Reflections about the current economy

The current shape of the yield curve suggests that interest rates are expected to increase in the future. This increases the demand for long-term funds by borrowers like Java and creates a downward pressure on the supply of long-term funds by investors or banks. Investors will increase the supply of short-term funds or a downward pressure on the demand for these short-term funds. The 3-month treasury has already dropped from 4 percent to 3.85 percent. The current spread between the 3-month and 6-month treasury is about 15 bps or less than 25 bps difference between notes and a revolver. The trade deficits and weak dollar will continue to pressure interest rates, due to the demand for compensation for the currency risk. The age of dollar dominance is about to end (as evident by the dollar weakening against all currencies), which will lead to higher interest rates within the USA. This also creates further upward pressure on inflation. Current treasury rates are unattractive to foreign investors and will be attracted to the higher rates abroad. As foreigners either shy away from treasuries or start selling off their current treasuries and do not purchase more, then higher rates will have to be offered to attract investors. The other risk is carry trade and a crowding out effect by foreign traders. Borrowing short-term funds from the USA and lending long-term funds outside of the USA will place upward pressures on interest rates. Higher taxes are expected due to Bush’s tax cut expiring and the Democrats winning both houses and the Presidency in 2008, which also increase the upward pressure on interest rates. Additionally, protectionism and increased government regulations will further weaken the dollar and spur inflation upwards. The context of the current macroeconomics equity is just too risky at this time. Any disappointments by the Federal Reserve will drive the equity markets down.

Read the article via this link about the weak dollar and reasons why.

http://articles.moneycentral.msn.com/Investing/JubaksJournal/WhyTheDollarKeepsDropping.aspx