Michael B. Krause

Why Treasuries Are the Way to Go in This Market

Leo: This is a search for appreciation trade, not a yield hunting one. Preferred stock purchases (or corporate bonds) have considerably higher downside in the event a recession occurs (as they take corporate risk). If recession happens (and inevitable increase of defaults associated with that), corporate debt credit spreads will rise and offset some of the gains in the underlying treasury position. (recall corporate debt = treasury of equiv duration + credit spread)

Furthermore, a yield curve inversion with a recession will enable the longer duration note and bond to fall past fed targets. So even if the fed stops at 3.5%, a flight to quality could enable the long yield to hit 2.5-3.2% just as easily.

Obviously its hard to imagine 2.5% 10 yr notes with the PPI and CPI #s we are seeing right now, but a global slowdown could turn this commodity based inflation move an opposing direction. Expect some volatility of PPI/CPI #s. I wouldn't be surprised to see negative CPI/PPI y/y (12 mos from now) if the consumer and world growth continue to slow. Then 2.5% yields are more palatable, aren't they?