Fed Fund futures are discounting a further rate cut of some 50bps on April 30, which would take the FF rate to 1.75%, or only 75bps from the historical low of 1.00% set in 2003 amidst the deflation scare. This could very well push 10YR TB yields back to 2003 lows.
Given that the Fed’s unprecedented countermeasures are still not addressing the root of the problem, i.e., imploding housing and real estate prices, any reversal in the USD’s slide is likely to be temporary, and the direction of the CBOE 10Yr TB yield index is still very much south.
It is one thing to hear Iran and Venezuela railing against the US and asking trading partners like Japan to pay for oil imports in Yen, and quite another to learn that South Korea’s National Pension Service [NPS], which is the world’s fifth-largest pension fund with $220bn in assets and a traditional buyer of US treasuries, say they are finding it difficult to buy more US Treasuries due to already large exposure and plunging yields.
The 500-pound gorillas in terms of foreign holders of US treasuries are Japan and China, whose holdings of $587 billion and $493 billion respectively are a full 45% of all foreign holdings and 64% of “official” foreign holdings of US treasuries.
As China has been making noises about diversifying away from the US dollar for some time, the last shoe to drop would be Japan, where USD holdings account for a full 60% of total foreign exchange reserves of some $979 billion. But even Japan is beginning to seriously debate the formation of a sovereign wealth fund.
Assuming a USD-based investor went long JPY versus USD in June 2007 and at the same time shorted the Nikkei 225, they would be sitting on a total gain of some 50% despite all of the credit market turmoil. This same trade could see another 50% as JPY surges to JPY79/USD, while the Nikkei 225 slides to 10,000.
Or, this same USD investor could have simply bought gold, which has gained 59% during the same period, and could go to $1,500/ounce under the above scenario, for an additional gain of some 50%.