1980s. The US unemployment rate rose to more than 11% by the end of 1982. The US had suffered with soaring inflation between 1979 and 1985. It would be instructive to analyse the developments at that time. The US economy was faltering in the late 1970s. In January 1979, crude oil prices went through the roof after Ayatollah Khomeini dethroned the Shah of Iran. In 1980, Iraq had invaded Iran and their war on the waters of Shat al-Arab in the Persian Gulf caused massive supply disruptions and oil prices shooting up dramatically. From a level of USD 14 a barrel in 1978, oil price surged to more than USD 35 a barrel (nominal prices), a phenomenal increase of more than 250 per cent by 1982. After becoming chairman of the US Fed in July 1979, Paul Volcker followed a policy of “slaying the inflation dragon” and raised interest rates in order to constrict money supply in the style of Milton Friedman. These measures failed to control the inflation monster quickly and revive economic growth. The economy was put on the growth path only after president Ronald Reagan offered massive tax cuts and deregulated the financial markets in a big way, among other things. In the highly adventurous world of financial markets, funny things occur many a time. Depending on the reference point we take, the data of various markets throw up interesting insights into correlation and divergence. The past data about oil price suggests that it is not correct to think that oil price goes down during times of economic recession. In fact, in the 1970s, when the economies of the US and several other countries were in recession, the oil price went up by 15 times (Jim Rogers). Ultimately, the principles of demand and supply rule the roost. China and the US: Siamese twins? China has expressed its concern about the falling dollar recently. They have suggested that the world needs to replace the dollar with another reserve currency, which has been endorsed by other countries. However, it is difficult to believe that China will push for an alternative reserve currency very hard as its economy is closely dovetailed to the US economy. The US consumer spending had fed export-oriented Chinese economy for decades. In turn, China has been responsible for bridging up the massive budget deficits of the US by investing its (China’s) forex reserves in the US Treasurys. That way, the economies of the US and China are conjoined twins.

Investors need to ask themselves the following questions in the months to come:
1. When will the US Fed start raising interest rates? (It would be a big move which may rattle the global markets completely and jolt them out of their complacency, if and when it happens.) 2. Whether rising US yields and sloshing liquidity point to a return of inflationary pressures in the US or is it premature to talk about inflation when experts are projecting GDP growth contraction? 3. Whether US stock markets are ignoring the ‘green shoots’ of inflationary concerns while US bond markets seem to be reading the signals correctly? 4. Whether oil prices will continue to move up despite the predictions of a massive economic contraction in the developed world and sharp dip in world trade? 5. Whether falling dollar would push up oil prices further? 6. What are the implications of a rising US bond yields on the world economy? 7. Whether Asian economies continue to invest their exports surpluses in the US bonds or will they diversify their forex reserves into other currencies or commodities? (China recently has shored up its gold reserves by 450 tonnes, up 75 per cent since 2003) 8. Whether US dollar will be replaced by another reserve currency as is being demanded by China and other nations?
Note: If you have any thoughts on the above, please let me know

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