Rates rose and the curve steepened in a week where risky assets didn’t fare any better. TIPS underperformed nominal bonds considerably, as breakevens tightened in by 18 basis points after a poor auction on Thursday. Inflation expectations as measured by TIPS Breakevens currently trade at 2.18%, down from their recent high of 2.41% on 1/5.

Munis had another bad week, as credit concerns continue for state and local governments. The graph below compares the performance of the Muni ETF to the Treasury ETF.

Although MUB is down 7.6% since 9/30/2010, most of that has just been interest rate movement. Spreads have widened out some, evidenced by 2.64% lag in performance, but with all the talk on widespread state defaults I would think they would have cheapened up more.

Is China in a Liquidity Crunch?

I apologize for this impossible to read graph. The green line is the Shibor yield curve as of today’s close, spanning from 1-day to 1-year, and orange is the same curve on 12/31/2010. The excuse for the spike in rates at year end was just year-end technical movements, but the short-term lending rates have spiked even higher in the last few days.

China’s central bank has been telegraphing more tightening in the near future, but that has been priced in for a while. This recent spike is concerning. Worries about China overheating are not new, but I’m surprised that the recent spike in short-term lending rates is going largely unnoticed.

I pointed out the year-end spike a couple weeks ago, after the Shed Spread rose 104 bps in the fourth quarter. It is now 50 basis points above the recent high. One would think that the Chinese economy would have to feel the effect of shocks like this at some point.

Have a great weekend. 

Cliff J. Reynolds Jr., Investment Analyst