Tuesday, April 12, 2011

The search for yield problem

The search for yield problem continues. The money market arena is in shambles with further declines in repo rates. Overnight repos have been cut in half since the Fall and with new rules for money market funds, there is little hope that any return will be received on the more than $2.7 trillion in funds held at money market funds. From the height of the financial crisis for funds moving into cash in March 2009 until this week we have seen a decline in money funds of over $1.1 trillion. If these rate levels continue,

The yield curve has gotten steeper since the beginning of the year with 3-5 year gaining over 10 bps. The CPI which has just been announced has increased 2.7% so you have to move out beyond seven years to get a real yield which is positive. Even accounting for CPI ex food and energy you have to move out the maturity three years to get a positive real yield.

This is all part of the Fed's plan. If you increase inflationary expectations and lower the real yield money will have to put to work and move out of cash. It has chased fixed income, but the fear of inflation has actually steepened the curve. Money will move to other risky assets. Silver and gold have been beneficiaries. Stocks have seen gains especially in risky emerging markets. Credit spreads have tightened.

However, there maybe a disconnect between the fundamentals and prices based on the search for yield. This is environment is no different than the mid-200's when Chairman Greenspan lowered rates to stop deflation. We know this will end badly even if we started in a more opportune place. I am thinking about the Minsky ponzi financial lending environment.

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