Tuesday, April 10, 2012

Deficits Must Not Matter -- U.S. Treasuries and Japanese Yen Both Rallying

The decline in U.S. stock prices and the increase in interest rates for the sovereign debt of Spain and Italy are getting most of the headlines today. However, it is noteworthy that the U.S. Treasury Bonds and the Japanese Yen are both rallying. The interest rate on the 10 year Treasury note dropped back below 2.0%. The Japanese Yen continued it's rally versus the U.S. dollar and closed at $0.807, a 4% jump in the past three weeks.

At least for now, traders are certainly complacent about the huge U.S. and Japanese deficits. The fact that the U.S. and Japan are projected to run the largest deficits as a percent of GDP among all world's developed countries is obviously not scaring off traders. As shown below, the deficits in the U.S. and Japan in 2012 are projected to be 9.3% and 8.9% of total GDP respectively.

Neither the U.S. nor Japan are taking any measures that will put a dent in their deficits in 2012. While continuing to run up massive deficits may lead both countries to fall off a fiscal cliff within the next few years, they obviously are considered safer haven than Europe.

Ultimately the huge deficits the U.S. and Japan are running up will matter. But given that the consequences of  unsustainable deficits may not wreck its fiscal havoc for a number of years, and traders have a very short time frame, deficits of countries that control their own currencies do not matter much for now in the bond and currency markets.

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