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Roughly one year ago, Americans witnessed Standard & Poor’s downgrade U.S. sovereign debt one level to AA+. This unprecedented event marked an end to the 70+ year reign that America had atop S&P’s ratings list, and quickly spooked investors around the globe.
However, the death of the American bond market has been greatly exaggerated, as yields have continued to fall despite the loss of the golden AAA status. In fact, yields are once again near all time lows while many Treasury bond ETFs have seen solid gains since this event.
For example, one of the more popular funds tracking the 20+ Year bond market, (TLT - ETF report), has added just over 28% since August 5th, 2011, while a shorter duration product that focuses on the 7-10 year Treasury bond market, (IEF - ETF report), has seen a 9.5% gain in a similar time period. Both of these performances actually outperform broad stock markets for the time period in question, suggesting that despite the downgrade, bonds have still been a very good choice for investors.
Unfortunately, these impressive gains have depressed yields to historic levels as a 30 Year Treasury bond now has a yield of just 2.74% while a 10-Year Treasury bond is now around the 1.65% mark. This means that a Ten Year is currently yielding about the same as inflation, implying that the real return for this security will probably be close to zero for most investors (read Is The Bear Market For Bond ETFs Finally Here?).
This scenario has forced many investors to look for yield in different places, like the stock market, in order to get income back at acceptable levels, or at least above the rate of inflation. With that being said, it does appear that some trends could be breaking in the market, and that investors are finally starting to get sick of the low yields in the American Treasury world.
The bid/cover ratio on the most recent 10 year note auction was just 2.49, the lowest level by a wide margin this year. It was actually the lowest in more than three years, while dealers took a majority (54%) of the auction, which suggests buy-and-hold participation was weak.
Yet even with the beginning stages of this trend, and some optimism from Europe, yields remain depressed and are likely to stay there for some time. This is especially true given the prospect of more QE, and the Fed’s ultra-accommodative interest rate policy which doesn’t appear to be changing soon either (read Escape Low Yields with These Three Bond ETFs).
Thanks to these clashing data points, rates could either move lower and the 10 year could touch its all-time low of 1.43%, or come back up to more reasonable levels like half of its long term average which would be a rate of 2.275%...
What do you think?
Will rates continue to remain depressed and stay in the 1.50%-1.90% range? Or will we see a breakout from this zone that either produces fresh lows or highs for 2012?
Let us know what you think in the comments below!