Monday, December 1, 2008

Treasury bond yields collapse

Fed Chairman Bernanke today said that the Fed's ability to provide monetary stimulus via lower interest rates was obviously limited (since the Fed funds rate today is trading at a mere 0.375%), but that doesn't leave the Fed powerless—they can simply buy bonds. That means the Fed will likely start buying bonds, and that news resulted in sharply falling yields. 10-year Treasury bonds now yield 2.7%, as they close in on their all-time low of 2.0% (1941), and 30-year bonds yield 3.2%, which marks a new all-time low (they weren't issued prior to 1977). Bond yields have fallen over 100 bps since mid-November.

And so we are witnessing what is probably the final chapter in the great bond market rally that began in late 1981. If you don't own any Treasury bonds, it's way too late to be a buyer now, since the upside is becoming extremely limited while the downside risk (e.g., what if the Fed overstimulates and pushes inflation up?) is becoming enormous.


Jon S. said...

Scott, can you work TIPS into this discussion, based on your previous posts in October arguing that buying TIPS early last month were a steal? Thanks -- Jon S.

Scott Grannis said...

Until recently, TIPS yields had risen while Treasury yields were declining. Anytime real yields on TIPS are high (3% or so) that makes them very attractive because you can lock in a guaranteed rate of return above inflation.

Rising real yields and falling nominal yields reflected the market's view that inflation was likely to turn negative for an extended period.

The combination of high real yields and negative inflation expectations meant that TIPS were very, very attractive. You could acquire their inflation insurance for next to nothing and you could lock in an attractive real return at the same time. I've been thinking that inflation risk is not something to dismiss or ignore at a time when the Fed is trying its hardest to avoid deflation.

Now in the past few days real yields on TIPS have fallen as nominal yields on Treasuries have collapsed. Deflation fears have actually decline a bit at the same time. So TIPS are a bit less attractive than before, but still worthy of your attention.

The Lab-Rat said...

What I find interesting is that the CDS market appears to be assigning some possibility of the US defaulting yet treasury yields continue to plummet. At what point does government duration become 'just another risk asset'? Albeit one wrapped by a printing press.

Scott Grannis said...

As I see it, the chance of a US default is still very small, so it is not reflected in Treasury yields. What is most astonishing though is the bond market's willingness to believe that the Fed's monetization of debt will not be inflationary. Gold, for example, is telling us that inflation is indeed a distinct risk.

Wei said...

Scott -

How come you have data going back to 1925? I'm trying to find similar data on the Federal Reserve website, and it only goes back to 1962 or so? Do you have the data in excel format? If so, would you mind sending it to me (