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We talked about this credit market relationship being a major risk back in April/May. Notwithstanding that we are coming in from a higher nominal level of rates, the fact remains that a flattening of the US yield curve is negative within the parameters of our multi factor risk management model.

It didn’t pay to ignore this relationship 9 months ago, and I don’t think it does today. Effectively, the yield curve is flattening because the US Federal Reserve is going to cut rates to zero (on a real basis to negative). Additionally, we have a Treasurry Secretary who apparently sees no problem floating trial balloons out to the marketplace that the US Government “could” cut or cap US mortgage rates to/at 4-5%. Not only does that rhetoric crush the long end of the curve, it leads the almighty US Consumer to a scarier place – saving!

Dear Hank,

He/She who saveth, spendeth less…

The US Economy has a 70% weight in Consumer Spending.

If you think you can create an expectation for ultra low long term mortgage rates, and the Amerian consumer isnt going to bake that into the cake of their decision making process (ie wait for lower rates), you are smoking something that we didn’t this morning here at Research Edge.

Flattening curves crush returns for the only American Capitalist who remains relevant. He or she who wants to borrow short and lend long, needs to see a spread and rate of return.

The head of the US Treasury should also consider what his #1 customer (China) might do with their bonds – if the Chinese realize that no rate of return on their bonds is not a risk worth taking, their selling will create the loudest bubble popping that we have heard in some time – the popping of the long term bond market bubble.
KM