California Is Dreaming

Pimco Says California Yields May Revisit 2009 Peak (Update1)

Feb. 3 (Bloomberg) -- Kenneth Naehu, who invests $2.5 billion for Bel Air Investment Advisors in Los Angeles, sold California bonds late last year as he saw deficits mounting -- and says he’s not ready to buy back in yet.

Naehu, 43, is among investors including Newport Beach, California-based Pacific Investment Management Co. and Thornburg Investment Management in Santa Fe, New Mexico, forecasting that the state’s yields -- which move inversely to prices -- may increase relative to other municipal bonds because of the financial strains. Pimco, the world’s biggest fixed-income manager, predicts the yield on 30-year debt may rise above 6 percent, the highest since last summer’s fiscal crisis.

California, the world’s eighth-largest economy, faces a $20 billion hole in the budget during the next 17 months. With its cash dwindling, the government may need to issue IOUs for the second straight year unless Governor Arnold Schwarzenegger and two-thirds of the Legislature can agree on a fix. Once the budget is balanced, the state is poised to sell billions of dollars of bonds after flooding the market with $36 billion in debt last year.

“This is a political mess,” said Naehu. “The state is not out of the woods. In fact, one could argue they are in even worse shape than they were before.”

From Bloomberg:
Portuguese Bonds Drop as Borrowing Costs Soar at Bill Auction 

By Matthew Brown
Feb. 3 (Bloomberg) -- Portuguese bonds slid, pushing the yield on the 10-year note up by the most in 11 months, as the country’s borrowing costs soared at a sale of bills on concern the government will fail to curb its budget deficit.
The decline sent the yield on the security to the highest since March, increasing the premium investors demand to hold the debt instead of benchmark German bunds to 147 basis points as of 4:17 p.m. in London, a 10-month high. Credit-default swaps on the bonds rose 29 basis points to a record 196 basis points, according to CMA DataVision, meaning it costs $196,000 a year to insure against losses on the debt for five years.
Portugal sold 300 million euros ($417 million) of 12-month bills today after indicating it planned to issue 500 million euros. The securities were sold to yield 1.38 percent, compared with 0.93 percent at a Jan. 20 auction. Portuguese central bank Governor Vitor Constancio said yesterday that cutting the budget deficit will require “difficult” measures and that the economy is unlikely to catch up with its European peers any time soon.
“The news flow for Portuguese government bonds is rather negative,” said David Schnautz, an interest-rate strategist in Frankfurt at Commerzbank AG. “There is a decent upward risk in spread terms for Portuguese bonds. They could go much further.”
The yield on the 10-year note rose 20 basis points to 4.67 percent.


If Schwarzenegger thinks he will be able to continue to borrow and spend in California as he has in the past then he is dreaming.
A large adjustment is developing in the bond market regarding yields.
Who wants to lend Greece, Portugal, Spain, Dubai or California enormous amounts of money without being compensated for the risk through much higher yields?

At some point we will start to see bond auction failures.

This is another deflationary indicator that is supportive of a US dollar rebound.