US fixed income

Pushkar

I quickly plotted the short and the long curves and the following come out in
your face.

1. Is this policy easing going to be a one shot ( a la 98 ) followed by a
quick pick up in economic activity, or is this going to be a more deeper
situation. That is the big one. The curves vote for a small road-bump which
will be rectified by a couple of eases over the next 6 months. Something the
Fed can handle easily and quickly. This is most likely NOT going to happen -
this is not a 98 and things are going to play out differently. There are a
number of other possibilities.

2. The current slow-down is two pronged - capital spending slowdown from
businesses ( especially on IT with the internet bust ) and the consumer
spending slow-down , possibly because of the stock market wealth effect. Both
of these have already hit the durable goods section. This reversal is 'Real'
which takes longer to turn then the 'Financial crisis' hence there is good
possibility we see a protraction of this weakness and even coupled with the
fed eases this is going to take longer than six months to get better.

3. The new administration is going to take this as a good opportunity to
force tax cuts. How does the Fed look at those ? Will the Fed balk and be
less aggressive in the rate cuts expecting the tax cuts , will it ignore
them. That makes the equation harder. It also to some extent argues that
longer term rates go up if these tax cuts materialize. But on the shorter
term who that effects Fed policy will have profound effect on the curve.

All these favor a steeper curve. The 2-5 at -23 ( -6 on swap curve ), 2 -10
at -15 ( 18 on the swaps ) and 2-30 at 19 bps ( 37 bp) should all be steeper
as market realizes the length of this ease cycle. If this cycle lasts an
year ( the final and the last ease happens next Dec ) then the 2-10 should be
40 bp positive, as the market realizes that.