PIMCO Disposes of Its Government Debt Portfolio while Bernanke Speaks of an Exit Plan

On the back of some weak data today on the employment and housing markets, and following some disappointing figures from China, stocks and commodities including gold and oil are performing very poorly. Ben Bernanke seems to have contributed his own part to the sudden shift by reassuring us confidently that he and his team of responsible people at the Fed are actually thinking of an exit plan as the economy improves. Expectably he did not make any commitments, but markets apparently don`t enjoy the hints being given so pompously and loudly. 

In Asia, the fact that China has ended up with a small yearly trade deficit instead of an expected sizable surplus is one of the top news items of today. Some have gone so far as to say that this event signals the end of the so-called currency war as the deficit removes the urgency of the need to appreciate the CNY, while others tie it to the government`s conscious efforts to boost domestic spending in order to rebalance the economy. The currency has been slowly appreciating since around June of last year, and a shrinking surplus is natural at this point. However one month`s negative number doesn`t mean much in the long sequence of positive sums stretching back to a long time ago, and if we also keep in mind that the deficit is almost entirely due to the huge jump in commodity prices that followed the Middle East unrest, it becomes clear that the reversal is not a consequence of Chinese actions, but rather of market fluctuations which do not mean much in terms of the USDCNY exchange rate debate. If the worst happens and oil prices skyrocket in consequence of chaos in producing nations, it is obvious that China would be just another victim with exports falling (as demand evaporates in the rest of the world with rising inflation) while imports rise with commodity prices. This is not a China specific event however, and for now its effect must be regarded as temporary because one doesn`t build a base case on a doomsday scenario.

What the Chinese numbers really signify to us is the euphoria that has overtaken the markets on the back of Fed-induced overspending in the U.S., as all the colossal events taking place in the critical Arab World and the chronic problems of European sovereigns were ignored on the basis of momentum trades.

Meanwhile, Bill Gross is preparing his fund for the previous version of the doomsday case, prudently in our view, by getting it rid of its entire government debt portfolio, completing a process that was known to be underway for some time. Mr. Gross apparently wants to play safe for although it is undeniable that any bullishness in the government debt market can last for a while (because it is a bubble), it is also safe to say that the higher it goes the deeper it will plunge, and it will be painful for those who tarry too much in quitting before the masses. We still believe that the U.S. will outperform most developed market economies when the crisis strikes, but that doesn`t mean U.S. paper will do well, only that it will burn with less severity than its less-favored peers in the rest of the world, due to a combination of safety and superpower effects.