April 20, 2024

Strategies: Why Are Investors Still Lining Up for Bonds?

“Who the hell knew it was so powerful?” he said. “If it gets nervous, everybody has to calm it down. If I’m ever reincarnated, I want to come back as the bond market,” Mr. Carville continued. “Then everybody will be afraid of me and have to do what I say.”

But where is that fearsome bond market now? It has been docile, to say the least. Consider these events.

In mid-April, Standard Poor’s placed United States debt on negative watch, saying there was a one in three chance that over the next few years it would actually downgrade the Treasury’s pristine triple-A rating. The agency cited concerns about the ability of Congress and the White House to agree on a plan to reduce the budget deficit.

On May 16, the Treasury hit its statutory debt ceiling — the point at which the government cannot borrow more money without Congressional action. But Congress didn’t act. To keep the government operating and bondholders paid, Treasury Secretary Timothy F. Geithner announced a series of maneuvers that bought some time. The clock is ticking, however. If Congress doesn’t enact legislation by Aug. 2, he said, the United States will default on its debt.

Has this melodrama shaken the bond market? Not a bit.

Since April 18, the prices of Treasuries haven’t fallen. To the contrary. They’ve risen while yields, which move in the opposite direction, have plummeted. On Friday, the 10-year Treasury yield dipped as low as 3.05 percent, its trough for the year. Despite a mounting debt burden and a dithering government, Treasuries have rallied.

Factor in the pronouncements of the Federal Reserve, and the situation is even more puzzling. In its program of “quantitative easing,” aimed at stimulating the economy and driving up asset prices — QE2, as it has been called — the Fed has been buying longer-term Treasuries. But it says it will end the program on schedule next month.

Any economics student knows that when you cut demand — in this case, when the Fed ends QE2 — all things being equal, prices ought to decline. And yet, despite the Fed’s announcement, prices have risen and yields have fallen to extraordinarily low levels. Inflation-protected Treasuries, also known as TIPS — those with terms ranging up to six years — actually have negative real yields, meaning their yields are even less than the rate of inflation. Buyers are essentially paying the Treasury for the privilege of owning them.

“There’s something wrong with this picture,” said Scott Minerd, chief investment officer of Guggenheim Partners. He adds, however, that the picture is bigger than this. “Examine the rest of the world for a moment,” he said in a recent interview. “Compare it to everyplace else, and the United States starts to look a lot better and a lot of this starts to make more sense.”

Europe and Japan, the two other large advanced economies, face crises that are, arguably, far more acute. In the aftermath of an earthquake, a tsunami and a still unfolding nuclear disaster, Japan is struggling through a recession.

In Europe, the probabilities have risen that Greece will need another bailout or will need to restructure its debt or default on it. Ireland and Portugal, which have also needed bailouts, are also troubled, and the European Union has so far been unable to come up with a solution. Leaders of the Group of 8 nations meeting in Deauville, France, on Thursday and Friday failed to make significant headway on these issues.

Meanwhile, growth in red-hot emerging market countries like China has begun to slow, as their central bankers raise interest rates to limit inflation.

Given the alternatives, the bond market has found United States debt quite appealing. The market is convinced that in the end, Washington politicians will trim the budget deficit, Mr. Minerd said. If that perception were to change, the market would react with vehemence, he said. “I think everyone expects that Congress will come to its senses before it’s too late,” he said.

With signs that economic growth is slowing — rattling the stock and commodity markets — the Fed is likely to hold interest rates near zero for months, he said, and Treasury yields are likely to dip even lower, meaning more profits for bond traders.

By this summer, industrial growth will be visibly slowing around the world, said Lakshman Achuthan, the managing director of the Economic Cycle Research Institute, a private forecasting group. The markets have probably reacted to early indications of that slowdown, he said, bolstering bonds and hurting stocks and commodities. “Until there are signs of another pickup in economic growth,” he said, “I wouldn’t be buying on dips in the stock market.” In this context, he said, Treasuries may seem a safer bet.

William H. Gross, the co-chief investment officer of the Pacific Investment Management Company, or Pimco, the world’s biggest bond manager, ruefully compared investors in Treasuries to complacent frogs sitting in a pot of slowly heating water. “Bond investors are receiving almost nothing for their money, and the situation is getting worse and worse. But they’ve gotten used to it. They don’t realize how bad it is. And before they know it, well, they’ll be cooked.”

Since early this year, Mr. Gross has been making statements like this, predicting the imminent end of the Treasury rally. “I was premature,” he said, adding, however, that his arguments were valid, if not well-timed.

At some point, he said, bond investors will realize that by accepting low — and even negative — real yields, they are being “skunked.” Using a fancier term, he said, they are experiencing “financial repression,” a hidden tax that is of great benefit to the government, which will be able to pay back its debt more cheaply as time goes on.

IN a situation like this, wealth is transferred from investors to a debtor government without investors entirely realizing it, said Carmen M. Reinhart, an economist at the Peterson Institute for International Economics in Washington. Ms. Reinhart, who has written extensively on the subject, says financial repression is still common in the developing world. Until the onset of the financial crisis, though, it had all but vanished from developed countries.

Now, she said, with debts mounting and central banks holding down interest rates, “We are beginning to see financial repression once again in developed countries like the United States.”

Article source: http://www.nytimes.com/2011/05/29/your-money/29stra.html?partner=rss&emc=rss

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