Personal Finance Advice

In times of economic distress, investors flock to safety.  The bond market usually acts as a safe harbor for many investors but the precarious financial position of many bond insurers has many shying away from corporate and municipal debt.

Since last summer, demand for treasury securities as well as the Fed’s rate cutting campaign, has steadily driven down yields.  Demand for 1 month T-bills has been especially brisk, with a number of money market funds reluctant to invest in short term commercial paper.

Back in March, in the wake of the near collapse of Bear Sterns, the yields on 1 month T-Bills fell to 0.27%, it’s lowest in over half a century.  Yields recovered slightly in the beginning of this month but are once again below 1 percent.

With many institutional investors feeling that the stock market hasn’t hit it’s bottom yet, the short maturing T-Bill gives them a safe haven to tide their money away until they feel the time is right to jump back into stocks while sacrificing very little liquidity.  The Treasury Department has also decreased the minimum face value of it’s securities to $100, down from $1,000 as of April 7, which makes it viable purchase for a larger number of investors.

Keep in mind that this is all taking place while inflation is on the rise and that the “real” yield is actually negative.  What we have now is an upward sloping yield curve, which is a favorable situation for banks.  Banks are able to borrow short at lower rates and lend long at higher rates.  Depending on how inflation plays out, long term interest rates may even rise further in the near future.

Recent economic data shows only a slight slowing in consumer spending but those numbers are misleading.  Higher prices are to blame for this, so while Americans may be spending the same amount of money, they are getting much less for their dollars than they did a year ago.

While some of it’s inflation, the weakness in the dollar also plays a large part in this because of the American consumer’s propensity for purchasing imports.  With the Fed forced to slash interest rates to cope with the growing credit crisis, the situation is not expected to improve anytime soon.

Americans are feeling the strain, especially in states like California and Florida.  With foreclosure rates at three times the national average, the housing bust has hit these regions especially hard.

Consumer confidence is at the lowest its been in years and we aren’t even technically in a recession yet.  People are having to spend a larger percentage of their disposable income on necessities like food and energy, whose prices have soared over the last year.

Many retailers are struggling as more and more Americans grow worried about inflation and job security.  While the economic stimulus package will provide a little relief, it is becoming increasingly unlikely that we will be able to spend our way out of this economic downturn.

More trouble may be brewing for credit markets in the upcoming year.  The growing fear of inflation has caused many large institutional investors to pump money into the commodities market, forcing prices upwards as the market becomes over saturated. 

The assault on the dollar in exchange markets has not helped either.  This is a huge problem with so much of our nation’s debt being held overseas.  Foreigners are becoming more  and more reluctant to hold U.S. Treasury Securities. 

Right now, the annualized rate of inflation is higher than the yields offered on Treasury Bills.  A number of central banks have expressed dismay at this and many foreign entities are considering drawing down their stocks of dollars and dollar denominated assets.

I wrote about this type of scenario back in November when China was threatening a massive sell off of U.S. Treasury Notes as retaliation for proposed trade sanctions.  If the fixed income market becomes flooded with Treasury Securities, prices will tumble and send long term interest rates soaring.

Once it starts, it could become a domino effect, forcing other entities to get out of dollars before it’s too late.  The effect on future economic growth could be devastating.  If you think it’s hard to find credit now, you haven’t seen anything yet.