Green shoots? Dig deeper into the yield curve

Anyone who has read this column in recent weeks will recall the scepticism, yea, the alarm and scorn, in which it holds talk of so-called "green shoots" of recovery. It's not that this column is a paean to the global recession, nor that it is written by some misanthrope who delights in misfortune, some miserable curmudgeon who kicks small animals and abhors human happiness. On the contrary, my idea of acting out is to yield to pedestrians and drive the speed limit in my rented SUV. Courtesy is contagious, I am confident, even if resistance remains high.

I remain hopeful, as well, that my prediction late last year will prove true, that emerging markets in Asia and the Gulf will experience a V-shaped recovery by the end of the year - that their economies are going to get a lot worse than most people fear, but end the year in better shape than most expect. That time, alas, has not yet come. A close look at the evidence still argues against recovery, although there is an abundance of misleading evidence to that effect.

Take the latest talk of a recovery in property prices, one based largely on a recent survey of property prices by HSBC that found that prices in Dubai rose 4 per cent in April compared with March and 5 per cent last month compared with April. Property prices may well be recovering, but this latest survey data simply isn't sufficient to draw that conclusion. Month-on-month data is extremely volatile, particularly in a market where so few transactions are taking place.

Between September and March, residential property prices in Dubai fell by 33 per cent, according to my own research of registered property transactions compiled by Reidin.com. That's not a survey, but a comprehensive analysis of more than 22,000 property sales. The important thing to note is that, even as prices were tumbling, month-on-month prices didn't fall in a straight line. In January and March, they actually rose compared with the previous month. Quarterly data are more reliable indicators.

Who buys and then sells a property the next month anymore? As of the first quarter, quarterly prices were still rising. Will they end up in negative territory in the second quarter? We'll have to wait until July to find out. Some also point to easing lending requirements as a sign of stability in the property market. But just because banks are willing to lend again doesn't mean people are ready or able to borrow. At the same time, banks are easing repayment terms for existing borrowers. That's not to promote new loans, but to keep old ones from failing.

So why the sudden burst of irrational exuberance? A lot of it has to do with the rally since March in global equity markets and in oil prices, much of which is in turn driven by a surge in international liquidity that is pushing up emerging-market assets all over. There is a growing divergence of opinion over whether this surge is a symptom of economic optimism or merely a side effect of US efforts to inflate its way out of recession. And at the centre of this debate is the yield curve on US government bonds.

Oh boy, I can hear you saying, a discussion of yield curves! Time to turn to the cricket results. But wait, this really is worth sticking out. Readers who follow the bond market will know that the US yield curve has been steepening recently. This means that interest rates on longer-term US bonds, such as 10 years to 30 years, have been rising relative to interest rates on shorter-term US bonds, such as three months to five years.

Normally, a steepening yield curve is a signal to investors that times are improving. Why? Investors are more inclined to lend in the short term at relatively lower rates, confident they'll get their money back. Conversely, they demand relatively higher rates to lend for longer periods because they believe the improving economy is likely to stoke inflation, forcing rates higher and reducing the value of existing bonds.

So, one might be tempted to conclude that the latest steepening of the yield curve is proof that the US economy, and with it the globe, is turning the corner. But there are strange things afoot in the yield curve and many economists, including some at the US Federal Reserve, worry that it is out of whack. While there is evidence that the US economy's decline is slowing, most data still point to a long and painful recession, followed by a slow and painful recovery. That means that global trade and exports are likely to stay in a slump for a lot longer, something borne out in trade data from Asia.

Why the steepening, then? Economists say it appears to be the result of concerns about rising levels of US government indebtedness and an increasing abundance of US dollars. As the Fed creates more and more dollars and the US Treasury borrows more and more of them, the US dollar is falling, prompting investors to seek safe havens such as emerging-market stocks and commodities such as gold and oil.

Analysts say the rise in oil prices has more to do with this trend than any shift in the supply-demand situation. As they try to keep their currencies stable against the dollar, central banks in Asia and the Gulf recycle, often by buying US treasuries. Concerned about the future of the dollar, many central banks have been shifting their purchases away from longer-term bonds and into the shorter-term stuff, thereby making the yield curve even steeper.

At the same time, high demand for short-term bonds, combined with effort by the Fed to boost liquidity, have kept rates on that debt near zero. With short-term dollar rates so low, investors have revived the so-called carry trade, in which they borrow dollars at low rates to invest in countries with higher rates, pocketing the difference. But this apparent yield-curve head-fake is that it raises troubling questions about one of the key assumptions that in the past made the US yield curve such a reliable indicator: that US debt is essentially risk-free.

With concerns rising about US debt levels, that may be changing - undermining what many investors have long held as bedrock. For economies with currencies pegged to the US dollar, liquidity could end up here today, gone tomorrow. warnold@thenational.ae