priced debt. Foreign holders have shown only modest interest in new US
sovereign exposure of late. Their increases are only in short-term debt
instruments. Central Bank holdings of coupon debt has increased by only
$50b (June 08 vs. June 09). During the same period the CBs sold $90b in
fixed rate Agency paper. If the Fed isn’t buying and foreigners aren’t either it
means that Americans are going to have to come to the rescue and buy a
great deal of bonds starting at some time in the near future. I can’t
imagine why anyone would do that. Treasury coupons are a terrible
investment.
If
you subtract the current 10-year yield from the ten-year TIP you get an
indication of how the market is pricing future inflation. The current
difference is 1.66%. I think that is a ridiculous assumption for the
next ten years. It will be higher than that. But these are big markets
and we have to use what these markets tell us.
This estimate
of inflation is also a discount rate to determine future values. For
example, if the actual inflation rate over the next decade is 1.66%,
then $100 today will be worth only $85.43 when the bond matures.
Similarly the interest that is received is worth less. The $3.30 one
would get in the tenth year is worth only $2.75. It gets worse.
The
Treasury has its hand out when it pays interest. The average marginal
tax on unearned income is 30%. So if you buy Treasury paper you only
get 70% of the income net of taxes. When taking into consideration the
tax impact and the rate of inflation the adjusted return to an investor
is just .43% for the current ten-year bond.
If your
expectations for inflation are closer to 2% versus the TIPS pricing
then you really have to stay away from Government bonds. At a 2%
inflation rate the return goes to zero. At 2.5% average inflation the
return is negative. For an investor who puts up $100 today they will
receive a TOTAL of only $94 in return over the ten-year period.
If
one was wondering why junk stocks have a bid, or why PEs are so high,
or why gold is pushing $1,000 you just have to look at this
calculation. The inescapable conclusion is that for a ‘buy and hold’
investor the very worst place to put your money today is in Treasury
bonds. It is just plain stupid.
Mr. Bernanke’s effort to keep
rates low through open market purchases has worked. It is hard to imagine what would be happening in the real economy were it not for
the QE program. As/when QE ends Mr. Bernanke will learn that no one
wants to play in his sandbox any longer. It is difficult to ponder
what market conditions will be like when that realization takes hold.
In five years total US government debt will be over %80 of GDP..Currently Japan's debt is about %180 of GDP.To compare the US to Japan is intellectual poppycock.
1.Japan holds around 400 billion of US debt
2.Foreign interests hold very little of Japanese debt.The vast majority of it has been issued by their postal savings system to fund retiree pensions.
3. Consumers in the US are much,much more indebted than Japanese consumers.
4.States and municipalities have issued huge amounts of debt and have unbelievable amounts of unfunded pension and health obligations
5.Who knows how much off balance sheet obligations that the US has made
6.The unfunded future obligations for social security and medicare are much worse as a % of gdp for the US than Japan
I am not bullish on Japan.Demographically they are cooked.
However,the current and previous administration in the USA have embarked on the most irresponsible spending spree in world's history.To think that the government is going to be rewarded for thses excesses with lower interest rates is ridiculous.While it would not surprise me if bond prices increased in the short term,shorting 30 bond obligations is setting up as one of the best trades for the next ten years
there is optionality in a TIPS bond, be careful when trying to ascertain the "market's expectation" of inflation via your method (particularly when deflation is seen to be at least possible...)
Deflation anyone?
The incentives that manifest in a ZRIP environment are truly perverse. We need the savings rate to rise so the serfs will have money to put into treasuries when SS, China and the Fed stop buying. But what incentive is there to save when CD yields are in the basement.
Forget pulling the plug on grandma, the Fed wants grandma to invest in "risk" assets and won't give her much of a choice about it.
If we have some form of stagflation in the future then every asset class will be a loser. But I guess the phillips curve says stagflation is impossible so we have nothing to fear.
Sorry, dude. With the bad debt remaining out there, asset prices are going to be under pressure for many years to come. Inflation requires an expansion of private credit, and that is not in the cards since banks and potential borrowers are broke or very wary.
Real inflation could easily average 0 to 1% for the next decade, considering that it has been about -5% over the last 12 months.
Wait for the commodity and stock bubble to pop just like last year, and then we'll see who was stupid, bond bulls or stock market and commodity bulls.
The markets feel like June/July 2008 redux. Remember how that ended?
i second this. relative risk/reward is on the side of the bonds these days. while 10 years are at 3.4% today, thats a solid 5.4% yield in real terms. what is the earnings yield on the S&P 500 these days?
i can't see the future, but i know that 10 years will stay sub 4% for a long time (until housing inventory is flushed through system). once that happens, then yes, potentially sky is the limit but that is at least a 5 year+ process
Agreed, the elephants in the room are the collapsing bank loan portfolios and the oh so very large and leveraged derivatives market that is being propped up with a tooth pick. Anyone know what the derivatives market is these days?
I expect the government to require GRA's (guaranteed retirement accounts) by 2011 in which all Americans will have to put 5% of their pay into this vehicles invested in Government Bonds. That will get the needed buyers for the government to continue to US Financial Ponzi scheme.
The treasury bubble will be the most horrific of all...
Great analysis, Bruce. I believe President Kirchner already solved the problem of getting that paper moved:
http://online.wsj.com/article/SB122471757680560465.html
The calculation assumes that the CPI is correct in the way it is calculated.
If you believe your government, fine. For a sceptical investor the numbers become way worse.
But the bid in stocks longer term makes only sense for companies that are going to survive, otherwise the money is completely gone.
speaking of which john williams reports
pre-clinton cpi at about 5% or so....that's now...
i believe that we have all the makings of much
higher rates....
and the point was well made that artificially
low rates drive perverse investment behavior...
"But these are big markets and we have to use what these markets tell us."
Sure, but remember our "dear leaders" at the Fed have manipulated these "markets" to the hilt, so we cannot really trust what they are "telling us". Some people have been saying lately that one of either the stock or the bond market is wrong; well, I say BOTH are wrong. Both of them will tank at some point - yes, together - and instead of the usual bond-stocks yo-yo we'll get capital flowing into PM's, and possibly other commodities as well.
Um. Commodities. You meant those things that will get passed around with no reguard or concern for comex being a going concern? Why park your money in a piece of paper that will never deliver. I think it will just freeze at some point. Like an immobile picture.
http://www.321gold.com/mustread/spotgold500_grrrrrr.html
Someone should explain to the HFTer's that speed and momentum can be dangerous if everbody digs thier heels in against it.
Maybe what the market is telling you is that we might be Japan. Japan's tried everything from stimulus projects to buying bonds. Look where their yields are.
We are Japan. Sushi anyone?