Fixed Income Recap

Treasuries
Thursday’s thirty-year sale completed a week of well received auctions in the Treasury market. The issue came in at 3.64%, and then rallied to 3.61% by market close. Bond prices move inversely to yields. This marked the third day in a row of auctioned bond outperformance.

Treasuries looked a little rich after rallying strong for a three day period that saw stocks (S&P 500) rally roughly 11%. It’s a general rule that Treasuries prices move inversely to stocks, although this is not always true. Today’s movements are just a correction in my mind.

The two-year finished up 2/32 after being down most of the day, while the ten-year was lower by about a quarter of a point. The benchmark curve steepened by 7.5 basis points on the day and stands unchanged for the week. A basis point represents .01%.

TIPS
Treasury Inflation Protected Securities were up roughly 2% for the week as they continue to be volatile. Today’s reality when it comes to inflation is concerning. Unprecedented fiscal stimulus, Fed Funds sitting at zero with virtually no chance of going up any time soon, a budget deficit from Washington with limited Treasury buyers besides the Fed, in addition to a bulging Fed balance sheet (TALF, MMIFF, Fed MBS purchases) that could reach 30% of U.S. GDP all point to a major inflation event.

We could be a year or two from feeling the effects of the current policy, but I don’t see how we don’t get one. Excuse me for getting a little technical but consider the following equation for monetary exchange.

MV=PQ

M (money) is what is increasing at a break neck speed due to the loose money policies I detailed above.

V (velocity) is the number of times a dollar is exchanged between parties during a period of time. This varies along with the business cycle.

P (price) Prices rise in an inflationary period and prices fall during a deflationary period.

Q (quantity of goods and services available) This number rises during economic booms and falls during recessions.

Money is raging right now, but with velocity being so low, no pressure is being put on the other side of the equation. When the economy begins to show a little life and velocity returns, the quantity of goods will struggle to keep pace, leaving prices as the only variable left to balance out the exchange of money.

This is what is meant by “too much money chasing too few goods”. The process of hiring people, bringing factories back on line, and rebuilding the systems essential to running a business take time and therefore lags money supply growth.

We believe TIPS are an essential part of a portfolio in an inflationary environment.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst