Government Bonds: What's the Long-Term Outlook?

I have been bearish on government bonds since March of this year and have repeatedly warned that they were an overpriced asset class, saying at the time:

… one should be cognizant of the fact that an investment in a 10-year Treasury Note will by definition lock in a total return of 3.5% over the next 10 years. This sounds unsustainable and I find it difficult to see the long-term investment merit of such an investment. Long-dated bond prices could be hit hard once yields adjust to more realistic levels. (See “Long Bonds in Injury Time”, March 28, 2008.)

Although rising bond yields have been given a reprieve because of the deteriorating outlook for economic growth and commensurate safe-haven buying, I maintain that the medium-term outlook remains negative owing to valuation levels still being stretched, especially in the light of mounting inflationary pressures.

The chart below shows the long-term pattern of U.S. ten-year Treasury bond yields and specifically the low of 3.14% reached on March 17 and the subsequent turnaround.

Source: StockCharts.com

A very apt and well-reasoned summary of the various factors impacting the outlook for government bonds appeared in The Economist a few weeks ago.

Comments

[Edward Janeck:]

We are at an end of this cycles low interest rates. The bond is going up in price as the world comes to turn with higher inflation and the US fiscal problems.

2008 Jul 03 10:43 AM

[Edward Janeck:]

We are at an end of this cycles low interest rates. The bond is going up in price as the world comes to turn with higher inflation and the US fiscal problems.

2008 Jul 03 10:45 AM

[whidbey:]

When interest rates rise, bond price falls. Why would anyone expecting inflation buy a wasting asset such as bonds? The better explanation would be that bonds represent the lowest risk of the available investments. Cash can be depreciated by inflation about 7% a year in global real terms, but bonds may pay some return, say 4%, and stocks appear to be too risky given the current disinflationary probabilities. The answer of course is precious metals would are the more likely hedge against inflation, and in disinflation gold can be held as hedge against disintegration..Yes we do have to be concerned that the US Congress will spend the nation into poverty and bankruptcy. We are grossly underestimating the damage that can be done by a government that knows no limits.

2008 Jul 03 05:10 PM