At Arm's Length - Financial Commentary about Money, Investing, and How It Affects the Average Investor

At Arm's Length: 03.17.05

Who's buying What

For months, all eyes have turned to a rather obscure and unnoticed piece of information published by the Treasury Department. It held such status largely because no matter how much debt was offered for sale, the world stepped right up and bought whatever was proffered.

But as the federal deficit grew, the world began to murmur that such large amounts of debt were not doing the world economy any good. In a sense, the continued borrowing by the world's largest economy would bring sluggishness to the rest of the global marketplace. At least that was the theory. That notion has been worrisome to the customers who hold the largest amount of this type of paper, namely Japan, China, and Taiwan.

If these countries suddenly realized that holding dollars in reserve was no longer worthwhile, then our economy would grind to a halt forcing interest rates dramatically higher, slowing growth, and otherwise widening a trade deficit that has already been recorded as the highest in our economic history.

The report that was issued recently showing January figures actually indicated a shift in the trend. On the surface this would seem to be good news. If our debt is purchased, our dollar strengthens. If the opposite happens for too many months in a row, the dollar weakens and the whole house of cards comes tumbling down.

But the surface of a pond belies the depth lurking behind the mirrored surface. In this case, the usual customers did not step up and make the purchases. Hedge funds did.

While many retailers consider any customer just as worthy as the next, in currency trading, the quality of the customer counts. Hedge fund traders are not concerned about the economic health of the United States, many of which are located in the Caribbean. Asian central bankers, because they already hold vast quantities of our debt, do not want to see the dollar in freefall, a condition that would transfer billions of dollars of additonal losses to the already mounting tally.

Mumblings about slowing purchases have sent the dollar falling twice in the past month. A comment by South Korea, quickly reversed and a recent comment by the Japanese Prime Minister, also quickly discounted had negative effects on our currency.

Remove hedge fund interest and the numbers did show a diminshing interest. Another reason the inflows seemed to increase was the growing lack on interest in investments overseas or outflows of capital. Any strength in the dollar lowers overseas returns.

Look for the Treasury yields to continue to move higher in the coming months while prices fall and demand decreases. While you are looking, expect the Asian investor to head for the door as well.

At Arm's Length: 03.14.05

Reasonable Attention

It has become a pricing issue in the fixed income markets. This led to a dramatic sell-off last week pushing the 10-year Treasury note to a yield of 4.54%. This is a significant move in a week, with the yield settling at levels not seen since last July.

The attention lavished on the fixed income came with realization that there are inflation pressures at work on economic growth. And if that is the case, the price, which moves in the opposite direction as the yield, was far too high to absorb this news.

The dollar hit the skids as well as currency investors had to parse the mumblings of another Asian nation, talk that was quickly muted by another lesser government official. This is the second time in as many weeks that one of America's biggest debt customers has had some public doubts about their investment strategy. Diversity is not a word to be taken lightly by those who trade dollars or by those who sell debt.

It took more that just inflation - which was hinted at in the Fed's Beige Book release - and the tumbling dollar. It was another seemingly unstoppable widening of the trade deficit. The President sees this as proof that the American economy is growing. Make that spending. Unfortunately, we are spending borrowed dollars. This is not, in the eyes of the fixed income market, a condition of growth.

The warning signs for the sell-off last week, apparently were right in front of everyone's nose. Even Greenspan, who warned us not once, but twice - first in the infamous conundrum speech, the one where he could scarcely believe that the long rates had not followed the short rates higher and secondly towards the end of last year when he suggested that only losses would occur should investors ignore the rising interest rate move he was orchestrating.

Greenspan really wanted a little help in doing his job. By not biting on the quarter point increases, 6 in all, the market had not permitted him the flexibility he required to make the moves he needed to, should, as we found out last week, inflation becomes a factor. Now, with that information is in the hands of investors, he can make the half-point moves he might need to make if in fact he so deems them necessary.

It is important to note as well, this new found understanding will play itself out even more dramatically in the mortgage backed securities. The long term effect in a shift in thinking will have ripple effects across the economy. Retailers depend on the wealth effect that inexpensive mortgages have provided, which will slow earnings among growth companies as inflation begins to whittle away at their current plans.

With the realization that long term rates may indeed begin to rise, something that has seemed almost impossible to every one but Greenspan, the unbridled optimism found among these investors has now been changed to reasonable attention.

Equity markets are also worried. If bonds become more attractive with lower prices, equity investors, who are now beginning to wrap themselves around the overvaluation of stocks, many may jump looking for those rock bottom deals with healthy yields.

The previous week's articles.

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