You probably don't> remember "Rollover," the 1981 financial thriller starring Jane Fonda in which a mass withdrawal from America's banks by Middle Eastern Arabs causes a crash in the dollar and a global economic collapse. (Watch Video here.)
However hackneyed, the storyline is not so far-fetched. The word "credit" is derived from the Latin root credere, or "to believe." As depositors, investors and lenders, we trust borrowers only to the extent we believe they will actually pay us back. The higher the risk, the higher the interest rate must be a lesson I learned the hard way from an unprofitable foray into microlending a few years back.
The higher interest rates demanded by investors in economically unsound countries, known as bond "vigilantism," are simply a reality check. That's why the recent spike in yields for Europe's heavily indebted "PIGS" (Portugal, Ireland, Greece and Spain) serves as a worthy indicator, and warning sign, of what happens when markets no longer believe in a country's creditworthiness.
Since I last wrote about the violent protests against government spending cuts in Europe last fall, the fiscal stress has become even more pronounced. Since the beginning of 2010, Greek 10-year government bond yields have doubled, now over 12.5%. Earlier this week S&P downgraded the country's credit rating further into junk status.
Portugal's borrowing costs have also skyrocketed. The country's 10-year government bond now yields more than 8%, a Euro-era high, having doubled since January 2010. S&P has downgraded Portugal's debt three times in the past week, leaving the country on the verge of losing its status as investment-grade. Like many debt-ridden countries, this is their "Rollover" moment: In April, $6.3 billion in government debt comes due; another $7 billion in June. Fewer and fewer people believe in its ability to repay.
Even comparatively strong Italy is showing signs of distress, with yields having jumped to 4.8% from 4% since the beginning of 2010. Active investors might consider taking a look at the recently launched PowerShares DB Italian Treasury Bond Futures Exchange Traded Notes (ITLY),
Conversely, you could simply position yourself for the U.S.'s "vigilantes" in demanding higher U.S. rates by becoming one yourself. With an ongoing stalemate in Washington over how to tackle a $1.6 trillion deficit and the dollar index near new multi-month lows, U.S. bond yields have once again started to rise following the Japanese quake-inspired panic buying although they have yet to retest last spring's highs.
One day investors might be scared to hold U.S. debt, but right now they're showing little fear. According to CME (CME)
30-Year Treasury Bond Historic Volatility:
ETFs like Direxion Daily Total Bond Market Bear 1x (SAGG),
Jonathan Hoenig is managing member at Captialistpig Hedge Fund LLC . At the time of writing, Hoenig's fund held positions in many of the securities mentioned.