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The Barclays Aggregate Bond Index has posted twelve consecutive years of positive returns.  We ask: Is this unusual?  What should one expect for the coming decade?

 

It has been a long and not-so-winding road.  The legacy of inflation-ravaged bond prices from the 1970’s was tough to overcome, but when inflation’s back was finally broken in the late 80’s, investor inflation expectations began to moderate.  And we were off to the races. 

 

Mortgage rates averaged more than 10% though the 80’s.  Young borrowers such as my wife and I could only gripe about the 3% mortgage rates that our parents crowed about from when they purchased their first home.  And now we have come full circle.  Mortgage rates are now consistently under 4%, and savers are the ones “taking it on the chin”.  Anyone attempting to live on CD rates, well, isn’t actually living.

 

Of course, it is not unusual for interest rate trends to persist for long periods of time, but a variety of factors are at work in this cycle. Recent declines, for short and long bonds, have been as much about where NOT to invest as they have been a vote of confidence in our debt-laden treasury.  A lack of alternatives has made the US Treasury the “best of what’s left”.

 

Corporations have wisely rushed to lock in low single-digit interest rates for upwards of thirty years.  Investors, still fearful of global economic uncertainty, and continuing to exit the equity markets, gladly lapped them up.  Few investors seem to have noticed the doubling of equity prices from the 2009 lows.  Hurt by a lost decade they have spurned stocks, and licking wounds in real estate, they have clung to "safety" in bonds.  Are they in for strike three - a bond bear market?

 

We have to ask: What is normal?  Are zero percent cash rates the new normal?  Should Treasury yields be less than the observed rate of inflation?  Can we expect another decade of steady returns?

 

Not to spoil the suspense, but Boardwalk thinks that the answers are “No”, “No” and…  “No”. 

 

Cyclical factors aren’t the most important ones to consider, but they matter:  Economic momentum, while hardly robust is still positive, and climbing prices of “soft” commodities (food) will surely put some pressure on inflation.   Investors will not accept negative real returns (after inflation) forever.  Over the long term, interest rates are a reflection of future inflation.  Negative real yields can persist for a while, but not indefinitely.

 

The Fed will eventually get out of the bond market.  The price of money (an interest rate) is determined by supply and demand.  When businesses demand more capital (presumably to pursue opportunities), rates rise, drawing money off the sidelines (i.e., money markets) tempted by higher rates in longer term bonds.  But recently, the Fed has been a massive supplier of capital, keeping rates low -- and artificially so, in an attempt to stimulate the economy.  Printing money to buy bonds might work for a while, but it is surely not a long term strategy for a sound currency.

 

Lastly, the flight to quality is about fear, but sooner or later, greed takes its place.  The natural cycle has not been repealed.  Eventually, and as we have recently seen in Spain, attractive yields entice investors to take risk.  This is surely not an assessment that "all is well" in Europe, because it is not.  But it IS evidence that there are no “one decision” investments. 

 

In summary, neither are US bonds a one decision investment – unless that decision, of course, is to be careful not to extrapolate past performance.