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Author: imdajunkman Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35351  
Subject: Re: Yield-Math Madness Date: 6/21/2006 12:38 AM
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I said: "That is serious money for short-term, high quality paper. If the market is demanding that kind of return, they're worried, and so should you be."

You asked: "Hey Charlie, care to explain? And if I should be worried, what should I do about it? My only real fixed income is for short term < 1 year things, so I'm specifically interested in that."

DeltaOne81,

I should just keep my big mouth shut sometimes. Less grief would come my way. LOL

I'll be honest. I can't explain what I said in ways I know can't be refuted. But let's divide my remark into two parts and have a go at them. The yields to be obtained from T-bills compared to elsewhere is Part One. The worry I'm assigning to those yields is Part Two.

Part One: T-Bills are unrated. But their presumed credit quality is higher than triple-AAA corporates. Treasuries are the gold standard. Therefore, they should trade at premium to all lesser quality debt. Currently, that premium is narrow or non-existent. Why? Is it because the market is taking a dim view of their credit quality? Is it because the market is taking a dim view of the credit quality of all other debt instruments, most of which are tied to the health of individual companies and/or the general economy? (Or are both things happening?)

Whatever the case, it is nearly impossible to match the yield on T-bills in the corporate market unless one goes far out the yield curve and/or quite a ways down the credit scale. Trolling the offering list will quickly prove that point. An effective yield of nearly 5.8% for a 6-months T-bill? Holy Moly! That's fat compared to what can be dredged up on the offering lists. That still isn't a real rate of return. But it's definitely closing the gap, especially since interest rates moves tend to be fairly glacial (compared to stock prices, for example) and parking money in T-bills won't hamper one's ability to pursue better opportunities as they arise.

Personally, I think interest rates are going a lot higher, and I intend to keep rolling up hill after them until things really do plateau and it becomes time to lengthen maturities. Compared to what small investors, and especially savers, have been having to accept by way of yield for the past several years, things are getting back into the clover again. The long end of the curve isn't yet back up to where it should be. The bond market is “tight”. But things are finally looking better for the little guy in terms of being able to rebuild savings without taking on some kinds of risks that are generally have to be managed, such as credit quality. That's part one.

This is part two. What prompted my remark about the market being worried was seeing the big jump this week made by the yield reported for the 6-moth's T-Bill compared to last week. I thought the jump was surprising, given the jaw-boning the Fed has been doing, the unsettledness of the stock market, the nearness of the next FOMC meeting, etc. My expectation was a decrease of the increases, as had happened a couple weeks ago. The spikes in the 4-week bill are, for all practical purposes, just noise. The government gets itself into a cash-crunch and has to accept a higher bid. The gov't doesn't need as much another week and can borrow a bit more cheaply. Plot a couple years of yields for the 4-week versus the 13-week and you'll see the variances. An astute observer could read a story from them, but I can't. (I'm a bond generalist, not a Treasury specialist.)

The relationship between the yields on the 13-week and the 26-week, OTOH, are a lot more stable, as are the changes from one day to the next on the various notches of the yield curve: the 3, 6, 12 24, 36, 60, 120, 240 marks. If one notch changed by 7 bps, often everything else did so, too, in the same amount or in an understandably proportional amount. But this week the 6-months bill, to my eye, spiked. It wasn't just playing catch-up, as some of the notches occasionally have to do. It surged. “Why” I asked “were bidders asking for their money?”

Why does anyone ask more for their money? Because they are worried was the only reasonable reply. Why are they worried? Who knows? But if they're worried, they are going to act in ways that people don't who aren't worried. And what does a fear-driven market do? It trashes everything senselessly. That creates opportunities, but it also does a lot of damage, especially if the fear gets out of hand and then attempts to stem the fears also over-react, in the way that back-burning often creates more damage that the fire it was intended to control. I don't think we are there yet. The market is unsettled, but not disorderly. A bit manic, but not panicky. People have an eye on the door and are maybe edging toward it, but the rush hasn't yet started.

Bu the real reason why I'm worried is because I'm a worrier. (That's why I'm a bond guy, not a stock guy.) I hear ghosts in every attic and see depressions in every whiff of recession. That's just me. But why did gold run to over $700 an ounce? How long will the US be able to service the interest on the money it is borrowing? How long before oil is priced in Euros? Where are the positives in the current situation compared to the negatives? What is the balance between them? I see the financial dikes springing more leaks as interest rates continue to climb.

I intend to chase those yields, but I also fear that the situation is a bit like arranging the deck chairs on the Titanic. The people whom I read, chiefly Austrian School economists, are worried. I think they make good arguments, so I take on their worries, too. But, in truth, whether anyone else needs to do the same is for them to decide, as they understand the facts. And this else needs to be understood. I'll often write a sentence for its sound rather than its sense. I like words. I like to play with language. I like the drama of constructing arguments. I use the dialectical process as a heuristic. So a lot of I say is just fluffs and bluffs, shadow boxing and feinting. There's generally a serious question or thought behind what I say. But that doesn't mean that I've been yet able to grasp what it is. So a lot of what I write amounts to treading water. I'm trying out ideas, trying to make sense of things of things that are complex and uncertain.

Worry was what I saw in the yield spike for the 26-week bill. So I said so. Am I right? Who knows?

Charlie
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