Best of the Week
Most Popular
1.SNP Offers Labour Deadly Death Embrace Alliance, Holding England to Ransom, Destroy UK From Within - Nadeem_Walayat
2.Gold And Silver – Most Widely Used Currency In Western World? Stupidity - Michael_Noonan
3.Election Forecast 2015 - Coalition Economic Recovery vs Labour Collapse - Nadeem_Walayat
4.Election Forecast 2015 - Debates Boost Labour Into Opinion Polls Seats Lead - Nadeem_Walayat
5.Why are Interest Rates So Low? Ben Bernanke, Confused as Ever, Starts His Own Blog to Prove It - Mike_Shedlock
6.Leaders Debate Election 2015 - Natalie Bennett Green Party Convincing Anti-Austerity More Debt Argument - Nadeem_Walayat
7.Labour Economic Collapse vs Coalition Recovery - UK Election Forecast 2015 - Video - Nadeem_Walayat
8.China’s Stock Market Mania; How High can Red-chips Fly? - Gary_Dorsch
9.Gold and Misery, Strange Bedfellows - 31st Mar 15 - Dan_Norcini
10.Ed Miliband Debate Election 2015 Analysis - Labour Spending, Debt and Economic Collapse - Nadeem_Walayat
Last 5 days
Stocks Bull Market Looks to Resume - 25th Apr 15
Gold And Silver - The U.S. Is A Corporation. Precious Metals Stand In The Way - 25th Apr 15
When the Nuclear Money Option Fails - 25th Apr 15
The War on Cash Special Report - 25th Apr 15
China Economic Slowdown Story - Why “Didi Dache” Is a Phrase You Need to Know - 25th Apr 15
The Trans-Pacific Partnership and the Death of the Republic - 25th Apr 15
Stock Splitting Caused the Stock Market Crash - 25th Apr 15
China Stock Market Parabolic Mania’s Global Risk - 24th Apr 15
What Will Happen to You When the U.S. Dollar Collapses? - 24th Apr 15
Why 2 of U.S. Dollar's Recent Bottoms Have 1 Thing In Common - 24th Apr 15
UK Economy Debt Timebomb Will Explode After Election - 24th Apr 15
Are Gold Stocks the Cheapest Ever? - 24th Apr 15
God, the Stock Market and Pascal's Wager - 24th Apr 15
Greedy Insurers Are in for a Nasty Surprise – Positioning You for Big Profits - 24th Apr 15
Four Things Missing From Obama’s First-Ever Energy Review - 24th Apr 15
How to Grow a Regenerative Medicine Industry - 23rd Apr 15
Stocks and Bonds Seven Year of Negative Returns; Fraudulent Promises - 23rd Apr 15
The Existential Danger To The Euro Is Elections - 23rd Apr 15
Stock Market No Clear Direction As Investors React To Quarterly Earnings Releases - 23rd Apr 15
Is China The Next United States? - 23rd Apr 15
U.S. Oil Glut: How High Can It Go? - 23rd Apr 15
Distorted Financial System Expect Deflation, Inflation And Hyperinflation - 23rd Apr 15
What McDonald’s Corporate Earnings Report Is Really Telling You - 23rd Apr 15
Gold Price Forecast to Become Priceless - 23rd Apr 15
FDIC Plots a Bank Heist Involving YOUR Accounts - 23rd Apr 15
$GOLD Price Year 2007 Again - 23rd Apr 15
Stocks Bubble - The Spread between Stock Prices and GDP is Blowing Out - 23rd Apr 15
Ukraine War - When Did We All Become Murderers? - 23rd Apr 15
Libya Crisis - EU Leaders Are Indicted for Nazi-Style Crimes against Humanity - 22nd Apr 15
Why Alternative Energy Isn’t Taking It on the Chin Despite Low Oil Prices - 22nd Apr 15
Bill Gross - German 10-Year Bunds Short of a Life Time - 22nd Apr 15
How to Profit from the Drop in the Oil Price - 22nd Apr 15
The U.S. Dollar's Move Is More Dangerous than You Think - 22nd Apr 15
Apple Watch Means Apple Will Become Worlds First $1 Trillion Stock - 22nd Apr 15
Half a Stocks Bubble Off Dead Center - 22nd Apr 15
They Said Go to College - Learning to become Debt Slaves - 22nd Apr 15
Best Cash ISA 2015/16, Instant and Fixed Savings Interest Rates, New Flexible Withdrawal / Deposit Rule - 22nd Apr 15
Unsound Banking: Why Most of the World's Banks Are Headed for Collapse - 21st Apr 15
Bitcoin Recent Low Price Volatility Might Be Deceptive - 21st Apr 15
Currency Wars Back As Russia Buys Gold - One Million Ounces in March Alone - 21st Apr 15
The Greece 'Grexit' Issue and the Problem of Free Trade - 21st Apr 15
Why Europe Lets People Drown - 21st Apr 15
Wealth Destruction for the 99.9 Percent - 21st Apr 15
SNP Publish England's Suicide Note as Pollsters Still Forecast Labour-SNP Election Disaster - 21st Apr 15
Characteristics of Extremely Over-Indebted Economies - 21st Apr 15
Trader Education Week -- a Free Event to Help You Learn to Spot Trading Opportunities - 21st Apr 15
Gold & Silver Alert: Silver Stocks’ Signal - 20th Apr 15
Now is the Time to Buy Resource Stocks, Especially Gold Equities - 20th Apr 15
DJ Transportation & Utility Averages Suggest Stocks Bull Market Is Over - 20th Apr 15
Crude Oil Price Bull Market Hope - 20th Apr 15
Stock Market Bears Get Slaughtered Despite Greece Counting Down to Grexit Financial Armageddon - 20th Apr 15
The Rise of the Paper Machines - 20th Apr 15
Gold and Silver Inflection Point - 20th Apr 15
SP500: A Butcher's Stock Market (Chop Chop Chop) - 20th Apr 15
Are Stock Market Bears Slowly Gaining Control? - 20th Apr 15
Sugar Commodity Price Bear Rally - 19th Apr 15
Avoid the Spread of the Stock Market "China Syndrome" - 19th Apr 15
Stock Market Going Nowhere Fast - 19th Apr 15
An Easy Way to Profit From the Two Biggest Trends in the Stock Market - 19th Apr 15
No Scripture Is Divine, Authentic and Beyond the Creation of the Human Brain - 19th Apr 15

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

US Historic Bubble

The Fiscal Cliff Deal Just Made U.S. Bonds Even More Risky in 2013

Interest-Rates / US Bonds Jan 16, 2013 - 09:06 AM GMT

By: Money_Morning

Interest-Rates

Martin Hutchinson writes: It was shaping up to be another be another strong year for U.S. Treasury Bonds right up until the moment it looked like a fiscal cliff deal would be reached.

Since then, 10-year notes yields have been on the rise jumping by as much as 23 basis points since New Year’s Eve. Now you have to wonder whether or not the bond bubble has suddenly sprung a leak.


The problem is that had we gone over the "fiscal cliff", long-term U.S. Treasury bonds would have remained a strong buy since the Federal deficit would have been cut by 77%. However that didn't happen. Instead we got a deal with modest tax increases, tiny spending cuts and $64 billion of tax-exemption pork.

In those circumstances, long-dated Treasuries suddenly became a bad buy. In fact, in the wake of the deal I would argue they have now become practically toxic. But there is quite a bit more to this story than just Treasuries.

What's less obvious is that this toxicity now extends throughout the bond universe, to prime corporates, mortgage bonds, junk bonds and emerging market bonds. Here’s the thing: In today's market, each of these categories has a different form of toxicity.

Let me explain, starting with U.S. Treasuries...

The Fiscal Cliff Deal and the Bond Market
At the moment, long-term Treasury bonds are currently being supported by $45 billion per month of purchases by Ben Bernanke's Fed. In theory, that ought to prop up the price.

However, in practice, since the "fiscal cliff" deal has removed less than $100 billion per year of the $1 trillion deficit (we'll see an updated calculation when the 2014 Budget appears next month) there's still potentially more supply than demand.

What's more, it is very clear from the last Fed meeting that the Fed is closer to withdrawing some of that "stimulus" than it is to supplying even more.

So the risk for long-term Treasuries is substantial. It could be triggered by either of two events: a market panic about the sustainability in US budget deficits or a surge in inflation. One or other is more or less certain within the next couple of years and very possible in 2013. As I discussed earlier, I think inflation is could very well be the economy’s hidden iceberg in 2013.

And make no mistake about it, if interest rates rise, the capital loss on your Treasury bonds will overwhelm the current pathetic interest they return of 2% or so. When it comes to prime corporate bonds, the risk is now two-fold with a combination of rising interest rates and credit downgrades. Here’s why...

Corporate profits are currently at record levels in terms of GDP, much higher than they were in 1929, while interest rates are at record lows. That has encouraged corporations to overextend themselves. In fact, yield spreads over Treasuries have become so compressed that 10-year A-rated bonds are yielding less than 1% above Treasury bonds. When these yields begin to rise, credit quality will decline, so corporate bonds have two risks to their current price, not just one.

Three More Sets of Toxic Bonds
High yield "Junk" bonds have the same risk as prime corporate bonds, only more so.

Fed policies have driven investors towards more risky assets, benefiting high-yield bonds, which saw a record $300 billion of issuance in 2012. Including capital appreciation, these high yield investments have returned over 15% on average to investors.

In this case, a rise in interest rates would not only affect the secondary bond market, it would also see a rise in defaults as happened in past credit crises, leading to losses of 25-30% or more for investors.

Mortgage bonds won’t fare so well either.
Mortgage bonds had benefited from a decline in interest rates, from a revival in the housing market, better underwriting and from $40 billion per month in Fed purchases.

As a result, mortgage bond yields of 2.34% only reflect a 0.4% premium over 10-year Treasuries. That's nowhere near enough to pay for their greater risk, which doesn't come from mortgage defaults but from duration uncertainty – mortgage re-financings fall when interest rates rise, so a mortgage bonds' effective maturity lengthens.

The Fed may also pull out of the market in 2013, giving mortgage bonds further uncertainty. However, when comparisons are to be made I'd rather be in mortgage bonds than corporates currently, let alone junk bonds.

Emerging market bonds sound like a good deal. After all, emerging market economies continue to grow more rapidly than developed markets and many emerging markets have avoided the foolishness of Bernankeism and fiscal "stimulus" deficits.

The problem is that the good emerging markets tend to have few bonds outstanding, so you are restricted mostly to buying the debt of the bad actors.

In the J.P. Morgan Emerging Market Bond Index (the main global index) the seven most important countries are Brazil (badly run and Socialist), Russia (need I say more), Turkey, (very over-borrowed, flirts with bankruptcy frequently), Mexico (decent if unexciting credit), Philippines, Indonesia (neither terrible investments, but not the Asian investments you'd want) and Venezuela (run by a Marxist nut-job.)

Meanwhile, the countries you'd want to invest in, South Korea, Taiwan, Malaysia, Singapore and Chile, have little or no foreign debt and so you'll have trouble buying their bonds.

That means given the interest rate risk and the credit deterioration risk, emerging market bonds are also to be avoided.

So what do you do if you need consistent steady income without the risks? Buy dividend stocks--especially those of solid long-term performers in non-financial sectors whose earnings tend to rise with inflation.

I promise you you'll sleep much better at night, at least in 2013.

Source :http://moneymorning.com/2013/01/16/the-fiscal-cliff-deal-just-made-bonds-even-more-risky-in-2013/

Money Morning/The Money Map Report

©2013 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2015 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014