Three weeks ago, the 30-year U.S. Treasury bond hit a peak yield of 4.62%. We committed a significant portion of client portfolios to that position at a yield just over 4.60%. As I indicated in my December 23 blog post, we were not making a long-term forecast that yields were about to fall significantly. We believed that yields had risen so far, so fast, however, that at the very least we were likely to see a meaningful pullback, even if rates were fated to head higher over time. With so many economic cross-currents and global debt uncertainties, the potential for an event that would lead to a flight-to-safety retreat into US Treasuries remains high. None has occurred, however, since our bond purchase.
Our purchase was immediately rewarded by a decline in yields, which we anticipated strictly on a technical basis. As I indicated in the December 23 blog post, we would potentially hold the position for quite a while, should deflationary or disinflationary conditions prevail.
This week, however, the bond market responded to Wednesday’s bullish ADP employment report with a rapid jump in yields. The majority of analysts took the employment news as an indication that the economy was building strength and that inflation was the likely outcome. Since our bond position was a contra-trend speculation, we were unwilling to stay with it if the danger of immediately higher rates reemerged.
This week’s strong reaction to positive employment news creates at least the possibility for rates breaking to new highs. With a closely-watched and anticipated employment number scheduled for Friday, we closed our position on Thursday at a small profit of about 1.2%. Yields could go either way in response to the news, but the low-risk aspect of the transaction had disappeared. Selling the position is consistent with our longer-term view that at current levels there is more risk if one is wrong owning bonds than there is reward if one is right. In such an environment, we are unwilling to simply buy and hold.
While we’re unable to know whether or not the next long rising-rate cycle has begun, it is instructive to recognize that the last such cycle from the early 1940s to the early 1980s penalized bondholders severely. In fact, for more than four decades, risk-free cash outperformed diversified portfolios of investment grade bonds.