Fixed Income
June 26th, 2007 by 
reality
TStockmann asked:”How do you think the likely decompression of the risk spread will leave returns/capital costs in other fixed AAA instruments and the Treasury market? Would a crunch push everything higher, or would the constriction at the lower levels push more liquidity into safer returns, factoring in the inevitable economic downturn?”
I expect that Treasury rates will decline all along the curve, because of an anticipated Fed ease and declining inflation expectations. Agencies (except for GNMAs) should be vulnerable because of the conditions of Fannie and Freddie and their exposure to housing. High-grade corporates should be OK for a while, but there is so much debt out there that almost everything other than Treasuries and GNMAs will eventually come under suspicion as the economy declines.
Personally, I have two-year US Treasuries and long Canadian Treasury zeroes.
Posted in Fixed Income | 
June 26th, 2007 at 7:07 pm
Frankly, I don’t understand those declining inflation expectations. The global demand is strong, M3s are growing everywhere by 10-30% a year, so I would think all prices are going to rise. What exactly is going to get cheaper in dollars? Houses, yes. But not oil, not food, not imports. Even if core inflation slows down, and even if the US finds new ways to massage reported numbers down to 1-2%, the true total inflation should remain strong (over 8%, according to John Williams at Shadow Stats), and this is the kind of inflation that should be reflected in higher long-term yields, isn’t it?
June 26th, 2007 at 7:24 pm
M1 is static but M3 is growing as a result of expanding debt (credit). Debt=Money. So if debt stops growing, then so does money. End of inflation. QED.
June 26th, 2007 at 7:45 pm
Right, I did not really understand that M1 was stable. What is the exact mechanism of the M3 growth? (you don’t have to explain, a good link or a book reference would do).
What do you think is going to happen to dollar and to gold?
June 27th, 2007 at 5:22 am
Tim, check out this excellent video.
Money As Debt
\”Inflation is always and everywhere a monetary phenomenon\” - Milton Friedman. As far as the dollar is concerned, I suspect it will be stronger than most people seem to expect. All the major currencies are just fiat. While I expect the US economy to be very weak, so will the others.
As to gold, I have no idea. Very much an emotional speculation.
June 27th, 2007 at 8:34 am
About Dollar, I think reality is right. I am no student of economics, neither do I have background to forecast. But looking at news worldwide, I do not see a place where debt did not fuel economy for last few (4-7) years. So, when debt crunch comes down, all country will suffer equally - only the time of suffering may vary, IMHO. So, dollar will be stronger. Also, now everyone hates US dollar. So, may be in contrarian view, that is a neglected asset class right now which may turn up to be stronger later.
About gold, after following history of gold and zealously following current gold scenario - it is purely emotional play. I have a little amount with me in case emotion runs high. ;)