Regressing to the Mean

China is planning on diversifying its massive hoard of dollar-denominated assets, estimated at over $280 billion in Treasuries and well over $500 billion in corporate bonds. That's a mighty big tree to fall in the forest.

At present, bonds are really, really expensive relative to the Federal funds rate. As of today, the one-month bond yield is 4.06%, while the 20-year yield is only 4.63%. That's a premium of only 0.57% for lending your money out for two decades. Bear in mind that the overnight Federal Funds rate is 4.25%. In other words, the one-month bond is actually selling at a large premium: it actually costs more to borrow money overnight than it does to borrow money for a month!

It is largely because of this bizarre market that our housing market, credit-card market, etc. have been able to shrug off the Fed's rate increases. But how long will these prices last when big players like China start to dump their reserves?

This makes it all the more urgent that we get serious on paying down the debt. Our economy is vulnerable to normal market forces of our own creation. If he's still alive, Osama should give up terrorism and start trading bond futures; he could probably do more damage there.

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