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Guest wrongmove

Down To The Last Drops Of An Unreal Era Of Easy Money

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Guest wrongmove

Down to the last drops of an unreal era of easy money

"Petrodollar states are quietly pulling the plug on the global bond market. Armed with annual export revenues of $1,250bn they have been the single biggest cause of the world "savings-glut", that vast pool of money compressing credit spreads to wafer-thin levels. The surpluses of Russia, Saudi Arabia, Kuwait, Nigeria et al have been the fuel behind the M&A excesses of the last year, not to mention all those high-risk CDOs, CLOs, and sub-prime mortgage packages.

This unreal era of easy money and silly leverage is drawing to a close because the oil powers are starting to spend their wealth, confident that crude prices will remain high. Much of what remains is being diverted from the money markets into new "sovereign wealth funds", to be deployed in more adventurous investments. This switch may be good for economic growth and equities, but it is dire for bonds.

Combine that with a nasty inflation scare and growling from the world's central banks, and you have the makings of a bond rout. Yields on 10-year US Treasuries - in effect, the price of global capital - have jumped to 5.13pc from 4.5pc in March. Gilts and German Bunds have moved in lockstep. Junk bonds have moved a lot further yet, victim of ballooning spreads.

A sudden step-change on this scale always causes casualties, so it is no surprise to see a couple of Bear Stearns hedge funds blow up on US sub-prime debt.

Other funds are undoubtedly in distress, although it will take some time before we know if flight from the murkier corners of the debt market entails a systemic threat.

The danger is if rating agencies begin to downgrade the better-rated tranches of mortgage AAA and AA securities, triggering a mandatory sell-off by institutional creditors. We will then find out if the swathes of debt taken on so lightly in the boom have any value. As the Bank of England's Governor Mervyn King said in his Mansion House Speech, CDOs and their ilk are "highly sensitive to small changes" and prone to total loss.

"It may say champagne - AAA - on the label of an increasing number of structured credit instruments. But by the time investors get to what's left in the bottle, it could taste rather flat". Leverage has always been the mother of financial crises."

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