Wednesday January 14, 08:29 AM
Govt stimulus plans fuel booming bond market: analysts
By William Ickes
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FRANKFURT (AFP) - Governments worldwide have pledged to spend trillions this year to ensure that a global recession does not become a global depression but a huge question mark hangs over whether they can finance those plans.
The sums involved are unprecedented -- the US government will perhaps seek to raise two trillion dollars, with Europe looking for more than half that even before Asia steps into the fray, setting up a potential scramble for funds unlike any before.
Most intend to offer longer-term bonds but investors will want to get the best possible return -- a high interest rate -- for locking up their money for so long against the darkest economic backdrop since the 1930s.
Analysts say it all comes down to the price governments can afford to pay.
Will they get the money?
"Hopefully," UniCredit Markets fixed income strategist Luca Cazzulani told AFP in jest, before adding: "It becomes a matter of price."
But there lies a catch -- if governments pay higher and higher rates to secure the money needed to fund their stimulus plans, they inevitably push up wider interest rates, undercutting the economies they are trying to save.
Central banks have slashed interest rates over the past few months to record lows in an effort to drive their economies out of what looks like the worst downturn since the Great Depression of the 1930s.
Now the drive to raise cash could cut across that policy, making life even more difficult for the central banks.
The problem gets more complicated too, the more money that governments seek to raise.
As "government deficits get deeper and deeper and deeper, bond markets will get quite concerned and they'll get quite discriminating," warned Jan Randolf, head of sovereign risk at IHS Global Insight.
For now, "the name of the game is wealth protection (with) a herd stampede" into sovereign bonds that has driven up prices, Randolf said.
"The question is how long will it last," he said, adding that some saw "yet another bubble in the making, this time one driven by fear rather than greed."
When bond markets are saturated, investors cherry pick the strongest issues, obliging weaker countries to offer higher rates that increase their financing costs.
Commerzbank (Xetra: 803200 - news) interest rate strategist David Schnautz said "this new supply is a huge issue right now."
So far, governments, especially Washington, have seen unrelenting demand for their bonds, with investors fleeing stock and commodity markets for the safety of national debt as the global credit crunch bursts one speculative bubble after another.
Demand has been so strong that returns, or yields, on benchmark bonds have hit record lows, suggesting to many analysts that despite some concerns, the market will take all the paper governments want to offer this year.
"Sovereign (LSE: SOGP.L - news) governments within Europe will find buyers for their debt," said Capital Economics strategist John Higgins.
Deutsche Bank (Xetra: 514000 - news) 's European rate strategist Ralf Pruesser added: "It's just a question of the price."
Cazzulani, Higgins and Preusser all thought the market would remain stable overall, citing an era of low inflation, which is good for fixed-rate investments such as bonds which provide a steady return.
At the same time, it is very likely that interest rates will stay low for an extended period and central banks may even buy up existing bonds, a step that would both keep yields down and pump even more cash into the economy.
"We still think that 2009 is going to be a very bond positive environment," Preusser told AFP, adding: "We don't see a sustained increase in yields."
Recent warnings by ratings agency Standard (SNDH.PK - news) and Poor's on debt issued by Greece and Spain "shouldn't have been a surprise to anyone" who tracks bond markets, he noted.
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