Coming Bear Market in Bonds

WHO'S NOT SELLING BONDS?
First, the US Treasury has hundreds of billions of dollars of bonds to sell to fund the trillion dollar deficits Congress is mandating.

Second, the Federal Reserve will be selling the trillions of dollars of securities they have purchased in the recent expansion of the monetary base.

Third, and finally, any investor who owns bonds will be selling to avoid the coming bear market.

Paterson is advising its clients to continue to extend the maturity of liabilities past the 5 year mark, and look at 10 year liabilities, or more.

TACTICS
Continue to shorten the maturity of assets and use money market arbitrage to improve earnings.

Consider borrowing long term deposits.

Use extreme caution on long term lending.

STRATEGY
Warn senior management and the board that a disaster is in the offing.

The flood of money recently added by the Fed will either cause inflation or increases in long term interest rates - or both.

Apology

For the past three months Paterson has been busy working with existing and new clients to avoid the disaster in the credit markets.

My apologies to students, casual readers, and potential clients for the absence of this weblog.

Paterson is back, explaining the situation and suggesting tactical and strategic plans for dealing with the extended downturn.

Markets at Major Turning Points

Gold at Major Support










Most of the evidence suggests the bounce will be small, and prices will continue to drop. But, traders don't bet it that way.

Bond Refunding Successful
US Treasury sold $27 billion of notes and bonds following the largest increase in CPI since the Volcker years.

Treasury Note Futures









Treasury Bond Futures









Note that ond prices surged following a successful auction.

Corporate Bond Spreads Falling











Stocks finding Support

NYSE Composite











S&P 500











Russell 2000











SUMMARY
10 years from now this time will be seen as a major turning point in stocks. With inflation banished, and the bull market in bonds ended, only stocks will have the investment potential for the future.

Remember, stock prices rise when interest rates come down and stay down.

Fed and Treasury Up Again

Recent moves by the US Treasury to purchase equity in Fannie and Freddie tell us two things.

1. They are in danger of going bankrupt.
2. The treasury will not allow them to go out of business.

Even though shareholders might lose all their money, the companies will still be reconstituted by injections of US government cash.

Along with this announcement came the news that the Fed will lend to the mortgage buying behemoths if necessary.

These two actions will support home lending by ensuring the ability to sell mortgages in the secondary market.

Inflation and the Bond Market

Bonds sank through support this month and are now back at May's support levels, now resistance for this instrument.



The question now is how low will prices go, and how high will long rates rise?

To answer this question we look at the money supply and the dollar. The first causes inflaton, and the second makes inflation worse.

MONEY SUPPLY
The monetary base is growing, but growth has been slowing for years.



This is a good sign for inflation, showing the Fed's commitment to control the supply of high-powered money.

In recent months, however, growth has accelerated slightly, but not enough to cause inflation.



Bank generated money has grown substantially in the past years, as businesses work their way through the recent Fed-caused disaster.



In recent months, growth in this leading indicator has slowed, leading to renewed confidence in the Fed's management of interest rates and the money supply.

In summary, inflationary pressures are not building, and there is no need to raise interest rates.

INFLATION AND THE DOLLAR
Price rises in the United States are connected to the falling dollar. Import prices are soaring as international demand for primary commodities pulls at suppliers.



The rise in commodity prices is directly related to the fall in the value of the dollar.



Notice the plunge in the dollar in 2006, and the simultaneous rise in PPI.

TACTICS
Prudent A/L managers will continue to lengthen liability maturities, shorten asset maturities, and work for higher spreads in lending.

Money market arbitrage is more profitable than ever, and those clients pursuing this activity have found their yields soaring dramatically.

The key to this business is a careful analysis of credit quality. High quality credits have been pushed off the curve hundreds of basis points, providing opportunities for lenders with excess cash.

STRATEGY
Now is the time to report to senior management and the Board on the A/L condition of the portfolio.

The institution is liquid, carrying good credits, good spreads, and profitable liabilities. In short, we are ready to lend to our existing customers, and prepared to take business from our weaker competitors.

The Asset/Liability department can take a bow.

Storm Strengthens

VOLUME yesterday was not enough to say this decline is over.

BEWARE the continuing fall in stock prices.

DO NOT add new money to the stock market.

STAND BY for continuing updates.