The Bond Strategist

Previews & Reviews of Credit Markets & Their Related Economies

The Economy and Bonds by Forex Indicators

The global economic slowdown has been lingering around for the last three to four years, and could linger on for a few more. This as we all know has kept interest rates at record lows. With yields this low it is hard to find a place to put your money that will give you any type of return. Up until the month of May the equities market had been up over 50% from its March 2009 low. If you had happened to get in and stayed in you would have profited handsomely. Many investors though were still very cautious of the stock market because of the past few years, and chose to stay out. Instead many had just put their cash into short term paper accounts, Treasury Bills or Treasury Bonds. Some even found a safe haven in the fixed income of highly rated companies with strong businesses that have been around for years.

There hasn’t been a better time for business to raise money than in the past few years. Rates have been so low that they continue to issue new debt to fund further operations, or to pay off debt that they issued years earlier at a high rate. The lower the borrowing rate a company has to pay the better chance it has to make a profit. Right now the government is encouraging growth with these low rates, and many are taking advantage of it. Even the little guys on Main Street can take advantage of the low rates. Mortgages are at historic lows and many people are either re-financing their previous loans, or applying for a new loan to buy their first home. Now is the time to issue debt or take out a loan from the bank, because in the not too distant future rates will have to rise.

Interest rates cannot stay at this level forever, and since they cannot go any lower the most logical move is for them to rise. The real question is when? The Federal Reserve has continued to hint that the rates will remain low for the foreseeable future. No one really knows what that really means, but until we see consistent job growth they should remain low. If the economic indicators signal inflation the FED will also think about moving the interest rates up to combat that risk. When interest rates start to rise bond prices will start to fall. The inverse relationship between bond rates and prices is a major fear for investors. Many investors are only buying short term Treasury Bills because they feel that within the year rates could possibly rise. These people are obviously betting that employment numbers will be good and the economy will grow faster than expected. Forex indicators, like the strength of the dollar, will also help to decipher what interest rates will do. A weakening dollar could cause oil and gas prices to rise, causing inflation for oil related products.

The fixed income market will continue to stay stable through the end of the year. However in 2011 look for the economic numbers to look good enough to warrant rate hikes. Slowly the American worker will find work and that will lead to a high consumer confidence number and more spending throughout the economy. When this happens the FED will raise their rates and bond prices will fall. As an investor make sure you are positioned in the shorter term maturities if you feel this might be the likely scenario. Investing in longer term bonds is not a bad investment if the rate you are receiving is acceptable. Investing in Treasury Bonds that yield fewer than 4% might not be worth taking the risk, if rates rise next year. Since our government is selling so much debt into the world to pay for the credit crisis, all it takes is one of the big holders of our debt to sell and the rates will rise and the bond prices will fall. Bonds have a valuable use in the world just make sure you understand their dynamics before investing in them.