Investors will be in search of the “cleanest dirty shirt” in the pile of alternatives among industrial nations. For this reason, I believe U.S. Treasuries will be selected from the pile as the “least risky” of investment options.
While I expect foreign and domestic financial institution demand for Treasury securities will be strong in the coming months, greater value may be found in mortgage securities and other credit securities including municipal bonds. Increasing regulatory requirements on bank investors may cause some institutions to shy away from credit related investments, which may allow the bonds to cheapen from very rich levels. Ironically, banks that have developed and implemented appropriate policies regarding corporate bonds and other credit sensitive securities will benefit from their purchases which will alleviate some of the pain of shrinking margins.
Until Europe develops a banking union which offers Euro-wide deposit insurance, global markets will be volatile and equity prices will trend lower along with U.S. bond yields.
I believe the Fed will develop and implement policies that focus on liquidity and low interest rates at the September or October meeting of the Federal Open Market Committee. These policies include expanding the balance sheet further by purchasing between $400 and $600 billion in mortgage securities (MBS) and longer maturity Treasuries (7+ years).
The year 2012 may be remembered as the year the cracks in the economies around the world grew and in the case of the EU and U.S, the cracks may become fissures if appropriate policy changes are not developed and implemented.
Will we fall off a “fiscal cliff?” At best, we can hope for an extension of the programs through 2013.
Sharon Lee Stark is the managing director and chief market strategist for Sterne Agee.
