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JP Morgan sees the possibility of the 10-year Treasury reaching about 1.50% yield before the European debt crisis is past one way or the other, as people seek to hide from risk. They also see the rate at about 2.75% a year from now.

In addition to loss of purchasing power during the holding period, the rise in rates portends a loss of nominal principal as well if the bonds are sold, presuming no self-interested retail investor would hold a 1.5% Treasury for 10 years to maturity.

We think that Treasury money market funds at 0% yield are a better bet than 10-year Treasury bonds, because the hiding position is not for along time, and the risk of capital loss in Treasuries is not worth the net yield.

Longer-term, the 2.75% yield prediction is well below where rates will likely go. Over most of time, 10-year Treasuries have a higher yield than the rate of inflation. A visual inspection of the spread between inflation and 10-year rates suggests something like a 2.5% spread.

If the Fed target is 2% inflation, and if history suggests perhaps something more like 3%, and if the flood of liquidity that has been unleashed since 2008 is not somehow dried up, 10-year rates of 4.5% or more are a virtual certainty. Owning a 1.5% to 2.0% Treasury as rates go to 4.5% or more would be highly unattractive.

Figure 1 shows the concurrent rate of inflation since 1962 along with the average 10-year Treasury rate for the period. Figure 2, shows the spread between those two rates.

All investment grade bonds should suffer as a result of any significant rise in interest rates.

Credit bonds should go down a bit during fear-laden periods such as now with Europe.

Investment grade (NYSEARCA:LQD) should do better than below investment grade (HYG or JNK).

Shorter-term (CSJ and SJNK) should do better than longer-term.

Treasury ETFs (NYSEARCA:IEF) will rise for now, but can't stay there.

Figure 3 looks at performance of several of those ETFs in comparison to the Aggregate Bond Index ETF (NYSEARCA:BND).

Figure 1:

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Figure 2:

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Figure 3:

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Disclosure: QVM has positions in HYG and CSJ as of the creation date of this article (May 18, 2012).

General Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.


Source: Bonds: Treasuries Up, Junk Down In Risk-Off, With Higher Rates And Lower Prices Ahead