Bonds Bust Markets

Selling transpired in Wall Street on Wednesday, as a drop in Treasurys, due to 10-year swap spreads going negative for the first time, caused for the retreat in equities. Interest rates for Treasurys to help fill the need for the new debt issued. My ETFs that I purchased as an interest rate hedge (post from last week) performed very well today and I believe there are more gains to come. It comes back to the simple economic principle of supply and demand. We know the amount of US debt that has been issued and continues to be issued and it is only a matter of time until "the demand" weakens. We saw that today.

As a result of the drop in Treasurys, we also saw a rise in the dollar. The dollar has been performing very this last month and was helped more today, due to the downgrade of Portugal's credit rating. UUP is one of those good rocks for me that keeps chugging away and brings in moderate returns. However, continual abuse of currency printing will eventually bring the dollar to worthless values (see chart below).

dollar spending abuse
Inflation isn't a worry for many at this point in the game. They feel that all measures should be taken to keep the economy afloat. I do agree that the government should do all that they can, but they are beginning to go much more and beyond than what is required. As a result, many are worried for what consequences may lie ahead. Sure, inflation is not an immediate threat, but we are almost guaranteed to see it in coming years. Thomas Hoenig, the President of the Federal Reserve bank of Kansas City said the following:

“When I was named president of the Federal Reserve Bank of Kansas City in 1991, my 85-year old neighbor gave me a 500,000 mark German note. He had been in Germany during its hyperinflation, and told me that in 1921, the note would have bought a house. In 1923, it would not even buy a loaf of bread. He said, ‘I want you to have this note as a reminder. Your duty is to protect the value of the currency.’ That note is framed and hanging in my office.

“Someone recently wrote that I evoked ‘hyperinflation’ for effect. Many say it could never happen here in the U.S. To them I ask, ‘Would anyone have believed three years ago that the Federal Reserve would have $1.25 trillion in mortgage-backed securities on its books today?’ Not likely. So I ask your indulgence in reminding all that the unthinkable becomes possible when the economy is under severe stress.

“If German hyperinflation seems an unrealistic example from the distant past, then let’s come forward in time. Many have noted that in the 1960s, the Federal Reserve’s willingness to accommodate fiscal demands and help finance spending on the Great Society and the Vietnam War contributed to a period of accelerating price increases.

“Although the Federal Reserve was a reluctant participant, it accepted the view that monetary policy should work in the same direction as the Congress and the administration’s goals and help finance at least part of their spending programs. Monetary policy accommodation during this period contributed to an increase in inflation from roughly 1½ percent in 1965 to almost 6 percent in 1970. It also helped set the stage for the Great Inflation of the 1970s as inflation expectations gradually became unanchored …

“Walter Bagehot’s famous dictum about banks holds equally true for governments — once their soundness is questioned, it’s too late. At that moment, governments and their citizens are forced to make sizeable, painful fiscal adjustments.”

Well, at least some of the leaders are aware of whats going on. Happy Trading.

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