Best of the Week
Most Popular
1.Is the Stocks Bull Market Over? Dow Trend Forecast into End January 2015 - Nadeem_Walayat
2.Gold and Silver Stocks Apocalypse Now, Bear Market Review - Rambus_Chartology
3.NHS Baldrick Plan to Spread Ebola Across UK - Sheffield, Newcastle, Liverpool, London Hospitals - Nadeem_Walayat
4.Ebola Terror Threat Suicide Bio-Weapons Threatens Multiple 9/11's, Global Plague - Nadeem_Walayat
5.Second-Richest Man Says Mortgages Now a "No Brainer" - Dr. Steve Sjuggerud
6.Gold And Silver Still No End In Sight - Michael_Noonan
7.NHS Baldrick Plan to Spread Ebola Across UK - Sheffield, Newcastle, Liverpool, London Hospitals - Nadeem_Walayat
8.The Gold Bug is Set to Bite Back - EWI
9.How Alibaba Could Capitalize on the EBay-PayPal Split - Frank_Holmes
10.The Consequences of the Economic Peace - John_Mauldin
Last 5 days
Focus on Graphite Companies with Green Energy and Technology Strategies - 22nd Oct 14
Crude Oil Price Hitting Bottom - 22nd Oct 14
Evidence of Another Even More Sweeping U.S. Housing Market Bust Already Starting to Appear - 22nd Oct 14
Gold Or Crushing Paper Debt Stocks Crash? - 22nd Oct 14
India Gold Demand Surges 450% and Bank of Russia Demand At 15 Year High - 22nd Oct 14
Bitcoin Stock Exchange Could Be "More Valuable than Alibaba" - 22nd Oct 14
Currency War - How to Profit from a Stronger U.S. Dollar - 22nd Oct 14
Banks Hold Treasuries and Make Loans- 22nd Oct 14
Gold and Silver Timing is Everything - 22nd Oct 14
Don't Get Ruined by These 10 Popular Investment Myths (Part VII) - 22nd Oct 14
Follow the Baby Boom to Biotech Stock Profits - 22nd Oct 14
Copper, Nickel and Zinc Won't Be Cheap for Long - 22nd Oct 14
How Will We Know That the Gold & Silver Price Bottom Is In? - 21st Oct 14
Is Gold as Dead as Florida Hurricanes? - 21st Oct 14
First Swiss Gold Poll Shows Pro-Gold Side In Lead At 45% - 21st Oct 14
The Similarities Between Germany and China - 21st Oct 14
The REAL Reason Why the Stock Market Turned Down - 21st Oct 14
Petrobras is a 'Scheme, Not a Stock' - 21st Oct 14
Stocks Bear Market Indicator Is Off the Mark - 20th Oct 14
Stock Market Ideal Turning Point is at Hand - 20th Oct 14
Investors Quit Complaining, The Environment is Perfect Right Now - 20th Oct 14
Ebola Armageddon Could Trigger a Rebirth in Gold and Silver Prices - 20th Oct 14
Gold vs Euro Risk Due To Possible Return of Italian Lira - Drachmas, Escudos, Pesetas and Punts? - 20th Oct 14
Stocks Rebounded Following Recent Sell-Off, But Will It Last? - 20th Oct 14
U.S. Responsible for West Africa Ebola Outbreak Says Liberian Scientist - 20th Oct 14
Stock Market Intermediate B Wave has Started - 20th Oct 14
Gold Stocks Analysis – FNV, CG, NCM, SBM - 19th Oct 14
Stock Market Primary IV Wave Counter Trend Rally - 19th Oct 14
Gold And Silver - Financial World: House Of Cards Built On Sand - 18th Oct 14
Anatomy of a Stock Market Sell-Off - 18th Oct 14
Why OPEC Has Declared an Oil War on Russia - 18th Oct 14
Gold and Silver Extreme Shorting Peaks - 18th Oct 14
Bitcoin Price Fall to $350? - 18th Oct 14
Tesco Supermarket Crisis Worse To Come as Customers Vanish! - 18th Oct 14
Sheffield Roma Crisis School Place Application's Fraud Perfect Storm - 17th Oct 14
Stock Markets, Commodities and Indicators - 17th Oct 14
“Save Our Swiss Gold ” - Game Changer For Gold? - 17th Oct 14
How to Trade the Ebola Stock Market Sell-Off - 17th Oct 14
When... Not if... Crude Oil Price Drops Below $70 - 17th Oct 14
Either You're The Butcher or You're The Cattle - 17th Oct 14
Gold Benefits from Market Uncertainty - 17th Oct 14
Stock Market Pullback Underway, Euro downside, Commodities - 17th Oct 14
Stock Market Seven Year Cycle and A Correction Ahead? - 17th Oct 14
Three Ways to Play Uranium: Top Stock Picks - 17th Oct 14
America Flirts With Deflation - 17th Oct 14

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Stocks Epic 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