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How the Bond Markets React There is no doubt, that in the coming days, many things will seem unchanged even as we are told they will be different (i.e. the handover of Iraq scheduled for mid-week), many things will change as we are told they will be the same (i.e. the jobs number will be hailed as encouraging although employers are making it clear, one slight bump in the road and all of those new workers will be gone) and the change that we all saw coming but knew not what to make of it (i.e. June's F.O.M.C. meeting where interest rates will change by too little too late) will finally arrive.
But we all know that. What we don't know is what will happen as a result. Holding it at arm's length might offer some assistance.
There are new term that while not new to seasoned investor, the hoards of newbies that have joined the ranks of investors over the last ix years may have little or no knowledge of them. The first is "negative carry".
Negative carry is a fixed market condition that makes the attraction of borrowing money from investors not worth the effort. When companies need money, they have two places they can go: the equity markets - selling additional shares or to the bond market - borrowing money with the promise of returning it with interest. Because the risk of default is higher among corporations, the yield they offer is often better than the government or municipalities offer.
There is some speculation that the short-term interest rate need to exceed inflation by two percent. With the old school belief that inflation is controllable after nearly four years of money as party favor, inflation will rear its ugly head, low rates or not. Companies have trimmed as much as they can. In order to maintain those stratospheric profits, prices need to rise.
Should interest rates hit 5.00%, we will see negative carry.
That brings me to our next bond buzzword: IDSs. That is short for "Income Deposit Securities", a new breed of bond/stock investment whose risk cannot be adequately determined by the S.E.C. That must frustrate those trying to sell these high yield junk bond offerings that have a dividend kick to them as well. Trouble is, the financing is a last ditch effort by many of these companies. There is little statistical evidence that bringing this type of offering to the general public will be good.
Mark my words, as the investment horizon begins to shift more noticeably away from the current sideways pattern and head steadily downhill, investors will jump in with both feet.
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