What a day.  We’ve had too many “What a days” lately, and its late.  Over at RealMoney today, I posted this:

		David Merkel
		Watching the Maple Leaves Rise as Fall Approaches
		9/20/2007 12:49 PM EDT

It brings a lump to my throat, but the Canadian dollar briefly traded over parity to the U.S. dollar today. My guess is that it decisively moves above the U.S. dollar, and stays there for a while. Why not? Their economy is in better shape.Oh, and to echo one of Doug’s points, watch the 10-year swap yield. Nothing correlates better with the prime 30-year mortgage rate. It’s up 13 basis points since the FOMC move.

Looking at slope of the yield curves 10-years to 2-years, the Treasury curve has widened 20 bp and the swap curve 23 bp. If all Bernanke is trying to do is calm the short-term lending markets, that’s fine, but the long-term markets are getting hit.

Even in the short-term markets, things aren’t that great. We’re past the CP rollover problem, but the TED [Treasury-Eurodollar] spread is 135 bp now, and that ain’t calm.

I’m not a bear here, but there are significant risks that we haven’t eliminated yet… most of them stemming from the need for residential real estate to reprice down 10%-20% in real terms. Hey, wait. Hmm… what if the FOMC doesn’t really care about inflation anymore? They could concoct a rise in the price level of 20% or so, which would presumably flow through to housing, bailing out fixed-rate borrowers with too little margin (ignore for a moment that floating and new financing rates will rise also).

Okay, don’t ignore it. It will be difficult to inflate our way out of the problem. Even as the dollar declines, it will cause our trading partners to decide whether they want to slow their export machines by letting their currencies rise or buying more eventually depreciating dollar assets.

I would still encourage readers to be cautious with real-estate-related assets and those who finance them. Beyond that, just be wary of firms that need financing over the next two years. It may not be available on desirable terms.

Position: none, but who is not affected by this?

Interesting Times

We are within a half percent of taking out the all time low (1992) on the Dollar Index [DXY].  Since the move by the FOMC the ten-year Treasury has moved up 21 basis points.  That’s not stimulative.  Then again, maybe the FOMC wants to address the short term lending crisis, but could care less about stimulating the economy as a whole.  If this is their goal, let’s stand up and applaud their technique, but perhaps not their goals.

All that said life has returned to the investment grade bond market, and may be returning to the junk market, and maybe even the LBO debt market, if the banks will take enough of a loss to get things moving.  What I am finding attractive currently in fixed income right now is prime residential mortgage paper (this is rare — I usually hate RMBS).  Implied volatilities in are high, just look at the MOVE index, but they will eventually come down, at which point, the prices of mortgage bonds should improve (on a hedged basis).

Beyond that, I like foreign bonds, but am uncertain as to what currencies to go for; I still like the Canadian dollar, yen and the Swiss franc, but beyond that, I don’t know.  Aside from that, keep it short and high quality, because the long end isn’t acting well, and the junk credit stress is starting to arrive.

Away from that, I also still like inflation protected bonds, but they have run pretty hard since April.  TIPS overshot on the FOMC announcement, and have undershot since.  What a whipsaw.

So where would that leave me if I were a bond manager?  Foreign, mortgages, inflation-protected, and short duration high quality.  Sometimes the game is about capital preservation, and nothing more.