Will Bonds Be “Burnt To A Crisp”?


Will Bonds Be “Burnt To A Crisp”?

That was the question that Bill Gross asked in his latest monthly outlook.  For now, that’s likely much more of a fear tactic, but as investors we must always understand the risk/return characteristics of our investments.

In my latest for the CFA, I perform some very elementary bond math on the 10yr treasury, showing the risk/return for various movements in interest rates.  I then look at the holdings of the Barclays PLC (LON:BARC) (NYSE:BCS) aggregate index, which many bond funds are based upon, to give investors an idea of what they may be holding.

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It’s getting tougher and tougher now to be invested in the fixed income markets. Previously attractive risk/return asset classes, such as non-agency MBS, high yield, and others do not have nearly the “margin of safety” they had even nine months ago.  Central bank balance sheet expansion has changed the economics of the fixed income markets. Everything has rallied and we need to constantly re-assess the attractiveness of such investments.

The premise of his article is that the United States needs to get its fiscal house in order or else the Fed will be stuck printing money to pay the debt deficiencies. Strangely, Gross asserts that the United States will resemble Greece if deficits are not conquered.

That is nonsense because the United States is a currency issuer and can never run out of dollars. Greece, in contrast, is a currency user and cannot issue euros at will. But in any case, investors are coming to the conclusion that economic problems cannot be solved by monetary policy alone. In this, Gross is correct; the United States’ and other countries’ decisions on fiscal policy will be the key determinants of future economic performance.

I am thoroughly convinced that, in the interim, fixed-income asset prices will be largely driven by central bank policy. My earlier post on QE went through the mechanics of QE3 and how it has affected various fixed-income classes. Understanding the capital flows caused by the Fed’s balance sheet expansion is important but not essential to understanding the full fixed-income universe.

Fixed-Income Strategy: Are Bonds Poised to Be “Burnt to a Crisp”?

By: Economicmusings

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