Best of the Week
Most Popular
1.Scottish Independence YES Vote Panic - Scotland Committing Suicide and Terminating the UK? - Nadeem_Walayat
2.Independent Scotland Will Disintegrate as Unionist Regions Demand Referendum's to Rejoin UK - Nadeem_Walayat
3.Bank of England Panic! Scottish Independence Bank Run Already Underway! - Nadeem_Walayat
4.Gold and Silver Price Ready To Go BOOM - Austin_Galt
5.Gold and Silver Potential Price Meltdown Scenario - Rambus_Chartology
6.Scottish Independence UK Catastrophe - The Balkanisation of Britain - Video - Nadeem_Walayat
7.The Price Of Gold And The Art Of War Part I - Darryl_R_Schoon
8.Main Reason Why Scotland Will Vote NO to Independence, 70% Probability - Nadeem_Walayat
9.Heavy Gold and Silver Shorting is Bullish - Zeal_LLC
10.10 Year U.S. Treasury Short Best Place to be Remainder of 2014 - EconMatters
Last 5 days
A Public Bank Option for and Independent Scotland - 17th Sept 14
The Charade of Independence for Scotland and UKIP - 17th Sept 14
Gold Report - U.S. National Debt Surges $1 Trillion In Just 12 Months - 17th Sept 14
How to Find Trading Opportunities in ANY Market Using Fibonacci Analysis - 17th Sept 14
Why Money Is Worse Than Debt - 17th Sept 14
Can Gold Price Finally Recover? - 17th Sept 14
Scotland Independence - Europe Holds Its Breath - 17th Sept 14
The Energy Prices at Risk with Scottish Independence - 17th Sept 14
Scottish Independence SNP Lies on NHS, Economy, Debt, Oil and Currency - 17th Sept 14
The Truth Behind the Dangerous "Helicopter Money" Delusion - 16th Sept 14
Central Bank Balance Bullying: Investor Implications - 16th Sept 14
U.S. Dollar and Gold Elliott Wave Projection - 16th Sept 14
The Origins and Implications of the Scottish Referendum - 16th Sept 14
The Collapse Of U.S. Silver Stocks As Public Debt Skyrockets - 16th Sept 14
Emerging Markets Are Set Up for a Crisis, What’s on Your Radar Screen? - 16th Sept 14
Scottish Independence Bank Run Already Underway - Video - 16th Sept 14
The Emergence of the US Petro-Dollar - 16th Sept 14
Economic GDP Drives Stock Prices Inestment Myth - 16th Sept 14
Don't Miss This Gold Buying Opportunity - 16th Sept 14
Why ECB QE Is Bearish For Gold Prices - 15th Sept 14
Property Rights and Property Taxes—and Countries That Don’t Have Them - 15th Sept 14
Junior Miners Breaking Out Higher Forecasting Gold and Silver Price Bottom? - 15th Sept 14
Stock Market Patiently Waiting for Mean Reversion - 15th Sept 14
A Closer Look at the US Dollar - 15th Sept 14
The Silver Price Sentiment Cycle - 15th Sept 14
Stock Market Correction Underway - 15th Sept 14
Marc Faber - “I Want To Be Diversified, I Want To Own Some Gold” - 15th Sept 14
The Myth of Nuclear Weapons - 15th Sept 14
US Dollar Forecast to Go Much Higher - 15th Sept 14
Analysis And Price Projection Of The Uranium Market - 15th Sept 14
Bank of England Panic! Scottish Independence Bank Run Already Underway! - 15th Sept 14
The Ethics of Entrepreneurship and Profit - 14th Sept 14
The Big Investor Opportunity in the Orbital Space Junkyard - 14th Sept 14
Kohl's and The Rest of The Retailers are in Deep Doo Doo - 14th Sept 14
Independent Scotland Will Disintegrate as Unionist Regions Demand Referendum's to Rejoin UK - 14th Sept 14
Stock Market Pullback Continues - 13th Sept 14
SNP Fanatics Warn of Day of Reckoning for Scottish Independence No Campaigners - 13th Sept 14
Scottish Independence Would Shake Up the Global System - 13th Sept 14
The World Order Becomes Disorder - 13th Sept 14
Is Geothermal Power About to Become The Next Great Battleground Over Fracking? - 12th Sept 14
Heavy Gold and Silver Shorting is Bullish - 12th Sept 14
Strong U.S. Dollar Undermines Gold and Silver - 12th Sept 14
Debt And The Decline Of Money - 12th Sept 14
Panic On The Streets Of London ... Can Scotland Ever Be The Same Again? - 12th Sept 14
Will The Real Silver Commercials Stand Up? - 12th Sept 14
If You Own Only One Investment, Make Sure This Is It - 12th Sept 14
Main Reason Why Scotland Will Vote NO to Independence, 70% Probability - 12th Sept 14
Better Days Ahead For U.S. Stock And Housing Market - 12th Sept 14
U.S. Meddling Dims Prospects for Ukraine Peace - 12th Sept 14
Is the Fed Preparing to Asset-Strip Local Governments? - 12th Sept 14
China Holds “Gold Congress” - Positioning Itself As Global Gold Hub - 11th Sept 14
Fire Ice Could be Energy's Magic Bullet or a Planet-killing Catastrophe - 11th Sept 14
The Mass Psychosis Of 9 /11 Will Never Be Healed - 11th Sept 14
Radical Islam's Crisis of Competing Caliphates - 11th Sept 14
Ukraine Crisis And Self-Determination - 11th Sept 14
Cameron and Miliband Desperately Attempt to Prevent Scotland Committing Suicide - 11th Sept 14
A Supply Crunch Points to Higher Uranium Prices - 11th Sept 14
The Myanmar Shadow - 11th Sept 14
Europe Takes the QE Baton - 11th Sept 14
Full Frontal Inflation - 11th Sept 14

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Huge Stocks Bear Market

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

© 2005-2014 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