Bond Market Outlook: Think Short Term

Since the Fed announced its intention to “monetize” (i.e. buy with newly printed dollars) our own Treasury debt, analysts have been pondering the eventual outcome of this operation. Will the marketplace render a verdict, in the form of a much weaker dollar or a much higher gold price, that the U.S. is pushing too far the privileges of issuing the world’s reserve currency? (Our sense is that the dollar’s status is not likely to be threatened anytime soon, due to a lack of credible alternatives, and a shared global interest in getting through this crisis without introducing another major uncertainty into a fragile marketplace.)

Will the Fed artificially suppress longer-term Treasury yields to such a degree that there will be no willing buyers, apart from the Fed, for the T-Bonds that will need to be issued in great quantity to fund projected fiscal deficits?

Will China, which has recently expressed its concerns about the U.S. dollar, take this opportunity to sell some of its Treasury holdings, and diversify into assets providing better longer-term value? China could achieve a reasonably high degree of safety combined with significantly better insulation from inflation by shifting a portion of its dollar-denominated reserves into short-term U.S. corporate bonds. Short-term investment-grade corporate bonds offer an attractive combination of return and safety for the lower-risk portion of a diversified portfolio.

Our preferred vehicle for this asset class - the Vanguard Short-Term Investment Grade Fund (symbol: VFSTX, or VFSUX for purchases of $100,000) – provides broad diversification (842 bonds), good credit quality (Aa average rating), and a short average maturity of 2.7 years in the event that inflation becomes a problem faster than markets now expect.

Comments

[Larry House:]

Reasonable. I like LSBRX. Overall credit quality is somewhat lower, but it is a good fund yielding about 8%.

Apr 16 11:38 PM

[Fund Insider:]

I own the recommended fund, but as part of a 3 piece income portfolio, including Vanguard Intermediate Investment Grade
and Vanguard Long Term Muni. All give high yields due to low expenses and great relative value for corporates and munis ever since the 2008 market turmoil. I tied up my longer dated assets in munis assuming a bit safer, credit wise. I also think a barbell approach makes sense in that you really don't know if we'll have inflation or deflation given the fragile state of the economy. Certainly the feds are doing all they can to avoid deflation, but Japan couldn't avoid it in the 90s, and there are many assets deflating here in the US. Locking up longer term rates makes sense in that scenario. It's all about diversifying risk so I'd not put all my fixed income into the recommended fund, though I do have a large portion in it.

Apr 17 10:24 AM

[$OMALIA:]

Always short term trade for long term results.

Apr 18 08:27 AM