Note to Self: The Fed Likes Bonds It Thinks Are Cheap

- Quantitative Easing 2010: The Fed Still Likes Cheap Bonds "Inside, we analyze which issues the Fed bought during the Treasury purchases of 2009 and compare them with what it bought this week using our spline model. The results: Last year it bought bonds that were cheap to spline, and this year it is doing the same."
- Ahead of the Curve: US vs. Japan "While we do expect the curve to flatten in the medium term, we do not think the Treasury market will move in lock-step with what the Japanese rates market experienced in the 1990s. Swift policy actions, strong productivity, and constructive demographics give us less reason to believe deflation and negative growth may lead to a Japan-style curve compression."
- Munis "Based on the experience of the early 1980s, local government employment could be vulnerable to significant additional employment reductions if predictions of a double-dip recession come true."

RBC US Fixed Income Weekly 20100819

Where should swap spreads be?

- Swap spreads: "We review several structural factors that should impact swap spreads in the coming years, and look at fair value in 10yr, 5yr, and 2yr spreads. The steep inversion in
the spread curve is currently between the 5-year and 10-year point—we think that inversion should be concentrated in the 2-year to 5-year segment."
- Zero rates: "Chairman Bernanke highlighted lowering interest on reserves as one of the
options for stimulating the economy. We think the most likely outcome is that a lower IOR
would do very little to increase economic activity, with the other outcome being a major
structural change to US markets that could severely hurt liquidity."
- Munis: "State economic indices measuring employment and earnings have been improving
in recent months. However, this trend may stall or perhaps change course somewhat, as
stimulus funds fade, census hiring ends, and state and local governments scale back payrolls."
- Treasuries: "We believe 2s, 3s, 5s and 7s will likely be reduced by another $1b in each of the next two months but from that point onward, all nominal coupons are likely to hold steady through at least the end of the year. More aggressive cuts in shorter maturities has pushed total issuance of 5s nearly on top of issuance of 2s, helping keep the average maturity of outstanding Treasuries at a relatively high level. However, we do not expect 2-year auction sizes will ever fall below 5-year auction sizes, limiting the scope for further extension of the average maturity of the debt."
RBC US Fixed Income Weekly 20100723

Risks to the global economy leave investors cautious

- "In the past month, financial markets have been hit with a bad case of the jitters on worries that the global economy will not be able to withstand the implementation of fiscal austerity measures in Europe and slowing growth in some emerging economies. Central bankers too have assumed a more cautious tone with both the U.S. Federal Reserve Board and the Bank of Canada pointing to risks to the outlook coming from developments abroad. While we have not changed our baseline forecasts for U.S. and Canadian growth or inflation, recent events suggest that downside risks to the growth outlook have risen leading us to revise the timing and magnitude of tightening in some countries."
RBC Financial Markets Monthly July2010