Never have so many paid so much for so little. This paraphrase of Churchill’s famous quote describes the rush of investors to buy high-priced bonds that are yielding historically low returns, especially given rising inflation.
With the benchmark 10-year Treasury index trading at 1.17%, near a six-month low, there have been massive inflows into the
20+ iShares Treasury Bond
exchange-traded fund (ticker: TLT), according to a note from Strategas’ technical and macro strategy team led by Chris Verrone. The influx into this popular vehicle for betting the bond market reached a statistical extreme that reversed the previous bearish positioning – betting on higher yields and therefore lower bond prices – seen earlier in the year, noted the team.
In the aftermath, the 10-year yield is down 57 basis points from its March 31 high, but still up 26 basis points from year-end. (One basis point equals 1/100 of a percentage point.) The ETF TLT rush suggests that much of the fall in yields is behind us, the Strategas note added. Indeed, feverish buying is a countercurrent indicator of rising risk in bonds.
Many explanations have been put forward for the rally in the bond market, which surprised many pros. Of course, the $ 120 billion monthly purchases of Treasury and agency mortgage-backed securities by the Federal Reserve cannot be ignored, even though they were underway when yields soared in the first quarter. .
But for months now, this column has suggested that the behavior of the bond market suggests the economy is slowing, even though the slowdown was due to boom-like growth in the first half of the year, spurred by fiscal stimulus and unprecedented monetary policy. Since then, concerns about the economic impact of the Delta variant of the Covid-19 virus have further weighed on Treasury returns.
TO Marc Grant, chief global fixed income strategist at B. Riley Securities, yields have fallen to such an extent that there is no longer any absolute or relative value in bonds. T-bills can offer security, but at yields well below inflation, you lose money every month, he recently wrote in his “Out of the Box” note. Corporate securities, whether high-quality or high-yielding, or mortgage-backed securities offer no relative value since you get paid “next to nothing” for credit risk, he argued.
James Tisch, CEO of
(L), describes bond yields even more lacically: “They’re damn too low,” he commented on the company’s recent quarterly earnings conference call. Only institutions that must hold bonds, such as banks and insurance companies, would buy fixed income securities that yield well below inflation, which he says is 6% or more. .
Another risk, less well understood, is the potential for prices to fall if yields rise slightly. If the 10-year Treasury yield were to rise only 10 basis points, the resulting fall in prices would wipe out an entire year’s interest income. “It seems like a miserable investment to me,” Tisch said.
Of course, there is another side of the argument. Longtime bond bull A. Gary Shilling writes in his August monthly letter to clients that it’s not impossible for 30-year Treasury bond yields to return to their 2020 pandemic lows, falling to 1 , 20% versus 1.90% when he went to squeeze. (It was 1.85% on Tuesday.) The move would produce a 24.1% capital gain on a 30-year zero coupon Treasury bond, among the most volatile fixed income securities in existence.
For B. Riley’s Grant, a better choice are high-yield closed-end funds earning 10% or more (although he is not able to name names for compliance reasons). I have written many times about this poorly understood asset class. For income investors, perhaps the subset best suited to the current environment is CEFs that invest in floating rate loans, which stay ahead of inflation with returns above 6% without them. risks of long-term fixed-rate bonds.
Write to Randall W. Forsyth at [email protected]