A flattening yield curve is the focus of a piece by Mike Whitehouse in the Wall Street Journal. This comes as mortgage-backed securities have weakened relative to treasuries. There is some dispute as the role the slope of the yield curve has on the economy.

Some economists, including soon-to-retire Mr. Greenspan, believe the multitude of factors affecting the yield curve has rendered it an unreliable predictor of economic activity. Others, however, believe that the curve isn’t only a reliable predictor of where the economy is headed but a catalyst. This camp believes the Fed — which has increased its short-term interest-rate target to 4% from 1% in the past 16 months and is expected to go to 4.75% by May — is underestimating the effect its rate increases will have on the economy.

“In the past three decades, the Fed has tightened eight times and inverted the curve five of those times,” says David Rosenberg, chief U.S. economist at Merrill Lynch & Co. in New York. “And of those five, all landed the economy in recession a year later.”

The news on inflation is certainly not helping the bond market. Barry Ritholtz at the Big Picture notes that higher producer prices represent a dilemma for companies and their earnings. Higher raw material costs will either lead to higher consumer prices, or will be eaten and cause lower margins. The question is whether higher prices will eventually dent the consumer’s appetite for spending.

For bond investors, ETFs have not become as popular or as prominent as their equity-based cousins. Paul Herbert at Morningstar.com notes the case for fixed-income ETFs are not as strong a substitute for open-end bond funds, as it is for equities. Despite their low expense ratios, fixed-income ETFs don’t have the tax efficiency of equity ETFs. According to Herbert:

All in all, we still think there can be a place for ETFs–and most other cheap, tax-efficient funds–in investors’ portfolios. And truly sophisticated investors may get some benefits from trading ETFs intraday or short-selling them. But given the strengths of traditional bond mutual funds, we continue to think that they serve most investors very well.

The case for fixed income is as muddled as it has been for quite some time. With the Fed raising rates and inflation on the march, this a good time for investors to take stock (no pun intended) of their fixed income allocations.

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