Interest Rate Roundup

Friday, December 01, 2006

Latest Pimco rumination worth a read

You've probably heard of Pimco, the mega-bond fund management shop headed by Bill Gross. Gross has years and years of experience in fixed income management and knows more about bonds than I ever will. Anyway, his latest monthly commentary is well worth a read, in my book. He focuses on risk spreads, or the amount of excess yield offered on corporate debt securities above and beyond yields on risk-free Treasuries. His argument in a nutshell: That they've compressed to unbelievably tight levels and can't go much further.

I think Gross is spot on. Despite the evident housing bust ... despite worsening economic news ... and despite the deepest yield curve inversion we've seen since just before the 2001 recession, risk spreads have continued to contract. At the same time, stocks have gone up virtually every day and the VIX, a measure of investor complacency, has tanked.

This simply doesn't make sense. One or more of these markets has to be "wrong." Either we're going to have a hard landing (meaning the Treasury market is "right," we're going into a recession, and risky bonds and stocks are "wrong"). Or we're going to find an economic bottom very soon and see much better growth and credit conditions in 2007 (meaning Treasuries are "wrong" and risky bonds and stocks are "right").

Personally, I think this economy is in more trouble than people realize and that credit spreads are way, way too tight. It's nice to have Gross, more or less, on my side!


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