Bond Market Notes

What a week. The yield curve disinverted with ten-year Treasury yields moving above two year yields. 30-year bonds traded off 11 basis points, 10-years 7 bp, 5 years 5 bp. The short end of the curve was largely unchanged.

But now look at Treasury Inflation Protected Securities. TIPS 10 years and longer fell a mere 3 bp. TIPS 5 years and shorter were flat. Now, I have a large allocation of my balanced mandates in TIPS and short-term debt, so my downside was protected this week.

So why did the bond market move that way? The FOMC shifted its monetary policy language this week in a way that said that they no longer have a bias to tighten policy, but they do have have a bias to worry about inflation. The Fed’s announcement this week says that they are willing to tolerate a little more inflation. The bond market reacted accordingly, and required more yield on bonds with no inflation protection.

What else happened? The equity markets rallied, both before and after the FOMC announcement. Credit spreads largely tightened, and the dollar fell on the FOMC announcement, before rallying back to flat the rest of the week. In general, the carry trade currencies, the yen and the swiss franc, underperformed, and higher yielding currencies did better.

What can I say, then? The willingness to take risk is alive and well, and the carry trade is re-emerging. M&A isn’t suffering; note the possible deals on Tribune, ABN AMRO, Chrysler and Volkswagen. And, at least according to Bloomberg, there are a scad of CDO deals in the pipeline waiting to be done. So, let the party continue; let others ignore the rising inflation (at your peril), and enjoy the punch that the Fed is serving. As for me, I’ll just enjoy my mug of tea, slowly reduce risk, and watch the spectacle.