US & China growth intertwined

, August 27, 2012, 0 Comments

When we look at the components of yield (nominal yield), real yield and expected inflation as show in the figure below it is pretty clear that if not for the positive bias of expected inflation the nominal yield would have breached zero mark. The bond market is one of the most reliable markets with speculation playing a minor role compared to equity or other asset classes. Historically, yields had predicted recessions with higher precision, for instance recessions were prophesied by an inverted yield curve. If yields still have that predictive ability then we can expect stagflation if we are not in one already.

Borrowings

As of June 2012 foreign investors had investment of more than USD 5tn in US Treasury securities which was up by 13% over a decade. And as shown in the pie chart below China and Japan have lion’s share in the pie while India had less than a percent. As mentioned earlier those countries with large exposure to US Treasuries will be more affected when the yields starts to risehence China, Japan, Oil exporters and Brazil will the most affected.


The following chart looks at year on year change in investment in US Treasury securities by various countries.

Except for China, the largest investor in US Treasury securities, all other countries have increased their exposure to the securities on the other hand a worried China is trying to get out a trap it laid by manipulating its currency. The country has sunk so deep in this trap along with USA that any effort on its side to ditch US and get out of this trap will cost it dearly. The two largest economies are so intertwined that they have to work in tandem to get out of this mess. And that is the price one pays for globalization.