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Editor's Note: This article was written by Robert Barone, head of Ancora West. Mr. Barone currently serves on AAAâ??s Finance and Investment Committee which oversees $5 billion of investible assets. The financial press has given credence to those who insist that, because interest rates have fallen rapidly since April, we're in some kind of a bond bubble. Investors, they say, should shy away from fixed income because surely they'll be hurt when interest rates rise. Technically, this statement is correct -- the crucial part of the statement is "when interest rates rise." If they rise in the near term, then the advice is accurate. But if they aren't going to rise for a long time, investors are missing out on valuable and stable returns. To ascertain the time horizon, consider the following facts:
There are two examples in modern history of very long periods of artificially low interest rates. The first is 1942-1951 when the Fed "pegged" the long-term Treasury rate at 2.5%. Today, the rate on the 30-year Treasury bond is 3.70%; so there may still be a significant downward move in rates, even from current levels. The second example is the Japanese experience of the past two decades where interest rates have been similar to what we see today in the US.While the supply of money appears plentiful, should we worry about the demand for our debt declining, thus causing rates to rise to place that debt? The demand from the Chinese and the rest of the world, we're told by the bond bears, can dry up rapidly and cause our interest rates to rise. Looking at the data, that's already begun to happen, as China reduced its holding of US Treasury debt in both May and June, yet the 10-year Treasury yield peaked in April and has steadily declined. With trillions of dollars in cash, no cost to borrow, no appetite for lending, no capital base required to hold Treasury debt, and the promise of low rates for an "extended period" by the Fed, US banks are purchasing all of the debt the Treasury can issue. Eventually, interest rates will rise. The question is "when." Here are some indicators to watch:
None of these appear imminent. If there's a bond bubble, it's in an early state. And, from the observations above, it appears that it will be quite a while before upward rate pressures appear.(CBOE Interest Rate 10-Year T-Note (^TNX) last traded at 2.65. Treasury Yield 30 Years (^TYX) last traded at 3.72.)
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