Don't Fight the Fed
I'm not moving…no really
You just try and push me out
No, I'm not moving…no really
No, I'm not going anywhere tonight
- Phil Collins
Leaving aside all the bluster regarding QE2 for a moment, I thought we might explore something closer to our hearts: short-term bond supply.
Recall QE2 affects only "longer-term" bonds presumed to mean bonds with maturities of two years or longer. But many of our clients live in the world of one year or even six months of liquidity. And these investors are being squeezed down to near zero returns by a tumbling Treasury market.
Why is this the case?
Of course there is continued risk aversion as investors remain gun-shy of any opportunity with risk — even longer dated Treasuries. This is driving funds into the shortest part of the yield curve hand over fist in the form of both separate accounts and money market funds (whether investing in Treasuries or not).
Outsized demand drives prices of these securities up and yields down. This is no surprise. But what may be a surprise are three other issues that will likely keep a lid on supply of short-term Treasuries for some time.
First, Republicans in the House will necessarily drive the process for raising the statutory debt ceiling when we start to bump into it in the first part of 2011. Today, there is only a $700 billion cushion for the Treasury to issue more debt while some prognosticators are looking for as much as $1.3 trillion in extra debt necessary by the end of next year.
It is not likely the Republicans will push forward an increase in the debt ceiling easily. As short-term bills mature(all "bills" are short-term as the term bill refers to Treasuries with original maturities of one year or less) it makes since the Treasury will first issue longer-term debt as replacement funding, driving down total outstandings in the T-bill market.
Though perhaps surprising to many, this is actually nothing new as the total outstandings of T-bills have been steadily decreasing for nearly two years. Instead, the Treasury has preferred to issue longer-term debt.
In fact, during the year ended September 30, 2010, outstanding debt with an original maturity longer than one year has increased by $1.5 trillion while debt with an original maturity one year or shorter has decreased by over $200 billion.
Looking ahead after the G-20 meetings, it's possible foreign central banks will continue to grow their T-bill holdings, providing further downward pressure on rates. These buyers are not rate sensitive as they are more interested in holding the most liquid, highest quality U.S. dollar assets they can find.
So where is an investor to turn?
We believe investors should consider shifting out of a government-only strategy into a strategy that includes also using select corporate securities, depending on the investor's objective.
To date, our conservative approach toward credit has yielded higher returns while maintaining the preservation of principal and liquidity. In fact, we only have a handful of approved issuers from which we buy corporate bonds for our clients on a regular basis. This select group is continually scrutinized for signs of potential problems on the horizon and we are quick to pull names from our approved list when we believe troubles seem ready to surface.
Today, we are getting north of 0.50 percent yields for clients who can go out one year and we are still able to gain significant yield for clients with a nine month maximum.
The old saying of "Don't fight the Fed" comes to mind today as it is trying to push investors out of Treasuries and into other investments. Should you wish to consider a higher yielding strategy, make sure you work with a partner who sees the playing field from your point of view and implements a rigidly conservative methodology.
Key DevelopmentsWholesale inventories rose 1.5 percent for September, after rising 1.2 percent the previous month. Suppliers are stocking up ahead of the holiday sales season. The advance in stockpiles may add to an upward revision to third quarter growth.
Jobless claims declined 24K in the latest week to 435K. The four week average moved lower to 446K. Continuing claims also dropped as well to 4301K. These figures do not include extended benefits under the federal program.
The University of Michigan confidence moved up to 69.3 for the preliminary November index. Consumers are feeling better given the rise in the stock market and a rebound in jobs the previous month.
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