Wednesday, May 27, 2009

Yield Curve

Today the long bonds took a huge drubbing. Investors are moving towards shorter duration in an effort to minimize the risk from inflation. So the longer bonds have seen a massive selloff with the roll into shorter treasuries. In order to finance the deficit, the Treasury is basically forced into issuing short term Treasuries because the interest rates on the longer bonds are becoming unaffordable. What is likely to happen now is short term Treasuries are going to start rising as traders roll down the yield curve and the supply gets issued on the short end. As a result, all forms of debt are going to see higher yields/lower prices unless the Treasury simply decides that it is just too expensive to fund massive deficits.

Once the deficit spending stops, there will be a accelaration of deflation which will likely wipe out more banks and get the fun ball rolling again. Until then, the reflation trade is still on.

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