Bank Notes - Archive

The Free Money Conundrum

Monday, January 11th, 2010

A 0% -25% fed-funds rate, combined with massive central bank purchases of bonds, has inflated the prices of fixed income securities and depressed yields to levels that do not adequately compensate investors for the risks of inflation and the inevitability of higher rates in the future.

When investors are able to borrow at these generous levels, and the Fed has signaled that free money will continue “for an extended period,” there is conceivably room for longer term interest rates and spreads to fall further. But over a time horizon measured in years rather than months, interest rates have nowhere to go but up. A battered and bruised dollar tells us that foreign investors may balk at continuing to support our “free money policy” through their waning appetite for U.S. treasury bonds. So, what to do?

Bond investors should adopt a defensive posture in anticipation of a rising rate environment, and concentrate their holdings in high quality, non-Treasury securities with maturities under five years. With this strategy in mind, it is of my opinion that institutions should also have an ample cash position on hand to take advantage of any sudden upward movement in interest rates and not get caught fully invested.

The inflection point when rates head higher is impossible to predict, but be prepared for rates to move significantly higher in 2010, based on the phase-out of Fed purchase programs, increasing inflation pressures, and a heavy supply of new bond issuance, primarily from the public sector.

In addition, in the months ahead, the Fed will find it increasingly hard to justify its misguided zero-percent interest rate policy, which punishes savers, distorts markets, weakens the dollar, and has no demonstrable positive effect on real economic growth or employment.

Current bond market yields may be unappetizing, but they look downright generous compared to miniscule money market yields. Bill Gross of PIMCO just wrote a piece on this topic, which was aptly titled “Anything But 0.01%.”  Through our FIDP (Federally Insured Deposit Program) we offer cash liquidity with a government guarantee on overnight money at 0.51%! That is a five fold greater return than most federal guarantee overnight rates offered. Our program gives investors full FDIC insurance coverage on a 12 million investment through 250K disbursements to over 50 financially sound banks.

Please call me to discuss the numerous benefits of investing in our FIDP program. Safety & liquidity, with excess returns, is an investment that is hard to beat.