No. of Recommendations: 2

Unfortunately even as far back as 15 years, which only takes us back to the Clinton years, we are still well within the boundaries of the secular bull run for bonds. I believe that still distorts our forward predictions when we look at past performance. We need to pan the lens way out and attempt to study several macro cycles to gain some insight into today.

I really do not know what will happen in the next 18-24 months. I doubt the Fed will push up the overnight rate by more than 50 basis over the next 12. My finger in the air guess is 25 basis by years end and that will be a compromise move between hawks and doves, a peacekeeping act within the voting membership of the OMC more than a tactical macro economic/money policy move.

Currently we have a truly odd mix of immovable object v unstoppable force events in play. The unstoppable force of money printing by the US and the Eurozone is putting upward pressure on inflation and thus interest rates. This is partially mitigated by not truly printing or circulating money via the odd debt swaps between the Fed and the Treasury. Lurking in the corner is the need of the Social Security committees need to spend the debt issued to them in years past.

On the immovable object side we have fiscal/liquidity concerns in the PIGS, the Eurozone's "austerity acts" which will dampen recovery/growth. (although most likely a long range stabilizing force). We have the current unrest among the more progressive Arab nations which is unlikely to be quickly resolved even if new government are formed.(infant governments managed by enthusiastic but unseasoned leaders are bound to have above average number of missteps). China's internationally public numbers differ very little from a mutual funds or hedge funds propaganda designed to encourage further investing. Centralized government trying to heavy hand manage capitalism has no track record of success. China has or will have inflation problems and currently has significant growing pain mixes of surpluses and deficiencies within their system. All of this paragraph places tremendous downward pressure on price/yield of stable sovereign debt.

Lurking in the corner is the new Congress' hopes/plans to curb spending and to take on the Social Security problem. Common sense strongly suggests both cost cuts and raised taxes will be needed to substantially effect our fiscal issues. Cutting spending, raising taxes or some combination of both will impact our GDP growth keeping further downward pressure on interest rates.

French academics would most likely use the term milieu to describe our current predicament. There is no clear discernible near term path.

Probable paths:
The Fed raises rates and the whole curve shifts up
The Fed raises rates and the curve flattens
The Fed does not raise rates or raise them enough and the curve steepens without giving as a real return for the risk taken on for going out further on the curve.

6 or so months ago I believe the bond vigilantes were getting ready to mount up and ride but international events have kept them from saddling up. I still believe the bond market movers are very dissatisfied with the current acts by the Fed, the Obama Administration and the Pelosi Congress. I also believe they do not have a better choice at hand then to play the market as currently dealt.

As for strategy and tactics, high quality debt bought short and at a discount is probably as good a choice as any. A slightly above average pile of cash might be wise as well. By high quality debt I do not mean what the rating agencies have declared high quality, we must perform above average due diligence on all rated debt. The above average cash pile will allow us to take advantage of predictable over reactions and leave room to mitigate the predictable dips. In more plain and metaphorical terms it is probably best if we are more the reed than the oak.

The consternation currently surrounding Muni debt may provide the best risk/reward opportunities and the research is a huge pain in the arse.

Thoughts? Anyone? Bueller?

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