Treasury bonds have recently endured a vicious correction, with yields on 10-year Treasuries rising from an all-time low of 2.04% on December 18th to 3.94% yesterday (June 10th). Using an Exchange Traded Fund that invests in a portfolio of 7-10 year Treasury bonds (symbol: IEF) as a proxy, the total return loss in Treasury bonds during that time has been -10.3%. That’s not exactly the kind of return investors usually expect from a perceived “safe” investment like Treasury bonds.
What’s been behind the recent rout in Treasuries? For one thing, risk appetites have slowly been returning to normal as the economy seems to have passed the worst of the downdraft, allowing investors to gradually move out of Treasury securities and into higher yielding debt and stocks. In addition, it seems that bond investors have a few concerns these days that are causing them to demand a higher yield, including massive new issuance as the government borrows trillions of dollars to pay for all of the bailout efforts; fears of foreign countries with large Treasury holdings selling them to diversify into other securities; expectations of stronger economic growth in coming months; and inflation worries as oil and other commodities have rebounded of late.
So, should investors immediately sell all of their Treasury holdings? Is a return to the double-digit interest rates of the late 1970s & early 1980s right around the corner? We don’t think so. The size and scope of the financial collapse has created a tremendous amount of idle capacity in the global economy, and so we don’t think that inflation is an immediate threat. And, there’s still a lot of uncertainty about the economic outlook, despite some positive developments lately, meaning that any setback could cause another stampede back into the safety of Treasury bonds. We think there’s a better chance that bonds will trade in a wide range, similar to what we believe may be in store for the stock market, with large moves in both directions as the economy works through a bottoming process. In short, we’re still confident that Treasuries play an important role in a diversified portfolio – for now, anyway.
