PIMCO’s Bill Gross Opines on the Bond Market Moves, QE, Inflation, Et Al

Monday, March 19th, 2012

PIMCO’s Bill Gross joined Dan Gross on Yahoo Tech Ticker to discuss a host of bond related and economic views.  Much like myself, he sees another round of QE (sterlized or otherwise) – in fact he takes it another step further and says there is a good chance of QE4 as well.

Another round (or two) of quantitative easing from the Federal  Reserve, muted growth and an end to the 30-year bull run in government  bonds. That’s what Bill Gross,  one of the largest bond investors in the world, sees for the U.S.  economy in the coming year.

Despite  the Fed’s communiqué earlier this week, Gross doesn’t believe the  central bank’s interventions in the bond markets are over. In two rounds  of quantitative easing (QE), the Federal Reserve printed money to buy  hundreds of billions of dollars of Treasury bonds and mortgage-backed  securities. “I believe there will be a QE3, and perhaps a QE4,” he said.  Why? In the past few years, whenever central banks have stopped or  paused their quantitative easing efforts, “stock prices have fallen and  economies have slowed.” The globe’s private economies simply aren’t  sufficiently strong enough to support robust growth, and the world’s  central banks aren’t willing to stand by and watch. “That’s not a policy  recommendation, it’s simply a realization that the substitution of  central bank monetary purchases will continue for a long time, as long  as they [central banks] try to support private economies on a global  basis,” Gross said.

Still, Gross  believes the 30-year long bull run for bonds may be coming to an end.  “We’re certainly close and have been close for a number of months,” he  said. It’s very difficult to imagine interest rates going lower. “The  bond market, whether it’s Treasuries, mortgages, or investment-grade  bonds in combination, basically yield a little higher than 2%,” Gross  said. “And unless the U.S. economy replicates Japan, where yields are  down to 1% on average, then you’d have to say that we’re close to the  bottom in terms of yield.” He adds: “It doesn’t mean the beginning of a  bear market, but it does suggest at least that the great bond bull  market since 1981 is probably over.”

Recent market activity in  some bonds certainly ratifies that view. In recent weeks, the yield on  the 10-year Treasury has risen from about 1.8% in late January to about  2.28% on Thursday. But “those yields aren’t attractive,” Gross says.  Gross recommends that investors avoid longer-term bonds —  i.e. 10-year and 30-year bonds — whose prices may fall if long-term  growth and inflation expectations rise. However, they should also avoid  short-term bonds. “The Fed has conditionally guaranteed that they won’t  be raising interest rates until late 2014, and that’s almost three years  from now.” Gross believes that bonds that mature in five, six, or seven  years occupy the sweet spot in today’s market.

Bond holders tend  to fear strong growth because it has the potential to ignite inflation  and boost interest rates, thus reducing their returns. Gross says that  while the economy has improved, it shows no signs of overheating. He  believes the U.S. economy is growing at about a 2% annual rate in the  first quarter “and probably beyond.” That’s about as good as can be  hoped for. While the Federal Reserve has injected close to $1 trillion  into the U.S. economy in the past year, growth is in large measure tied  to what happens in the global economy. And the omens from abroad aren’t  particularly good. “China is slowing and the euro land is in recession,”  Gross said. The U.S. is growing at a decent clip, “what we call a new  normal, but it probably won’t get back to the 3 or 4% real growth  numbers that we witnessed over the past decades.”

Tags: Bill Gross, Bond Investors, Bond Market, Bond Markets, Central Banks, Consumer Price Index, Economic Views, Federal Reserve, Good Chance, Oil Prices, Opines, PIMCO, Principal Reasons, Qe, Qe3, Stock Prices, Term Bonds, Term Debt, Term Interest, Treasury Bonds
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QE2 Investment Performance (Econompic Data)

Wednesday, August 24th, 2011

by Econompic Data

Let’s rewind… the Economist detailed back in November:

Even before the Federal Reserve unveiled its second round of quantitative easing (QE) on November 3rd, critics had already denounced it as ineffectual or an invitation to inflation. It cannot be both and it may not be either.

The announcement of “QE2” was hardly breathtaking. The Fed said it will buy $600 billion of Treasuries between now and next June, at about $75 billion a month, although it also said it could adjust the amount and timing if need be. That was about what markets expected but far less than the $1.75 trillion of debt it bought between early 2009 and early 2010 in its first round of QE. Yet QE2 seems already to have exceeded the low expectations it has aroused. Since Ben Bernanke, chairman of the Fed, hinted at it at Jackson Hole on August 27th, markets have all done exactly what they should. Under QE the Fed buys long-term bonds with newly created money. This lowers long-term yields and chases investors into riskier, alternative investments.

Tags: Alternative Investments, Asset Performance, Ben Bernanke, Bonds, Chairman Of The Fed, Chases, Debacle, Debt Ceiling, Economic Terms, Federal Reserve, Investment Performance, Jackson Hole, Low Expectations, Performance Terms, Qe, Qe2, Rewind, Term Bonds, Term Yields, Treasuries, Uprisings
Posted in Bonds, Brazil, Markets | Comments Off

Need Income? Think Calls

Monday, June 27th, 2011

by Vikash Jain, archerETF

Horizons AlphaPro Enhanced Income Equity ETF ( Ticker: HEX )

There was a time when dividends and bond coupons could make for a good steady income. No more. Yields on the iShares S&P TSX 60 (XIU-TO) are around 2.25% and on the iShares DEX Universe Bond Index ETF of mid-term bonds is around 3.8% with considerable price risk given that rates will eventually rise. For the income-hungry investor, one strategy to consider could be covered call writing.

Covered call writing strategies have been used for years to generate income, especially when equity markets are flat to slightly positive. The strategy involves selling or “writing” call options on a security you already hold in your portfolio, say the iShares TSX 60 ETF (XIU-TO).

If you sell me a September 2011 call option with a strike price of $19 on your XIU ETF for a premium of 40 cents, it gives me the right, but not the obligation, to buy your XIU ETF from you at $19 at any time before the option expires. If XIU’s market price exceeds the $19 strike price before the option expires, I could demand XIU from you and you would be obliged to sell it to me for $19.

On the other hand, if the market price never exceeds the strike price during the term of the option, then the option expires worthless and you keep the 40 cent premium. Annualized, that is about 8.6% and more than enough to make up for the miserly dividends.

There are just a handful of equity exchange-traded funds that come pre-packaged with call options. They have been around for years in the United States but two have recently arrived in Canada. In January, the Bank of Montreal launched an ETF holding the six big banks with call options on each.

To avoid such concentration, a better choice is Horizons AlphaPro Enhanced Income Equity ETF (HEX-TO). It invests in 30 equally weighted Canadian large-cap stocks and writes call options on each. Since its mid-March launch, HEX has paid 42 cents in dividends, annualized that would be an incredible 15.6% and includes the dividends on the stocks. Keep in mind that this is over just four months and cannot be extrapolated. HEX will also need to demonstrate its strategy over a longer period.

More realistically, Horizons expects its call writing strategy to generate at least 8% in excess return, with dividends in addition to that. However, even that may be ambitious: equity markets have been highly volatile since mid-March and that has inflated option premiums. From experience, a more realistic long-term target for excess return is closer to 5-6% annually.

The limited choice in pre-packaged ETFs means many investors, including ourselves, opt to select specific call options customized to specific portfolio holdings. Most major ETFs have options available: ETFs like the iShares TSX 60 (XIU-TO), SPDR S&P 500 (SPY-US) and Vanguard’s Emerging Markets (VWO-US). Even individual country ETFs like iShares Brazil (EWZ-US) and iShares Japan (EWJ-US).

There is also more flexibility in selecting specific options. Sometimes, it makes sense to sell a call option with a strike price that is much higher or “further out of the money” than the current market price or to select a three-month term instead of a one-month. We also consider the volatility of each ETF when selecting the appropriate call option. Other times, it makes sense not sell any call options at all, often after a sharp correction when markets are expected to rally.

The goal of the covered call strategy is this: generate income while keeping the portfolio intact. You can generate more income by selling options that are closer to the current market price but that risks having the option exercised and the security called away. That will happen occasionally but it should be the exception, not the rule.

Compared to the pre-packaged choices, selecting specific call options is generally cheaper but requires more vigilance and a sound understanding of options markets.

The archerETF Global Tactical Portfolio

archerETF offers Global Tactical Portfolio Management.

Our outlook is Global: we invest across countries, sectors, commodities and other asset classes to improve returns. Our management is Tactical: we strive to select the right opportunities at the right times in response to changing market conditions to manage and minimize portfolio risk.

Please call us at TF 1-866-469-7990 for more information.

Copyright © archerETF

Tags: Bank Of Montreal, Bond Index, Brazil, Call Option, Call Options, Canadian, Canadian Market, Cap Stocks, Commodities, Dividends, Exchange Traded Funds, Handful, Hex, Horizons, Income Equity, Ishares, Launch, Mid March, Price Risk, S Market, Term Bonds, Tsx, TSX 60, Writing Strategies
Posted in Brazil, Canadian Market, Commodities, ETFs, Markets | Comments Off

China Plows Into Absurd Bet on Long-Term Japanese Debt

Wednesday, June 8th, 2011

by Michael ‘Mish’ Shedlock, Global Economic Trends Analysis

Bloomberg reports China’s Net Purchases of Japan’s Long-Term Debt Rises to Record in April

China’s net purchases of Japan’s long-term debt reached a record as the larger nation seeks to diversify the world’s biggest currency reserves.

China bought a net 1.33 trillion yen ($16.6 billion) in Japanese long-term bonds in April, the biggest amount since records began in January 2005, according to data released today in Tokyo by Japan’s Ministry of Finance. The nation sold a net 1.47 trillion yen of short-term debt, the data shows.

“As China tries to diversify its assets with its huge foreign-exchange reserves, it probably wants to have yen- denominated assets to some extent” in the longer term, said Tetsuya Inoue, chief researcher for financial markets for Tokyo- based Nomura Research Institute Ltd. “China has a strong trading relationship with Japan.”

Japanese government debt due in 10 years and longer has handed investors a 2.2 percent gain since the start of April, versus a 1 percent advance for the broad market, based on Bank of America Merrill Lynch data. The Nikkei 225 Stock Average has fallen 2.9 percent over the same period.

$16.6 billion is peanuts to China, but the trade itself is ridiculous. 10-Year Japanese debt is yielding 1.2%. 30-year Japanese debt yields 2.2%.

Pray tell what is the upside? Is 10-year debt falling to zero%?

Bear in mind that nations do not enter trades on a profit-loss basis so losses are of no concern. However, why take risks for almost no chance of gain when there are huge risks of losses, especially when there is a more viable play.

Buying long-term Japanese bonds is a heads you break even, tails you lose your ass bet. One can lose twice if yields rise and the Yen sinks. It is a sure loser if yields rise substantially, even if the Yen appreciates.

Holding Yen straight-up at least has a chance. I do care for that play, but perhaps I am wrong.

So what is China thinking? The answer is they aren’t thinking.

Copyright © Mike “Mish” Shedlock

http://globaleconomicanalysis.blogspot.com

Tags: Bank Of America, Bloomberg, Broad Market, Chief Researcher, Currency Reserves, Foreign Exchange Reserves, Global Economic Trends, Government Debt, Inoue, Japanese Government, Merrill Lynch, Michael Mish, Ministry Of Finance, Mish Shedlock, Nikkei 225, Nomura Research Institute, Profit Loss, Research Institute Ltd, Stock Average, Term Bonds
Posted in Markets | 1 Comment »

The Biggest Urban Legend in Finance (Arnott)

Wednesday, March 30th, 2011

by Robert Arnott, Research Affiliates

Stocks ought to produce higher returns than bonds in order for the capital markets to “work.” Otherwise, stockholders would not be paid for the additional risk they take for being lower down the capital structure. It comes as no surprise, therefore, that stockholders have enjoyed outsized returns for their efforts for most—but not all—long time periods.

Ibbotson Associates, whose annual data compendium¹ covers U.S. stocks and U.S. bonds since January 1926, shows the S&P 500 Index compounding through December 2010 at an annual rate of 9.9% vs. 5.5% for long-term government bonds, an excess return of 4.4%. This return compounds exponentially with time. A $1,000 U.S. stock investment in 1926 would have ballooned to $3 million by December 2010 vs. $92,000 for an investment in long-term bonds, a 32-fold difference.

Emboldened by the 1980s and 1990s (when stocks compounded at 17.6% and 18.2% per annum, respectively), “Stocks for the Long Run” became the mantra for long-term investing, as well as a best-selling book. This view is now embedded into the psyche of an entire generation of professional and casual investors who ignore the fact that much of those outsized returns were a consequence of soaring valuation multiples and tumbling yields. In this issue we examine historical U.S. equity performance from a larger perspective and find that today’s overwhelming equity bias is built on a shaky foundation, reliant on a short and unrepresentative time period.

Let’s Talk Really Long-Term

For those willing to do the homework, longer-term stock and bond data exist for the United States. But that picture isn’t quite as rosy as from 1926–2010; therefore, it doesn’t receive as much attention from Wall Street optimists. From 1802–2010, U.S. stocks generated a 7.9% annual return vs. 5.1% for long-term government bonds.² Our realized excess return was cut to 2.8%—a one-third reduction—by adding 125 years of capital markets history!

Of course, many observers will declare 19th century data irrelevant. A lot has changed! The survival of the United States was in doubt during the early part of the century (War of 1812) and during the debilitating Civil War of the 1860s. The United States was an “emerging market”! The economy was notably short on global trade and long subsistence agriculture. Furthermore, there were three major wars and four depressions—two were deeper than the Great Depression—between 1800 and 1870, a span when data on market returns were notably thin.

By the following century, the United States and its equity markets enjoyed good fortune. It was not invaded and occupied by a foreign power. It did not suffer a government overthrow… just ask Russian investors their return on capital after the Bolshevik Revolution! As Ben Graham might caution, beware the difference between the loss on capital (a drop in price, from which we can recover) and a loss of capital (100% loss, from which we cannot). Russia’s stock market wasn’t alone in the 20th century as three additional top 15 markets in 1900—Egypt, Argentina, and China—suffered a 100% loss of capital while Germany (twice) and Japan (once) came very close.³

Whether we use 200+ years or 80+ years, how many people are pursuing an investment program of that duration? No one, of course. Even “perpetual” institutions such as university endowments aren’t exempt. As the late economic historian Peter Bernstein commented, “…this kind of long run will exceed the life expectancies of most people mature enough to be invited to join such boards of trustees.”⁴ Relevant horizons for all “long term” investment programs are significantly shorter—10 years or 20 years, maybe 30.

Shouldn’t a span of one, two, or three decades be sufficient for investors to be rewarded for bearing the risk of holding stocks? As displayed in Table 1, trailing returns for stocks haven’t come close to earning the excess returns that we’ve all come to expect, even after stocks worldwide doubled from the early March 2009 lows during the Global Financial Crisis! We’ll save an exploration for how the Fundamental Index® concept radically reshapes this picture for another time.

Where is the wealth creation implied by the Ibbotson data? Stock market investors took the risk—riding out every bubble, every crash, every spectacular bankruptcy and bear market, over a 30-year stretch. How much were they compensated for the blood, sweat, and tears spilled with all this volatility? A measly 53 basis points per annum! Indeed, investors who have incurred the ups and downs over the past decade have lost money compared to what they could have earned from long-term government bonds. They’ve paid for the privilege of incurring stomach-churning risk. Not only did Treasury bond investors sleep better, they ate better too!

A 30-year stock market excess return of approximately zero is a huge disappointment to the legions of “stocks at any price” long-term investors. But it’s not the first extended drought. From 1803 to 1857,5 U.S. equities struggled; the stock investor would have received a third of the ending wealth of the bond investor. Stocks managed to break even only in 1871. Most observers would be shocked to learn there was ever a 68-year stretch of stock market underperformance. After a 72-year bull market from 1857 through 1929, another dry spell ensued. From 1929 through 1949, stocks failed to match bonds, the only long-term shortfall in the Ibbotson time sample. Perhaps it was the extraordinary period of history—The Great Depression and World War II—and the spectacular aftermath from 1950–1999, that lulled recent investors into a false sense of security regarding long-term equity performance.⁶

The Odds

Fortunately for the capital markets and equity investors, an examination of history shows that, yes, stocks have a high tendency to outperform government bonds over 10-year and 20-year periods. Figure 1 illustrates rolling 10- and 20-year “win rates” for equities versus government bonds. We break the data into Ibbotson (1926–2010) and Total (1802–2010). The Ibbotson timeframe confirms investor behavior in the 30 years since Ibbotson and Sinquefield published their groundbreaking study.⁷ For the vast majority of periods—86% for 10 years and 96% for 20 years—equities outperform bonds. But the longer term data are less convincing. For 10-year periods, equities outperform in 71% of the observations, rising to 83% for 20 years.

A 70% or 80% win rate still offers pretty good odds. In professional basketball, those are average to above-average free throw percentages. But the relatively small probability of failure masks the magnitude of a miss. Just as a single missed free throw can cost a basketball championship, so too can an equity “miss” lead to drastic consequences, as the past 10 years have shown. There is no guarantee of superior equity returns, which begs the question: Why does our industry act like there’s one? More important, why take all that risk for a skinny equity premium?

Conclusion

We aren’t saying that we should expect bonds to beat stocks over the next 10 or 20 years. Rather, this brief history lesson illuminates that the much-vaunted 4–5% risk premium for stocks is unreliable and a dangerous assumption on which to make our future plans. In our view, a more normal economic environment would suggest 2–3%, which is the historic risk premium absent the rise in valuation multiples in the past 30 years. But these are not normal times. Today’s low starting yields, combined with the prospective challenges from our addiction to debt-financed consumption and aging population, would put us closer to 1%.

It would be foolish to act as if the past 200 years is fully representative of the future. For one thing, the United States was an emerging market for much of that period, with only a handful of industries and an unstable currency. In the past century, we dodged challenges and difficulties that laid waste to the plans of investors in many countries. Nassim Taleb points out that “Black Swans”—unwelcome outliers that exceed the bounds of normalcy—are a recurring phenomenon; the abnormal is, indeed, normal. Our own stock market history is but a single sample of a large and unknowable population of potential outcomes.

Peter Bernstein relentlessly reminded us there are things we can never know, that prosperity and investing success are inherently “risky”; they can disappear in a flash. Uncertainty is always with us. The old adage puts it succinctly: “If you want God to laugh, tell him your plans.” Concentrating the majority of one’s investment portfolio in one investment category, based on an unknowable and fickle long-term equity premium, is a dangerous game of “probability chicken.”

Endnotes

1. Ibbotson® SBBI® 2011 Classic Yearbook: Market Results for Stocks, Bonds, Bills, and Inflation 1926–2010, Morningstar.

2. For much of this section, we rely on the data that Peter Bernstein and I assembled for “What Risk Premium is ‘Normal’?” Financial Analysts Journal, March/April 2002. We are indebted to many sources for this data, ranging

from Ibbotson Associates, the Cowles Commission, Bill Schwert of Rochester University, and Bob Shiller of Yale. For the full roster of sources, see the FAJ paper.

3. See Arnott and Bernstein (2002).

4. See Peter Bernstein, “What Rate of Return Can You Reasonably Expect… or What Can the Long Run Tell Us about the Short Run?” Financial Analysts Journal, March/April 1997.

5. 20-year bonds were used whenever possible but the longest maturities tended to be 10 years for much of the nineteenth century. Also, in the 1840s, there was a brief span with no government debt (we should be so lucky!),

hence no government bonds. Under these circumstances, the equivalent to today’s Government Sponsored Enterprises, railway and canal bonds, were used as these projects typically had the tacit support of the government.

6. For more on this, see Robert Arnott, “Bonds: Why Bother?” Journal of Indexes, May/June 2009.

7. Roger G. Ibbotson and Rex A. Sinquefield, “Stocks, Bonds, Bills and Inflation: Year-by-Year Historical Returns (1926–1974),” Journal of Business, January 1976.

©2011 Research Affiliates, LLC. The material contained in this document is for general information purposes only. It relates only to a hypothetical model of past performance of the Fundamental Index® strategy itself, and not to any asset management products based on this index. No allowance has been made for trading costs or management fees which would reduce investment performance. Actual results may differ. This material is not intended as an offer or a solicitation for the purchase and/or sale of any security or financial instrument, nor is it advice or a recommendation to enter into any transaction. This material is based on information that is considered to be reliable, but Research Affiliates® and its related entities (collectively “RA”) make this information available on an “as is” basis and make no warranties, express or implied regarding the accuracy of the information contained herein, for any particular purpose. RA is not responsible for any errors or omissions or for results obtained from the use of this information. Nothing contained in this material is intended to constitute legal, tax, securities, financial or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this material should not be acted upon without obtaining specific legal, tax or investment advice from a licensed professional. Indexes are not managed investment products, and, as such cannot be invested in directly. Returns represent back-tested performance based on rules used in the creation of the index, are not a guarantee of future performance and are not indicative of any specific investment. Research Affiliates, LLC, is an investment adviser registered under the Investment Advisors Act of 1940 with the U.S. Securities and Exchange Commission (SEC).

Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination, or redistribution is strictly prohibited. This is a presentation of RA. Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in RA’s presentation thereof.

The trade names Fundamental Index®, RAFI®, the RAFI logo, and the Research Affiliates® corporate name and logo are registered trademarks and are the exclusive intellectual property of RA. Any use of these trade names and logos without the prior written permission of RA is expressly prohibited. RA reserves the right to take any and all necessary action to preserve all of its rights, title and interest in and to these marks. Fundamental Index® concept, the non-capitalization method for creating and weighting of an index of securities, is patented and patent-pending proprietary intellectual property of RA. (US Patent No. 7,620,577; 7,747,502; and 7,792,719; Patent Pending Publ. Nos. US-2007-0055598-A1, US-2008-0288416-A1, US-2010-0191628, US-2010-0262563, WO 2005/076812, WO 2007/078399 A2, WO 2008/118372,EPN 1733352, and HK1099110).

The views and opinions expressed are those of the author and not necessarily those of Research Affiliates, LLC. The opinions are subject to change without notice.

Copyright © Research Affiliates

Tags: Annum, Best Selling Book, Bond Data, Capital Markets, Capital Structure, China, Currency, Emerging Markets, Excess Return, Government Bonds, Ibbotson Associates, Investment Bonds, Optimists, Research Affiliates, Robert Arnott, Russia, Shaky Foundation, Stock Investment, Stockholders, Term Bonds, Term Investing, Term Stock, Time Periods, Urban Legend
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A Magic Bullet for Inflation and Deflation?

Wednesday, February 3rd, 2010

During the better part of the last 18 months, since the financial crisis erupted, the debate over whether we are in store for inflation or deflation has dominated the investment decision making thoughts of all market participants, from retail investors to hedge fund managers.

The burning question – “Are we heading for inflation or deflation?” – is the toughest one to hurdle. Since there is no way of knowing, you have to make a decision based on what you know about each, then, make a decision about how to invest, based on your decision. Its precarious at best. Many investors, however, unable to settle on an outlook, will choose the option that requires the least amount of thought – cash, GICs, and short term bonds – and wait for things to be clarified.

That’s why something hedge fund manager David Einhorn, of Greenlight Capital wrote last year has got my attention again.

Read the whole article here.

Pierre Daillie (AdvisorAnalyst.com), GlobeAdvisor.com, February 1, 2010.
http://www.globeadvisor.com/advisoranalyst/aa20100201.html

Tags: Burning Question, David Einhorn, Financial Crisis, Fund Managers, Gics, Globeadvisor, Greenlight Capital, Hedge Fund Manager, Inflation And Deflation, Investment Decision, Magic Bullet, Market Participants, Retail Investors, Term Bonds
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The Yield Curve is Flattening?

Wednesday, December 17th, 2008

Long-term government bond yields are dropping everywhere. Is anybody going this way?

Here is what some of the folks in the bond market are saying:

Eric Lascelles, Chief Economic and Rates Strategist,  TD Securities Inc.: “It is remarkable, the speed at which this is happening,” said Eric Lascelles, chief economics and rates strategist for TD Securities Inc.

Stewart Hall, currency and fixed-income strategist with HSBC Securities (Canada) Inc.: “I think one of the overarching themes today is global recession.” On a positive note, “You have the Fed and other government agencies operating in an imaginative and innovative fashion to throw as much as necessary [at the problem] to get the economy back in track.”

Mark Chandler, fixed-income strategist with RBC Dominion Securities Inc.: “Long-term rates are playing catch-up in terms of the decline in yields we have seen in short-term bonds.  There is limited downside in short-term yields.”The relatively greater drop in yields on long-term bonds compared with short-term bonds is a theme that could continue into the first half of 2009, Mr. Chandler said. In the parlance of bond traders, this is known as a yield curve flattener, as the difference in yield between short-term and long-term bonds narrows.

The decision by the Fed last week to buy $500-billion (U.S.) of agency guaranteed mortgage-backed securities, along with $100-billion of other agency (government-sponsored enterprises) debt, is a force acting to push yields down.

On an increasing basis, the Fed has been taking steps to manage through the U.S. housing crisis. The plan injects liquidity into the system, and frees up cash available for mortgage lending, as well as serving to lower U.S. mortgage rates. The rate of 30-year mortgages has fallen to 6 per cent last week from 6.5 per cent.

Less than two weeks ago, Federal Reserve Board chairman Ben Bernanke indicated that the Fed could also decide to buy longer-term U.S. Treasuries, which would reduce bond supplies, resulting in higher prices and a decline in yields.

From Bloomberg:

The 10-year note’s yield fell as much as 14 basis points, or 0.14 percentage point, to 3.37 percent. It traded at 3.40 percent at 3:04 p.m. in Toronto. The price of the 4.25 percent security maturing in June 2018 advanced 84 cents to C$106.86.

The yield on the two-year government bond dropped six basis points to 1.77 percent. The price of the 2.75 percent security due in December 2010 rose 12 cents to C$101.95.

The 10-year bond yielded 163 basis points more than the two- year security, down from 168 basis points yesterday. The so- called yield curve reached 184 basis points on Nov. 6, the steepest since May 2004.

Our thoughts are that Government of Canada bond yields which are still higher than those of comparable US treasuries will also come down over the next year, as investors seek the refuge of government securities (and Canada’s higher yields), on the Canadian as well as global recession trend. The current blows to the Canadian economy come as the Auto industry copes with the difficulties of the Big Three automakers, and in the commodities sector, with the decline in commodities prices that has led producers to consider shutting in mining and exploration projects, and laying off employees. On this basis, it seems far more likely that Canada’s yield curve could continue to flatten along with the US treasury yield curve, leading to higher bond prices and lower yields.

Levente Mady, a fixed-income strategist at MF Global Canada Co.: “Inflation doesn’t matter any more. It’s deflationary concern that’s underpinning the bid in the long end of the market. Yields are literally gravitating towards zero. It’s almost like it doesn’t matter if the news is good, bad or indifferent.”

Sources: Globe and Mail, Bloomberg

Tags: Array, Ben Bernanke, Bloomberg, Bond Traders, Bond Yields, Cad, Canada Inc, Canadian Market, cent, Chief, currency and fixed-income strategist, Eric Lascelles, Federal Reserve Board, Federal Reserve Board Chairman, fixed-income strategist, Global Recession, Globe And Mail, Government Bond, Government Of Canada, Government Sponsored Enterprises, Hsbc Securities, HSBC Securities (Canada) Inc., Lascelles, Levente Mady, Mark Chandler, MF Global Canada Co., Mining, Mortgage Backed Securities, Other Government Agencies, Rbc, Rbc Dominion Securities, Rbc Dominion Securities Inc, Stewart Hall, Strategist, Td Securities Inc, Term Bonds, Term Yields, Toronto, United States, Us Federal Reserve, usd, Yield Curve
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