If You Own U.S. Bonds, This May Be the Perfect Time to Pause and Reflect
The year 2012 wasn’t a bad year for the stock market, thanks to the Federal Reserve keeping interest rates near zero and the Fed increasing the money supply to a record level. But for bonds, it was a breakeven year, as U.S. bonds closed out 2012 at about the same level they started the year.
The Federal Reserve has been keeping interest rates artificially low since the financial crisis struck the U.S. economy and investors in U.S. bonds faced falling yields and the price of bonds rose. (Bond prices go up when interest rates go down and vice-versa). Real returns on bonds are actually negative when one considers inflation.
Here’s a chart of the 30-year U.S. Treasury:
Chart courtesy of www.StockCharts.com
At the beginning of 2011, the yield on 30-year U.S. bonds went as high as 4.8 %. Now the same bonds yield is just a little above 3.0%. The 30-year U.S. bonds fell to as low as 2.4% in April of 2012.
Here’s the 10-year U.S. Treasury chart:
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Chart courtesy of www.StockCharts.com
Same story; since the beginning of 2011, the yield on 10-year bonds has fallen more than 50%, to as low as 1.4% in April of 2012.
The big concern is that the longer the Federal Reserve keeps interest rates low, the more the chances of inflationary pressures. As inflation rises, investors in U.S. bonds get a lower real rate of return. In fact, investors in U.S. bonds might even be faced with negative returns after adjusting for inflation. Add to this the fact that the never-ending spending of our government could be destroying the credibility of U.S. bonds, and you have trouble.
Currently, the U.S. government has debt of more than $16.4 trillion (see the debt clock at www.investmentcontrarians.com) and, by no surprise, it continues to rise. Unfortunately, it doesn’t stop here; the Congressional Budget Office (CBO) estimates that, in the next 10 years, the national debt will increase to $20.0 trillion. (Source: Wall Street Journal, January 2, 2013.)
Credit rating agencies are already being cautious. Both Moody’s Investor Services and Standards & Poor’s (S&P) advised that the U.S. government has to take more measures to reduce its annual budget deficit (increase revenue or cut spending). The efforts to ward off the effects of the infamous “fiscal cliff” were not enough. Yesterday, Fitch Ratings said that if the U.S. doesn’t raise its debt ceiling by the end of February, its credit rating could be cut again. (Source: Toronto Star, January 15, 2013.)
If you own U.S. bonds, this seems to be a perfect time to pause and reflect.
The Federal Reserve has been keeping the interest rates low and inflationary pressures are building up fairly quickly—look at the food prices, oil, and other commodities. I believe the U.S. economy will weaken in 2013 and the Fed will have no choice but to keep the money taps open. This will push down the yield on U.S. bonds further, which is good for bonds.
But once interest rates start to move higher in the wake of rising inflation and too many dollars in circulation, interest rates could move up very quickly, causing a sudden fall in bond prices. As they say, “Investor Beware!”
What He Said:
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