Mish's Global Economic Trend Analysis Message Board

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Strategies & Market Trends : Mish's Global Economic Trend Analysis

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To: CalculatedRisk who wrote (8075)	6/19/2004 11:12:10 AM
From: mishedlo	Read Replies (2) of 116555

Brian Reynolds on the Carry Trade and Treasuries This is paraphrased Back in April the Carry Trade was rapidly taken off and Brian wondered if it would be put back on at higher levels. There are indications it is being put back on right now and that might explain why corporate bonds have improved so much. Brian speculates that the equity markets MAY hit new highs if the tone in corporate bonds remains good. Corporate Bonds have been acting well since the middle of May. The Bond market was handed two more chances to panic recently, on the June Payroll numbers, and Greenspan's speech a week ago Friday. The Bond market did not panic. The last 5 and 10 yr autions also went well. The fact that so many tightenings are priced into the market is causing some to put back on the carry trade. 2 year yields are yielding almost 2.90% and held to maturity the trade becomes unprofitable if the cost of financing exceeds 3% over the life of the loan. If the FED were to hike interest rates 200BPs next year in equal amounts the cost of financing in one year would be 2%. That means financing costs for the second year would have to average over 4% for the trade to become unprofitable. That implies a 5% FF rate. For the trade to become significantly unprofitable, the rate would have to exceed that. If the FED tightens less than that or we get a rally in the two year, the trade has a chance for a home run. The prospect of this carry trade being put back on does not worry Brian. He thinks it is being done selectively (buying low and selling high) which is a marked change in mentality that happened back in late 1993. Putting back on the carry trade may in fact explain the bounce in financial stocks that caught many investors by surprise. If putting back on the carry trade is supporting the corporate markets and attracts more bond investors and individuals, then there is a chance of significantly higher equity prices. =========================================================== Mish take Lot's of this makes sense and perhaps ties anumber of things together: The bounce in gold at 380 strong resistance at 400 Trading range on the QQQs Trading range of the US$ vs the Euro The market seems to be thinking the FED will go slower now with 25BPs in June and not 50. Putting back on the carry trade works with slowly rising "normalization" of interest rates. IMO Brian has an overly simplistic model of equity prices vs corporate bond action, but perhaps not. At the 2002 lows, it was hard to get financining and stock prices reflected the chances that many companies would go under. It is unfortunate that some of these zombie companies did not go under but that is another story as well as debatable. Many of these companies refinanced for 2-3 years and we will see just how easy money is to get in 2006 and at what prices. I think a lot of bonds become due in 2006. I will aks Brian his take on this and just how spread out this financing is. At any rate, I think interest rates (for corporate borrowings) are going to be substantially higher in 2006. Will investors have a huge appetite for junk as they do right now? Personally I doubt it. A slowdown in the economy with hugely higher corporate borrowing costs (on a %wise basis), might be the next disaster a ways down the road. Mish

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