In looking at our own fiscal impasse in the U.S., it made me compare and contrast this with the highly charged discussions that have taken place in Europe over the past several years. The only significant difference I can come up with is that the U.S. has the luxury of having unlimited access to domestic borrowing. The whole self-imposed drama in the U.S. seems almost surreal as we read seemingly contradictory headlines like ” Dollar index reaches multi-week high as fiscal cliff seems unavoidable” or even more bizzare, ” Bonds rally strongly as both sides unwilling to compromise”. While Greece stared down the barrel of 30% short rates of interest and a forced promise to sell assets and affect real tax collection, the U.S. enjoys negative real rates of interest all the way out the Treasury curve. While it may seem unreasonable to compare southern Europe to the United States, the important point of comparison is discipline. In the case of some southern european countries such as Italy, Spain, and Greece discipline is being meted out by the market participants who are demanding some level of fiscal discipline and austerity. In the case of the United States, market participants themselves are being disciplined( or lulled) to believe that fiscal soundness does not matter as the captive buyer (Fed) will be there, regardless of what the infants in Washington hash out.
An important lesson of the last several years is that highly stable environments lay the groundwork for something highly unstable. By manipulating the entire U.S. Treasury curve, the Federal Reserve has been highly successful at maintaining an extremely low and stable rate environment. As a result, a multitude of strategies and structures have been built around the fact that rates will not be rising for several years. However, as we just discussed stability breeds instability. In a free market, low prices cure low prices and ultimately too low rates cure too low rates. However, in our lookingglass world, low rates are indicative only of a Fed constantly in “whatever it takes” mode.We wonder however, how much their activity would need to be ratcheted up in a market where they are not only the biggest game in town, but the only game in town. In that not too unlikely scenario, look to buy stuff not paper.