With hindsight, treasuries have proven a safe bet in the midst of the market turmoil that has left little else intact in its wake. As the subprime tentacles appeared in the most unlikely of places (money market instruments, triple A rated securities) investor appetite for risk took a nosedive. With the volatility index back to normalcy and the days of cheap credit a thing of the past, flight to quality has gained momentum. Fixed income gurus that back in June were convinced that the bull run era that started over two decades ago was reaching its end seem to have gotten it completely wrong. Treasuries posted their best returns last year since 2002 only to be overtaken by TIPS as markets were uncertain whether we were heading into stagflation or just plain stagnation or even recession.
As the U.S. economy showed further signs of deterioration and the risk of dragging the rest of the world into a protracted slowdown grew, inflation worries evaporated prompting the Fed to embark into one of its most aggressive accommodative policies in recent history, cutting the Federal Funds Rate by a spectacular 125 basis points in the span of just a week. If the Fed continues in this direction, it won't be very long before we reach negative real interest rates. This is troublesome as it is difficult to predict the consequences on the economy of having negative rates.
