When stocks rise bonds drop right? Wrong! Through September and early October we have seen a nice recovery in the stock market, but yield levels continue to fall:
One line of thought could be that the prospect of Fed induced inflation is destroying the dollar, raising gold and raising the price of stocks. We could rationalize that by saying that growth expectations are slowing, so the real value of stocks is not rising but the nominal value is. Lower growth would imply a lower expected yield on bonds. The problem is that the former argument suggests that there is a rise in inf lation expectations which should raise the inflation premium built into treasury yields. We have seen a slight increase in breakeven US inflation rates from TIPS, if we believed in higher inflation then why would you lock in your money today for 10 years at a yield of 2.4%?
The second line of thinking is that the Fed treasury purchase program is having a large and meaningful effect on yields. It does not necessarily mean that the Fed is driving the treasury market, but the fact that investors believe that the Fed will continue to purchase gives investors the comfort that even at today’s low interest rate levels they can purchase treasuries under the assumption that the Fed will drive the yields even lower via Quantitative Easing 2.0.
I guess I am tired of trying to make investment decisions based upon potential political and policy actions. 2008 was the game of “who’s going to get saved?!” and since then it has been a game of guessing how long interest rates are going to be kept low and which markets are going to be manipulated.
In my opinion, if the investment does not feel right, then do not invest in it. Locking in a rate for 10 years at 2.4% does not feel right to me. The only outcome where I truly benefit is a Japanese deflationary spiral. If I believed the probability of that outcome was high, then I guess I would jump on board. If instead I am playing a game of hot potato and front-running the fed’s purchases, then I would prefer to sit out. Eventually that potato is going to get hot enough to burn your hand. The game will work until it doesn’t.