Interesting WSJ discussion on the flattening yield curve:
"Economists’ explanations for what is happening to yields vary, many amounting to too much money chasing too few long-term investments, pushing prices up and potential returns down. Asian central banks and private investors, for example, have been big buyers of U.S. bonds. And as the U.S. population ages and the government prods companies to better fund their pension plans, demand has grown for the kind of long-term bonds that can guarantee payments to future retirees.
The Fed’s own actions also have played a leading role in keeping long-term interest rates low. Over the past year, the Fed has been unusually open about signaling its intentions to the market before each of its short-term rate increases. The predictability of Fed policy has calmed peoples’ worries that a sudden increase in inflation could erode the value of their investments, making investors more willing to part with their money longer, for little extra return.
You know the real reason I’m a referncing this is because I am some bizarre combination of a graphic groupie and a chart whore. Well, we aim to please:
click for larger graphic
What’s this mean to investors? In a word, RISK:
"It has also encouraged investors to take on more risk — for example, by buying long-term bonds with money borrowed at short-term rates. In one indication of investors’ rising tolerance for risk, securities dealers’ outstanding short-term loans to their clients reached an all-time high of $3.5 trillion at the end of June, though it has decreased somewhat since.
If strong economic data — or some shock such as a sudden rise in inflation — prompt investors to sell bonds purchased on borrowed funds, long-term interest rates could jump. For now, though, added demand for long-term bonds is pushing prices up and interest rates down, undermining the Fed’s ability to influence long-term rates."
Go figure. Ultra-low rates encourages speculation in the fixed income markets.
When all is said and done about Greenspan’s Chairmanship, I believe his final legacy will be his surprising willingness to encourage specualtion — in Nasdaq stocks, in Real Estate anmd now in Bonds.
Fed’s Fight Squeezes Banks, Spooks Markets
Vanishing Gap Between Rates For Long- and Short-Term Debt Means Lower Profits for Lenders
MARK WHITEHOUSE and ROBIN SIDEL
WALL STREET JOURNAL, August 9, 2005; Page C1