So far the hopes of a rebound in the economy appear slim in 2009. The markets have steadily traded downwards since the beginning of the year, wiping out all the gains that were seen last month of 2008. The question on everyone’s mind is where does the value exist currently? With deflation being the new buzz word thrown around, and the government seeking to “combat inflation at all cost”, by spending multiple billions of dollars that have been created from thin air, buying treasuries now doesn’t seem reasonable. Current yields for US treasuries are not particularly exciting/attractive, we have 3 month Treasuries sitting at a yield of 0.13%, 5 Year Treasury yield at 1.48%, one has to lock up funds for a 30 year period to get an interest rate close to 3%.
Many investors and fund managers have justified their loans to the US government at 0% by stating that it’s much safer to have your money whole at the end of three months, as opposed to investing in an extremely volatile market or in a bank that may collapse anytime soon. News from RBS and Bank of America have not provided any warm fuzzy feeling in the market, and may have exacerbated the fear of the market dipping below it’s November lows, so very few dollars are flowing back into the stock market currently because of the perceived increased volatility.
(click to enlarge chart)
With that being said, it’s worth taking a look at intermediate and long-term Treasury Inflation Protected Securities, or TIPS. Taking a look at the chart of the 10 Year Treasury constant bond vs. the 10 Year Treasury Inflation adjusted bond, we see the market is technically pricing in deflation as the major concern, hence the near 0% rates being seen. This in itself is misleading, technically from the chart inflation is a concern, but fundamentally billions of dollars that were initially parked in stocks and money market accounts in the face of this economic crisis have been moving into US Treasuries as a safe haven. With the economic bailout looking more like a 2 or 3 Trillion dollar job, long term inflation is a certainty.
Based on the chart above, the market is projecting approximately 0% cumulative inflation over the next 10 years, but the Fed projects that we’ll see a negative number for inflation, or rather deflation, and they have employed a few mechanisms to fight this by setting the target Fed Funds rate to 0.25%, bailout monies, and absorbing bad debt from the balance sheet of financial companies, all of which will be monetized (by increasing reserves).
The graph below from the St. Louis Fed shows the progress being made in increasing reserves.
The Austrian school and the Keynes school both have varying perspectives on how to deal with the current economic situation. From a Keynesian view, and this is where the current Fed stands, printing money (or stimulating a moderate monetary inflation, which symbolizes economic growth) is the right way to handle the current economic situation.
The question then becomes how much money is too much money? Since economics is not an exact science, and many times various policies put in place to stabilize the economy usually have a delay before results are seen. More than likely, the government will continue to print more money until economic data begins to show a rebound in the economy, at this point the Fed would have injected enough money in the system to stabilize the economy, or more than is necessary to provide stability in the system, the result of which is inflation, the latter is often the case.
With this in mind, a safe haven investment will be an investment in TIPS, the value may not be seen in the short term, but inevitably as time goes, the effects of inflation will be seen and the value in TIPS will have added premium.
Learn more about TIPS and buying here at Treasury Direct.
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