Two articles about investing in bonds, which has become a bit confusing. (At least I am confused :)
Bond investments seem to be in the doghouse... and are staying there.
Bonds to Economy: Drop Dead?
December 2, 2005
The way bond investors see it, the stronger today's jobs report is, the more reason it will give to despair over the economy.
Keeping up with their tendency to play Dr. Doom to the stock market's Dr. Pangloss, bond-market participants reckon a slowdown is in the offing. Fed-funds futures, which trade off of rate expectations, show that traders are betting the Federal Reserve will keep raising its overnight target rate through the first part of next year and then ease off as the economy cools.
Traders worry that the housing market is losing steam. Their concern: that consumer spending has been far more dependent on soaring real-estate values than the Fed believes, and the Fed will raise rates longer than it should as a result.
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But rather than considering a big jobs number as an indication that the economy can absorb a slowdown in housing, the bond traders may see it as garbled by Katrina's aftermath and unreflective of what's really happening in the labor market -- while at the same time giving the Fed cause to keep raising rates. Such concerns could prevent them from pushing the yield on the 10-year Treasury much higher than yesterday's 4.52%.
Flat Yield Curve Has an Upside: Fixed-Income Choices Get Simple
November 30, 2005
Watching the yield curve is ordinarily about as interesting as watching paint dry, but have you looked at it recently? The "curve" really is about as flat as it can get.
On Monday it briefly inverted when two-year Treasury notes yielded more than the five-year bonds. Earlier this week, the spread between two-year and 10-year Treasury notes was just seven basis points. (A basis point is one-hundredth of a percentage point.)
The inverted yield curve has traditionally been the harbinger of a weak economy, which is hardly good news for investors. But don't despair. This time I suspect the flat or even inverted curve may prove beneficial, and at the very least, make fixed-income investment decisions much easier while it persists. Here's why.
A flat or inverted yield curve doesn't happen that often -- the last truly flat one was in 1989, and the last inverted curve was in 1981. This is an economic anomaly because it assigns little or no risk premium to the passage of time. Short-term investors reap the same or higher rates than long-term ones.
There's something else peculiar about today's fixed-income market: The spread between nearly risk-free Treasury bonds and higher-yielding alternatives has never been narrower. This is true of not just of higher-yielding junk bonds, but investment-grade corporates, emerging-market debt, real-estate investment trusts and energy partnerships.
My suspicion is that bond buyers aren't making any prediction about the future health of the U.S. or global economy, which looks fine at the moment. The creditor nations have shown a voracious appetite for U.S. debt securities, and appear to be all but indiscriminate in their buying.
For the rest of us, this simplifies our lives rather dramatically. Last week I needed to rebalance my portfolio and add some fixed income. Never has the task been easier. Having already shed every other high-yielding and long-term debt security, I simply bought a ladder of one- two- and three-year certificates of deposit. The rate difference was marginal: 4.2% for the one-year, 4.5% for both the two- and three-year CDs. When I checked on the Internet this week I saw rates even higher, with a few offerings at 5%. With such short maturities there's little risk of principal fluctuation and since CDs are federally insured, there's no risk of default. With the flat yield curve I gave up virtually nothing in current yield. So here's to the flat yield curve while it lasts.
