The 'Bond Vigilantes' Are Back

Long-term U.S. Treasury bonds were the top performing asset class in 2008, but they have been the worst-performing investment in 2009. The 10-year Treasury bond yield has increased 170 basis points this year, and has jumped 120 basis points since March 18, when the Fed announced its intention to purchase Treasury bonds to hold down interest rates. It seems the “Bond Vigilantes” are back.

This is a term used to describe Treasury bond investors who can enforce some discipline on a government that is potentially behaving very irresponsibly with respect to fiscal and monetary easing, and courting serious inflation risks. A dramatic rebound in inflation expectations accounts for nearly all of the rise in nominal Treasury yields in 2009. In the past six months, the spread between the 10-year Treasury yield and the 10-year TIPS yield (which represents the market’s expectation of the annual CPI inflation rate over the next 10 years), has jumped from under 50 basis points to nearly 200 basis points.

Treasury investors are clearly becoming concerned about the $10 trillion in projected federal budget deficits over the next 10 years, and the ability of markets to absorb this supply. Hopefully, the recent jump in Treasury yields has delivered a warning shot to the government to restrain its spending excesses now that the financial crisis has largely been resolved. Outside of conventional Treasuries, 2009 has been a rewarding year for investors in a number of fixed income categories, including corporates (especially high yield), emerging markets, municipals, and TIPS.

[click to enlarge]

Comments

[prairiedog555:]

But what is the pick going forward for fixed income?

Jun 11 08:15 AM

[Emerald:]

My pick is a combination of investment grade corporates, high yield and muni's. Spreads will continue to narrow for corporates and high yield and tax rates will inch higher (for muni's). I am long accordingly.


On Jun 11 08:15 AM prairiedog555 wrote:

> But what is the pick going forward for fixed income?

Jun 11 11:59 AM

[CLH:]

The best pick for making coin is equities when bonds go down. Bonds had a great run--1982-2008. Its over folks --buy stocks.

Jun 11 03:24 PM