This TCW Advantage installment highlights ways in which our analysis is integrated across RMBS metrics through benchmark analysis. We review how TCW develops and maintains custom collateral benchmarks that help our portfolio management team spot risk and value that may be overlooked by others in the marketplace.

It has been six years since the Fed zeroed out rates and still we wait for assisted growth to become real growth. Beginning with the recovery summer of 2010, the Fed has proclaimed that cheap money would rocket the economy to escape velocity, launching an organic, self-sustaining economic recovery. Instead, central bank policy has vaulted asset prices into the stratosphere even as wages wait their turn on the launch pad. Low rates have failed to deliver the goodies, but the Fed has its story and is sticking to it.

5 years removed from the depths of the crisis and behind the tailwinds of an incredibly accommodative Federal Reserve, asset prices and of course Non Agency RMBS prices have improved dramatically. When double-digit loss adjusted yields were available most participants in the market did very well if they were able to simply overcome the fear of buying an asset class that was seemingly in freefall. At current prices and significantly lower loss adjusted yields today, however, the margin for error is far lower and many managers without the expertise, infrastructure and experience will underperfor

It isn?t what you earn ? it is what you keep that matters in investing. While systematically underwriting too little risk may mean that you do not earn all that you might, underwriting too much towards the end of a business cycle can be disastrous. With this in mind, it becomes obvious that timing an investment strategy may be the most important single decision an investor needs to get right. But how is one to know where you are in the cycle?

The Non Agency RMBS asset class is still ripe with alpha generating opportunities and attractive loss adjusted yields. Nonetheless, the return prospects have come down versus what we have witnessed over the last few years. Yields are lower and spreads are tighter. However, the fundamental trends continue to improve, which should lead to stronger cash flows and total returns for the non-agency market overall.

With this recovery, prosperity has always been just around the corner. It wasn?t supposed to be this way. True, the massive fiscal and edgy new monetary measures enacted in the wake of the 2008 crisis kept the economy?s heart beating. The Fed deftly executed its role of lender as last resort, and for this we should all be grateful. What has become steadily less clear is why, five years after the crisis, the Fed remains committed to its zero rate policy. Are artificially low rates truly the secret sauce that takes a weak recovery and makes it strong?

The shift in capital flows triggered by former Fed Chairman Ben Bernanke?s tapering remarks in May 2013 set off a cascade of market events that continues to this day. His comments also birthed a cottage industry of emerging market doomsayers, who now predict regularly: 1) the end of growth in emerging markets (EM), given that it was, in their view, all a mirage fueled by carry and leverage; and 2) a wave of defaults of the kind last seen in the 1990s that threaten to bring down not only emerging but developed markets as well.

Non-agency mortgage bond investors look to voluntary prepayment projections as an essential component of assessing future cash flows and returns. Voluntary prepayments are the annualized percentage of the mortgage pool that leaves the pool each month due to refinancing or paying off a mortgage without a loss. Without equity in the home, it is nearly impossible for a non-agency borrower to refinance the mortgage and the sale of a home would generate a loss through a short sale or foreclosure.

Either the markets or the Fed itself will come to accept that financial repression is a box canyon whose only escape is by climbing out through higher rates and wider spreads on risk assets. Staying risk on requires the investor to underwrite the exacerbating risks inherent in an economy that is being given bad signals and is accumulating a menagerie of mispriced assets and bad loans. Yes, you should walk away from a Fed that prints money.

The bond market continues to struggle to find support, with 10-year Treasury yields touching 3%, a sell-off of roughly 140 bps in the last 4 months! While reduced dealer risk capacity and impaired investor loss tolerances are two underlying factors contributing to recent rates volatility, this violent move to higher yields has been primarily led by expectations that the Fed will begin to taper asset purchases in their upcoming meeting on September 18th.

For at least the past five years, the Fed has cast an exceedingly long shadow over the capital markets. For this reason, understanding Fed policy has been central towards proper guidance and direction of investor capital allocations. Since Chairman Bernankes trial ballooning surrounding a potential taper of the Feds QE policy, longer maturity Treasury interest rates have soared over 100 basis points.

Weve just witnessed the dress rehearsal for the end of the Feds Quantitative Easing (QE). Markets that had learned to stop worrying and love the financial repression have been given reasons to fear the interest rate cycle. For five years we have lived with a central bank that has used, or abused, a zero rate policy and QE to effectuate the Great Risk-On trade to cure the ills of the Great Recession.

Markets work. Not because they are perfect, but because they self-correct. Inherent to their functioning is the ability for buyers and sellers, borrowers and lenders, to freely express their predilection to engage in commercial transactions as proxied by the price mechanism. This is all utterly basic. So, why are the capital markets in general, and the credit markets in particular, not to be trusted to operate without the price and quantity guidance of the Federal Reserve? I

Emerging market (EM) local currency bonds broaden the scope for income generation and risk diversification in a global fixed income portfolio. The asset class offers a unique opportunity to access higher income and potential for capital appreciation through a basket comprised of mostly investment grade credits with an average yield spread of 475 basis points over US Treasuries.

As in the case of Europe, the U.S. unemployment situation is likely to get worse in coming months because few moves toward meaningful structural changes in the labor market (e.g., training for the unemployed to improve skills), or fiscal shifts to aid hiring (e.g., targeted employment tax-credits) are likely to be implemented before the November presidential elections. We may have to wait for a reelected President Obama, or President Romney, to move in this direction in 2013.

Earlier this month, I suggested that investors closely watch 12 macroeconomic and financial indicators in deciding whether the world economy is improving or worsening (12 Indicators for 2012, January 3, 2012). Some readers wrote to ask if I would discuss what those indicators would mean for investment strategies. That was the genesis of the present piece which is intended to be consistent with expectations on the economic and financial fronts.

On Friday European leaders completed their 14th or 15th crisis-related summit meeting since the beginning of 2010. Fitting a pattern, the results were termed a success by the leaders. Wolfgang Schuble told Focus magazine that he was certain that the leaders will be able to handle the debt crisis in Europe with the agreed, far-reaching measures on institutional reform of the European currency union. A close examination of factors behind the agreement suggests, however, that the decisions may end up being another band-aid solution to the still festering crisis.

Major world equity markets had their best weekly performance in three years, boosted by economic numbers from the US, and by hopes that European leaders may find a solution to the debt crisis. U.S. manufacturing showed signs of regaining momentum, with both new orders and exports coming on strong. At weeks end, jobs numbers for November indicated that the open unemployment rate had dropped from 9.0% to 8.6%. Healthy sales on Black Friday (November 25), the traditional beginning of the holiday shopping season, also cheered investors during the following week.

The most important risk indicator in Europe-and for the global economy-is Italys ten-year bond yield. Italys 1.9 trillion in total public debt makes the country too big to save. After rising to over 6% in recent weeks and stubbornly staying above that critical level, the yield surged by over one-half percentage point today to more than 7.25%. Just as important, the ten-year German bond, the regions safe haven, fell in yield to 1.72%. Clearly, the market is suggesting that Italy is not too far behind Greece in either being forced to restructure its debt, or default on its obligations.

European leaders ongoing crisis summit in Brussels, Belgium is the 13th such meeting since 2010. The ultimate resolution of the European debt crisis, repeatedly promised during the past year and a half, is now set to be announced on Wednesday. What are some of the central elements of the solution likely to be? Even though we are just two days from the self-imposed deadline, some of the important decisions have yet to be made. Frances President Nicolas Sarkozy insisted yesterday that more long hours of discussion were necessary before the European leaders could announce major decisions.

Regardless of your philosophy, financial crises do test the mettle of the investor and judged this way, the past three years have been among the most challenging period in decades. Perhaps because crises mean different things to different groups of investors, we have lived with the ultimate traders market, one alternately characterized by the risk on or the risk off. Interestingly, the level of the Dow Jones is within just a few points of where that index started the year. Had you just returned from the Antarctic, you might have concluded that 2011 was a snoozer.

The French word dnouement connotes a form of final resolution of a problem or an issue. We may be approaching such an end point in the European debt crisis. After repeated bailouts of debt-ridden countries through the imposition of austerity and adding to debt levels-actions which only worsened the countries debt ratios-European leaders are discussing seriously, for the first time, the possibility of significant haircuts for creditors. Kicking the can down the road, the trite phrase used to describe the European policy reaction, may no longer be the path for debt-ridden economies.

The zero U.S. job growth also had an impact beyond its own borders. Even though U.S. markets were closed yesterday for the Labor Day holiday, Asian and European equity markets fell sharply on growing fears that the data release signaled the beginning of a U.S. recession. (Concerns about the solvency of the European banking system were the other reason for the market setback.) The United States and the European Union each account for about one-quarter of world GDP, and emerging markets cannot maintain global growth despite their faster pace of expansion.

We heard about the frailty of developed economies on both sides of the Atlantic. However, Bernanke seemed to suggest eventual additional monetary measures, rather than recommend that structural reforms carry the bulk of adjustments in the U.S. economy. And while the head of the IMF pointed to the inadequate level of European bank capital compared with the size of the sovereign loan losses they may experience, she was not yet ready to recommend that the European powers undertake measures to reduce the level of debt. Simply put, we are nowhere near achieving a successful economic stabilization.

As I have emphasized repeatedly in the past, none of these band-aid measures is likely to end the European debt crisis. Several countries of the region are excessively in debt, pure and simple. When that is the case, the solution ought to be a reduction in the level of debt through the exchange of existing debt for discount bonds, reduced-interest rate bonds, or equity. Unless the European powers recognize and act on this reality, European debt will continue to be a millstone around the global economys neck.

News from Brussels suggests that European Union leaders have reached yet another agreement to bail out Greece. For the first time since the birth of the Eurozone in 1999, the proposed plan contemplates a default on bonds issued by a Eurozone country, in this instance, Greece. Remember, as recently as last Friday, the European bank test results made no assumption of a default by a Eurozone member. Greece, Ireland and Portugal will also enjoy reduced interest rates on their bailout programs as part of the new solution.

Commentators have described the end of QE2 as a ?major milestone- the first tightening move from the Fed since the financial crisis began.? Our view is that this is just the end of one balance sheet program and is certainly not the first monetary tightening since the financial crisis. Monetary tightening is all around us in the form of new regulation, changing lending practices and increased bank capital requirements. The Fed will monitor the impacts of these changes and adjust policy as needed. Currently, the plan is to continue to replace assets on the Fed balance sheet as they roll off.

The limit on the amount of Federal debt outstanding has been in place since 1917, when Congress enacted the Second Liberty Bond Act. Since 1940, that limit has been increased 80 times and now stands at $14.3 trillion. The debt that is subject to this limit is marketable debt (Treasuries) as well as non-marketable debt (State and Local Government Securities or SLGs) and the debt the U.S. government owes itself (trust fund obligations to Social Security). In sum, this borrowing represents debt already accumulated, not future obligations. The stakes are too high for political gaming.

All of us want growth and to see unemployment back down to where it belongs. In pursuit of these objectives, our national govern- ment has ?manufactured? liabilities ? Treasury bills, notes, and bonds ? and sold them to investors, many of which are based overseas. In so doing, the U.S. Treasury laid claim to resources ?released? by these lenders and put those re- sources to work in the U.S. today with a promise to return those resources, with interest, tomorrow. Economic pain inside the U.S. has been reduced in the here and now as a result of obtaining access to these borrowed resources.

Given that the current credit cycle is but 30 months old (as compared to the more typical 60+ month cycle lifespan), TCW views current conditions as reflective of a mid-cycle correction and not a harbinger of a return to recessionary conditions. As such, current high yield bond spreads are attractive.

The spring season has tested the mettle of the high yield market. A common inquiry on investor minds of late is whether this is a short-term bump on a longer journey or alternatively that risk is rising for high yield investors. This note touches on (i) relative value, (ii) fundamentals and (iii) the potential interest rate effect on high yield.

Job creation still appears not to be a priority for the Obama administration. After the first year was spent implementing a comprehensive health care reform in the midst of a financial crisis, and bailing out financial institutions considered too big to fail, the emphasis switched to fiscal and monetary measures that had little direct impact on jobs.

The decision was made to implement new purchases of $600 billion in U.S. Treasurys by June 2011. The transactions would expand the balance sheet of the Federal Reserve to about $2.9 trillion, a multiple of the $800 billion dollar level it was at in September 2008. This paper examines how the countries which have been recipients of the newly created liquidity have responded to the Feds move. While the Fed explained that its purchase of securities was intended to make riskier assets, the excess liquidity also made its way to foreign countries to take advantage of attractive interest rates.

Portugal will be the third European country to be bailed out in recent months following Greece (May 2010) and Ireland (November 2010). It also follows a pattern of individual governments and the EU repeatedly asserting that no bailout is necessary, that the high bond yields and rating downgrades are unjustified, and that speculators are largely to blame for Europes problems.

During the early hours of Saturday, the major European powers met in Brussels and agreed on measures to resolve the long-simmering debt problems in the weaker economies. Although the meeting was considered to be preparatory for the European Union summit set for March 24 and 25, the surge in Greek and Irish debt yields, in particular, pushed the leaders to announce an accord. A closer examination of the terms of the treaty suggests, however, that this is just another temporary solution that may provide relief for a few days. It is unlikely to be a permanent solution.

Treasury yields are lower today than they were in the early 1930s. This is despite a paucity of evidence that prices are deflating, or that the U.S. is the beneficiary of a flight-to-quality. Furthermore, the low rates have continued notwithstanding QE2, a program of thinly disguised ?money printing.? Our belief is that low rates are the product of a zero rate policy that is distorting Treasury pricing. This ?artificial? propping up of Treasury pricing will last until such time that bank balance sheets are substantially repaired. As such, our outlook for Treasuries is decidedly negative.

Even though the unemployment rate declined to 9.4% in December from 9.8% in November, the drop was largely due to 260,000 individuals leaving the work force. Now, with the unemployment compensation extended as part of an agreement that President Obama reached last month with the Republican opposition, the unemployment rate will likely resume its climb toward the 10%-mark. Here are three suggestions to deal with the growing problem of unemployment in the U.S. economy.

The beginning of a new year is a time to make resolutions. It is also a good time to set out ones wishes regardless of whether they can be actually achieved during the following months. In that spirit, here are my top wishes for the U.S. and global economy during 2011. Achievement of even a few of them would help bring about sustainable economic growth as well as reduce the level of risk in the financial system.

I have had three recommendations in 2010: 1) Extend the Bush tax cuts of 2001 and 2003 for at least one more year. 2) Implement Free Trade Agreements (FTAs) with South Korea, Panama and Colombia all important U.S. trade partners. 3) Permit greater flexibility in labor markets.

The 440 billion ($617 billion) European Union bailout package approved earlier this year provided new loans to debtor nations from the EU and the IMF in return for pre-agreed austerity programs. Germany, the major creditor nation and the biggest single contributor to the bailout package, agreed on Friday to provide the fund permanent status, but only if the debt reduction cost were shared with private investors. A variation of the decision that Germany made last week is likely to confront President Obama during the next two years as the U.S. deals with its own bailout programs.

A key item on the agenda last weekend during the meeting of G-20 finance ministers was the U.S. desire to have member nations' current account deficits and surpluses limited to 4 percent of GDP. A country with a bigger surplus (e.g., China) would have to let its currency appreciate. The United States, however, cannot insist on deciding on the size of QE2 based purely on domestic considerations, accuse Chinese authorities of currency manipulation, and expect other countries to provide a level playing field for American exports all at the same time.

Today's QE program is conceptually similar to the Kennedy administration program known as Operation Twist. The Fed's form of payment, an accretion to the banking system's reserve accounts, is equivalent to the Fed issuing an IOU to the private sector. In effect, the Fed may have concluded that the pre-recession economy was unduly dependent on a consumption binge enabled by a housing bubble. With housing wealth lost 'forever,' the U.S. must adjust to being a more export-focused economy. Thus, by weakening the dollar, the Fed may be accelerating an adjustment that must, in any case, happen.

Senior monetary officials worldwide have complained about the massive inflows of capital into their financial markets resulting from expectations of monetary easing in the United States. One of the major pitfalls of quantitative easing is that beggar-thy-neighbor currency interventions do not result in increased growth for all participating countries. Instead, they sharply increase the risk to exporters and international investors and, eventually, dampen global growth.

The clamor from some economists for additional quantitative easing in the United States comes after two years and $1.5 trillion of such easing have already taken place. Similarly to the Japanese experience, the U.S. economy's growth has slowed to a crawl after just a few quarters of adrenaline rush due to increased liquidity. Even though newly minted cash has surged, bank lending to the private sector has not. And, again not surprisingly, U.S. banking sector profitability has sky-rocketed.

Emerging Market corporate debt is rapidly growing into a significant asset class backed by the world?s fastest-growing economies. These bonds benefit from strong fundamentals, improving credit quality, declining default rates and superior prospects for economic growth across most of the emerging world. One of the most compelling aspects is their consistent outperformance relative to other fixed income asset classes since 2002. Currently, they offer a yield pick-up over comparably rated corporate issues in the U.S., despite the fact that they frequently enjoy stronger credit fundamentals.

The unemployment rate is a leading indicator of economic activity in this business cycle due to the potent force of discouraged consumers, rather than a lagging indicator, as we have been taught in our economics courses. That, in turn, means that we cannot ignore the large number of jobless workers in the belief that economic growth will subsequently cure the problem we won't have sustained economic growth unless we lower unemployment first. The disappointing employment numbers last Friday are indicative of this trend.

In its attempt to bolster housing and stem the tide of foreclosures, the government has enacted several new policies and mandates over the past year to provide underwater borrowers with poor credit histories with subsidized mortgage rates. These policies, however, will likely end the participation of many private mortgage investors. They will cost taxpayers, new home buyers, pensioners and private investors, while giving overseas investors the cold shoulder. Ultimately there is a limit to the assistance the government can provide private markets without doing more damage than good.

With the Obama administration's $787 billion stimulus money mostly spent or committed, the fiscal deficit has risen and borrowing needs have gone up, but the private sector is still incapable of generating sufficient employment or economic growth. While the $8,000 first-time home buyer credit temporarily helped housing, and 'cash-for-clunkers' was a boon to the automotive industry and car dealers last fall, the end of programs like these has typically been marked by a falloff in demand.

'The road to hell is paved with carry.' We investors find ourselves facing a most unusual mortgage-backed securities market. Mortgage prices are now at or near all-time high dollar prices. And with mortgage rates also near all-time lows, are we not at the precipice of the mother of all refinance waves? Will negative convexity hit us like a Mack truck and mortgage investors suffer poor returns? The simple answer is a resounding no. While we still are walking down that proverbial 'road paved with carry,' the nature of that carry has changed.

Komal Sri-Kumar comments on US China relations, looking at how both sides view the appreciation of the RMB. Washington has lectured and Chinese officials have retaliated with their own diagnosis that the crux of the problem was lack of adequate regulation of U.S. financial institutions, and have suggested that the Obama administration should reduce the fiscal deficit rather than focus on the exchange rate. What Sri-Kumar believes is missing from this conversation is an understanding of the role played by exchange rates in balancing international trade.