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How the Bond Markets React 02.27.05
The Diminishing Appetite
Traders of Treasury notes have begun to grimace in earnest. The reasons it seems is coming from all angles making it difficult to discern who said what and whether it will have any effect on bond offerings.
First off, the Treasury's auction of $24 billion in new notes went largely unclaimed. South Korea had announced at the beginning of the week that they would be seeking diversification in other currencies. They quickly recanted but the numbers backed up the notion that foreign investors are not as eager to fund the United States current spending.
Secondly, the falling dollar, a topic that went largely undiscussed as the President toured Europe for the first time since beginning his second term, may have the effect of increasing the value of comparable currencies while sending the dollar through the floor. Japan for one, invites the new increase in purchases coming from the Chinese mainland. China has pegged their currency, the yuan, to the dollar, a move that makes their currency less valuable. This keeps their exports cheap and allows imports to be bought at bargain prices.
Bond traders are hoping that the February jobs report, due out on Friday will be much better than the January report. I highly doubt it. Employers are feeling the pinch of higher costs and the relative inability to pass those costs off to the consumer. The consumer on the other hand may be slowing a bit - not saving more, mind you, but spending with less abandon.
Hiring people does little for the bottom line. Right now, companies need to convince equity investors that all is well and profits look to be good in the coming quarter and for the full year. Expect the jobs number to be below 100,000.
For fixed income investors looking to protect themselves, the long end of the investment is beginning to look tempting. Short term problems that include the ever flattening yield curve, the inability of Fed chairman Alan Greenspan to decipher the reason for the curves reluctance to cooperate, and folks like Bill Gross of Pimco stepping in to comment on the artificial lowness of the current yield, do little to fix the situation.
If you believe the opportunity to create a better return is in the junk market, it is best that you be aware of some new facts that have come to light. The first and certainly not the least is the lure of those high yields comes with an ever increasing default rate over a ten year period. That rate on the lowest rated bond, the Triple C is now around 50% over the life of the issue, usually ten years. Add to that the cost of owning them. The prices you may have paid are being deeply offset by the companies whose credit ratings have fallen as their stock prices have risen. This will also decrease your return - if you get one at all.
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