|
|
|
|
Who We Are
Money Focus Mutual Funds Insurance Mortgages Taxes Step by Step Hot Topics Contact the Editor
Featured Site AfterHourTrades.com, Inc. Featured Columnist: |
How the Bond Markets React 01.18.06
The "On-the-Other Hand" Economy
You want what all investors want. But just as all investors differ in temperament, some looking for rolling momentum for their cash, markets that look for the stratosphere, while still others look for protection from gathering storms. What brings investors together from across all boundaries is the undying pursuit of the investment that leaves their money largely unscathed. In return for the trouble, we'd all like a little yield.
So what should anyone with those goals make of December's weak but obvious inversion of the yield curve? An inverted yield curve happens when the yield of a shorter term fixed income note or bill begins to exceed that of a longer term offering. It usually signifies a lack of confidence for the economic outlook in the coming months. It has been saddled with the curse of predicting recessionary times in the offing.
Some stats bear this out but not conclusively. One economist reported that the predicted recessionary downturn was avoided 38% of the time in the five largest economies over the last sixty years. On the other hand, flattened curves between the 3 month and ten year Treasury did foretell a significant downturn almost 100% of the time.
Yet another economist pointed out that you need to look much further back that just a shorter term note and even shorter term bill all the way to the federal fund's target rate. If that were the benchmark for an inverted curve however, we would still have a little bit more flattening to go before we reach inverted. The 10-year Treasury is hanging around the 4.40% mark as of this writing and the target rate mentioned earlier is a full 15 basis points or 0.15% less.
It is a close-but-no-cigar situation that can be easily overcome if a few more pieces of the puzzle fall into place.
First piece of the puzzle is Alan Greenspan. He disagrees that the inverted or flattened curve is a good indicator of anything much at all. He failed to pay it heed back in 1999 as the curve inverted just as the equity markets heated up. That event went almost unnoticed because of the bad news it portends. Irrational exuberance was the feeling of the moment.
The lesson to be learned from that was one of timing. Market watchers and mavens tend to be an impatient lot. Predicting something requires that it materialize in the very near future. Which is why, when the outgoing Federal Reserve Chief weighs in on the subject - remember his conundrum? - one can expect the slowdown and possibly a recessionary one will happen in the next six months.
While we are on the subject of Greenspan and co., you might as well be aware of the F.O.M.C. braking system. Never very good at stopping once it builds even the slightest acceleration, expect the brakes that Bernanke will need to apply by this fall to be too late to stop any movement to the downside. The Fed just can't stop on a dime.
A flat to inverted yield curve dries up the mortgage and lending markets. Unable to attract the kind of investors needed to keep the money flowing at a reasonable profit, this second piece of the puzzle forces banks to simply tighten. That kind of a squeeze will hurt the small cap companies, which in turn will squeeze anything above them.
The net effect of this will be lower inflation through banking controls. An additional net effect will be a flight to high yileds with high risk. More corporate bonds will be looking more attractive as some are moved into junk status by the change in financial markets.
The third piece of the puzzle is more of an international phenomenon. There is prevailing belief that if the rates are low here at home, investors looking to park cash will find another marketplace that seems reasonably safe and invest there. But the trend towards one country, and one as large as the U.S. going it alone on the economic front in a downturn have become less likely as the world contarcts inot one giant economy.
Global long term rates are down among all of the great importers. This creates a conundrum for the world's greatest exporters. The Middle East, China and Russia are all facing a global market place that is increasingly reacting in tandem with each other.
While bond markets have always been roiled with unease and tension abroad, the Iranian noise may be just enough to start the slow tumble. Add to that a slight bump in the producer's price index, slower retai; sales in December, oil price still rising and if you look at the bad omen of both oil and gold rising in tandem, fixed income investors are downright nervous. In any case, the increased search for risk free government securities may be the ultimate vote for paying attention to what the other hand may be telling us.
|
