Bonds on sale but still too dear

June 12, 2013

June 12 (Reuters) – Sometimes, as with Treasury bonds right
now, a better deal just isn’t good enough.

A sharp selloff in Treasuries has taken yields higher,
theoretically offering better returns and better protection
against inflation. In fact, so-called real yields, meaning yield
adjusted for inflation, have actually gone into positive
territory. Benchmark 10-year Treasury Inflation Protected
Securities’ (TIPs) yields now stand at 0.13 percent, having
climbed into positive territory late last week after 18 months
in which investors paid for the privilege of getting some of
their money back later.

That’s better, but it is still not that good and does not
constitute much of a reason to load up on Treasuries.

Funnily enough, I say that as someone who doesn’t believe
the central Treasury bear case – that the Federal Reserve will
later this year be able to begin to taper its purchases of

There has been an awakening to the risk that Treasuries, of
which the Fed is the single biggest buyer and owner, face a
change in the direction or strength of official support, in
large part because Fed Chairman Ben Bernanke raised the
possibility in a late May speech.

That’s probably a good thing, but actually looking at the
data, it is hard to see why someone with Bernanke’s dual mandate
of moderate inflation and maximum employment would see now, or
any time soon, as the time to tighten conditions.

The fundamentals do not argue for the Fed easing up.
Inflation not including food and energy is as low as it has been
in the history of the data series back to 1960. Commodity prices
are falling and wages are, at best, stagnant. None of this gives
the impression of an economy about to generate inflation, much
less above-trend growth. Inflation expectations over 10 years
continue to fall.

In other words, nothing fundamental has changed that would
lead an investor to think his investment in Treasuries will face
rising inflation.

So no, I don’t see the Fed tapering any time soon, and given
that reality, I think there is a decent chance that the recent
losses on bonds are reversed, at least in part, over the next
several months.


Even so, I’d be extremely cautious with Treasuries,
inflation linked and otherwise, which seem to offer really
asymmetric risk. A puny 13 basis points of real return does not
a value investment make, and there are plenty of ways Treasuries
could go wrong.

First off, it is an asset whose only maker and biggest buyer
and owner are essentially the same entity – the U.S. government.

Secondly, though it may be a long time in coming, even a
moderately strong recovery will simply kill Treasuries at these

It is little wonder then that Treasuries have slumped, as
when recovery finally does come, you will have higher inflation
and the 800-pound Gorilla will have turned from big buyer to
moderate buyer and finally to sideline dweller.

None of this is even taking into account the possibility
that the Fed decides that QE doesn’t work, and begins to scale
back on bond purchases despite a troubled economy.

It seems lots of investors are trying to front run this.
Treasury bond funds suffered their largest outflows ever in the
June 5 week, losing almost 1 percent of funds under management,
or $2.6 billion, according to BofA/Merrill Lynch.

As Toby Nangle of Threadneedle Investments has pointed out,
the traditional reason for owning Treasuries in a portfolio is
not that you think they will outperform, but rather that they
will help to reduce volatility in the portfolio, smoothing
returns and allowing you to take more risk than you otherwise
might. He argues that at very low rates of return, Treasuries
will no longer be as effective as portfolio ballast.

Indeed, there is something sobering in the fact that the
most recent bout of equity market weakness may well have been
touched off by volatility in global bond markets. Not a lot of
diversification value there.

In short, don’t expect the Fed to torpedo the bond market
anytime soon. But if you have an investment time horizon of more
than a few months or quarters, don’t expect Treasuries to do
your overall returns much good.

Treasuries are both on sale and too expensive, at the same

(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at

(Editing by Dan Grebler)

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