Ireland Debt Fears Spread to…California?


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Fears of the dreaded sovereign debt "bond bubble" re-appeared last week when Irish debt concerns spread to some troubled U.S. states and municipal bond markets. In fact, on Tuesday, municipal bonds posted their biggest one-day loss since October of 2008. Specifically, California had to postpone further sales of its municipal debt in light of the Irish crisis, since counties, states and municipalities that have poor credit ratings can no longer rely on the bond market to help shore up their increasingly dire fiscal shortfalls.

California, Portugal and Spain have suffered from the "contagion" effect or Ireland's debt woes, since bond investors are closely scrutinizing all bond offerings now. Although Spain had a successful bond sale on Thursday, and a new loan from the European Union ( EU ) and the International Monetary Fund ( IMF ) patched Ireland back together, troubled central banks had to offer higher yields because investors are concerned about the creditworthiness of Europe's troubled PIGS (Portugal, Ireland, Greece and Spain).

In America, about $700 million in municipal bond debt was shelved last week due to lackluster demand. In particular, California saw tepid demand for its latest sale of "revenue anticipation notes." Tom Dresslar, a spokesman for the California State Treasurer,  said, "The tax-exempt municipal bond market is a cold, cold world now, for issuers and taxpayers." In the end, California decided to cancel a $267.3 million bond sale.

Despite the Fed's quantitative easing policies, market forces are overpowering the Fed, causing Treasury bond yields to hit a three-month high last week. It appears that the Treasury bond bubble has been "popped."

The good news is that these ongoing bond market woes are causing investors to return to stocks. That's what fueled the market's recovery on Thursday. We can also credit the General Motors IPO and the fact that traders are anticipating an early holiday season rally. The "January effect" now begins in late November, as a Santa Claus rally and year-end pension funding push the market consistently higher!

The Fed's QE-2 Policies Will Help Stocks

The Fed is clearly frustrated with the ongoing criticism of its quantitative easing, so on Friday Federal Reserve Chairman Ben Bernanke lashed out at China, blaming Beijing for much of the world's problems. Specifically, in a speech prepared for a conference at the European Central Bank (ECB) in Frankfurt, Germany, Bernanke said that China's decision to undervalue the yuan has essentially thrown a monkey wrench into the global economic recovery and said the result could be slow growth ahead "for everyone."

Bernanke also said "currency undervaluation by surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals." In the past year, President Obama and Treasury Secretary Tim Geithner have also tried to persuade China to allow its currency to strengthen at a faster pace, but they have all been unsuccessful.

Meanwhile, China is blaming the U.S. for the inflationary forces that are now crippling its domestic consumer economy, especially their higher food prices. On Friday, China's central bank raised its capital reserve requirements for the fifth time this year. In addition, Hong Kong significantly raised the stamp duty on residential property transactions in an attempt to curtail its overheated housing market.

Frankly, China will likely win this war of words, since it is the 800-pound gorilla in the room and can do whatever it wants. I suspect that China will continue to ignore President Obama, Treasury Secretary Geithner, Fed Chairman Bernanke and other critics. I also suspect that Mr. Bernanke's speech was an attempt to divert criticism of the Fed's easing strategy and protect the Fed from an inquiring Congress.

In the interim, the Fed's second round of quantitative easing is scheduled to persist through June, which means that the Fed will be artificially suppressing long-term Treasury bond yields. The Fed's ultra-low interest rate policy is a boon to stocks for four reasons. (1) Fed easing encourages corporations to borrow in the bond market at ultra-low interest rates. Recently, corporations were borrowing $20 billion a week, which is a trillion-dollar annual rate! (2) Companies are now awash in cash from the bond market boom, so they are aggressively buying their outstanding stock back (e.g., Cisco Systems (NASDAQ: CSCO ) announced a $10 billion stock buyback on Friday) or they are buying up other companies. (3) Rising inflation fears and growing talk of a "bond bubble," especially in Treasury and municipal bonds, is causing many bond investors to return to the stock market for superior total returns, while (4) continued strong earnings and a weak U.S. dollar are lifting corporate earnings, quarter after quarter, thereby helping to restore investor confidence.

Overall, there is little doubt that the Fed's quantitative easing is helping to boost the stock market, since the Fed is pumping literally $110 billion per month into to financial markets by buying Treasury bonds, while investors in those bonds are fleeing to other financial assets, like corporate bonds and stocks. While the rest of the world prepares to hike interest rates to try to squelch inflation, the Fed is continuing its 0% interest rates policy and printing billions of dollars to lower Treasury bond yields. The net result should be a continued weak U.S. dollar, which will persist until the U.S. government embraces austerity cuts.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks
More Headlines for: CSCO , EU , IMF

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Louis Navellier

Louis Navellier

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