Monday, December 1, 2008

The Debts of the Spenders: The Fed Is the Greatest Treasury Bull

The Fed is empowered to buy and sell Treasuries. Taken by itself this is not unusual and in fact forms a normal part of its operations. However, the Fed is now engaged in record buying of Treasuries that goes well beyond its traditional mandate.

The effect of Bernanke being the main buyer at recent auctions has been a record push of T-bills and T-notes to nearly zero percent interest rates. The government's aim is to force people to look for alternative investment channels that can offer higher returns, e.g., equities and corporate bonds.

This strategy will work. . . at least in theory. Investors remain wary of equities for a good reason. The fundamentals have not changed and have in fact gotten a lot worse. Corporate bond markets are a little better but the yields in some areas are priced for armageddon - commercial real estate and property funds are offering (forward) dividends in the triple digits (percentage wise)! More conservative bonds are pushing the low double digits. So, does this mean that corporate bonds are now the next green pasture to attract the Treasury bulls?


Institutions have to be convinced first. Since bonds are denominated in increments of roughly $10k or more the debt markets remain the domain of the big boys. Unfortunately for the government, many institutions have conservative mandates that require them to invest in less risky asset classes. And that has meant US government paper. For now anyway. I would not be surprised to see fund managers with links to dubious (aka troubled) firms lobbying the SEC and other regulators to allow them to change their investing mandates in the near future.


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