The Federal Reserve has yet to announce when it will start to increase interest rates in the U.S. economy. Meanwhile, there seems to be disagreement within the central bank’s affiliates regarding its loose monetary policy.
The President of the Federal Reserve Bank of St. Louis, James Bullard, recently said, “It’s important to start to remove accommodation—even when you go up to 1 percent or 1.5 percent, that’s still very easy monetary policy.” He added, “It’s a matter of getting to a normal level of interest rates at the right time. I don’t think you want to wait until everything is exactly the way you’d expect it to be.” (Source: Saphir, A., “Fed should raise rates in 2013, Bullard Says,” Reuters, February 6, 2013, last accessed March 12, 2013.)
In anticipation of the eventual end to the “easy money” policies of today, the bond market is selling off. From the chart below, you can see that bond investors ran toward the security of 30-year U.S. bonds in early 2012. But one year later, 30-year U.S. bonds are losing ground. Actually, the 30-year U.S. bond market has been falling since the beginning of 2013.
Chart courtesy of www.StockCharts.com
The theory that’s making the rounds as to why the bond market is falling is that as the Federal Reserve continues to keep the interest rates artificially low while increasing the money supply, inflationary pressures are building up, and the Fed will eventually need to raise interest rates to fight inflation. Interest rate hikes might just come sooner than some might think; hence, the bond market, as a leading indicator, is reacting now.
While “official” statistics might show inflation as tame, most people know the real story; the figures released by the government on the inflation rate do not reflect reality. Almost everything we buy today is more expensive than it was three years ago. Gas costs more; so does food. The stock market is inflating and real estate prices are rising again—all inflationary. The bond market, by declining since July of 2012, is telling us that something is wrong.
But contrary to those who believe the sell-off in the bond market will be steep, I believe it will be slow and gradual to begin (as it is now) and then it will speed up as we start to see more inflation pouring into the U.S. economy.
Bond investors who bought in mid-2012, when the bond prices were at their highest level ever, are running deep losses now. Caution and capital preservation are hands down the best strategy for bond investors today.