Quantitative Wheezing: The Difficult Search for Yield

It seems as though the post on competitive devaluation of the U.S. dollar was a bit more timely than even I expected. Ten-year Treasury rates have absolutely collapsed (top chart) in the wake of announced Fed policy. As a result, the euro (middle chart) has soared about 10% versus the dollar in the past five trading sessions alone. The yen (bottom chart) is now trading at 13+ year highs versus the dollar. Gold, meanwhile, is trading at its highest level since early October.

In the wake of these events, I talked with a bank president yesterday, who was unusually candid. His bank was lowering its CD rates because it didn't need to attract more capital. Why? It is difficult to find creditworthy lending projects. The bank isn't keen to lend money for real estate-related loans, and the business climate is hardly looking good for expansion.

As Mish points out, banks can borrow money essentially for free from the Fed and simply stash it at higher interest rates further out on the yield curve. Making money cheaper doesn't necessarily increase the incentives for banks to lend. Meanwhile, I talked with representatives from two large brokerage firms, both of whom confirmed that their inventory of longer-term certificates of deposit (more than 3 years) had been completely bought out.

Retirees are going to be facing an interesting dilemma in 2009: Accept government guarantees with Treasuries, CDs, etc. and face paltry yields, or accept greater risk as well as return in the corporate and municipal bond markets. I notice we had a good pop in price for investment grade corporates (LQD) and municipals (TFI) today; perhaps those yields are looking juicier in a zero interest rate world. Of course, all those returns are denominated in U.S. dollars and, hidden to average investors, is the dollar devaluation of their accounts in the past week.

Comments

[poggi]

While I understand, appreciate and agree with your claim that retirees investing in US securities will "suffer" dollar devaluation; however, so what? Most retirees are not globe trotters; and, if they discipline their purchasing habits, they can live "on the US economy" for the most part. Secondly, how many retirees or their financial advisors are capable of constructing a currency-hedged, low-risk investment portfolio?

What did investors/savers ever do before we had interactive, up-to-the-second exchange rates and access to financial writers who have time to muse and write about these things? Oh, I remember. We simply lived our lives in a much less complicated way.

2008 Dec 17 08:36 PM

[bick2]

Yawn.

Next week the Eurozone banks will drop their rates and the dollar will regain its losses.

2008 Dec 17 09:58 PM

[CautiousInvestor]

I enjoyed the observation that many banks will simply take the 0% money and invest it further out on the yield curve. Were I a banker and depending upon how I would play this arb opportunity, I would hedge this play in some manner to protect myself from the prospect of rising interest rates and declining note/bond prices.

2008 Dec 17 11:04 PM

[Alex Filonov]

Welcome dollar carry trade. Anybody remembers how huge Yen carry trade started?

2008 Dec 17 11:34 PM

[bearfund]

And what happens to those banks with all their capital stashed away in bonds yielding 2.5% when interest rates start rising? Seems like another bubble-bursting, deleveraging-triggerin... collapse-inducing disaster to me. As a condition of having access to free money, banks should be barred from owning Treasuries. Put the money to work in the real economy or you don't get to borrow it.

2008 Dec 17 11:58 PM

[Moon Kil Woong]

There are trillions of more dollars to do a dollar Euro trade then there were ever yen to do a dollar carry trade. However, beware, where the US goes the Euro tends to follow. As Bick2 points out, when the Euro lowered it's rates after months of bickering, the dollar made big gains against it.

Risk may not always be reward. It may in fact result in a loss. That's why we call it risk not a CDS fantasy.

In the meantime I agree with the author. Not only are we getting poorer in America we are also getting poorer internationally and won't be able to buy much of anything if the Fed and Treasury keep playing a loosing game of make funny money and give it all to friends to pay off other friends.

2008 Dec 18 12:05 AM