SAFT ON WEALTH-Bonds on sale but still too dear
(James Saft is a Reuters columnist. The opinions expressed are his own)
June 12 (Reuters) - Sometimes, as with Treasury bonds right now, a better deal just isn't good enough.
A sharp selloff in Treasuries has taken yields higher, theoretically offering better returns and better protection against inflation. In fact, so-called real yields, meaning yield adjusted for inflation, have actually gone into positive territory. Benchmark 10-year Treasury Inflation Protected Securities' (TIPs) yields now stand at 0.13 percent, having climbed into positive territory late last week after 18 months in which investors paid for the privilege of getting some of their money back later.
That's better, but it is still not that good and does not constitute much of a reason to load up on Treasuries.
Funnily enough, I say that as someone who doesn't believe the central Treasury bear case - that the Federal Reserve will later this year be able to begin to taper its purchases of bonds.
There has been an awakening to the risk that Treasuries, of which the Fed is the single biggest buyer and owner, face a change in the direction or strength of official support, in large part because Fed Chairman Ben Bernanke raised the possibility in a late May speech.
That's probably a good thing, but actually looking at the data, it is hard to see why someone with Bernanke's dual mandate of moderate inflation and maximum employment would see now, or any time soon, as the time to tighten conditions.
The fundamentals do not argue for the Fed easing up. Inflation not including food and energy is as low as it has been in the history of the data series back to 1960. Commodity prices are falling and wages are, at best, stagnant. None of this gives the impression of an economy about to generate inflation, much less above-trend growth. Inflation expectations over 10 years continue to fall.
In other words, nothing fundamental has changed that would lead an investor to think his investment in Treasuries will face rising inflation.
So no, I don't see the Fed tapering any time soon, and given that reality, I think there is a decent chance that the recent losses on bonds are reversed, at least in part, over the next several months.
FUNDAMENTALS OF BOND BUYING
Even so, I'd be extremely cautious with Treasuries, inflation linked and otherwise, which seem to offer really asymmetric risk. A puny 13 basis points of real return does not a value investment make, and there are plenty of ways Treasuries could go wrong.
First off, it is an asset whose only maker and biggest buyer and owner are essentially the same entity - the U.S. government.
Secondly, though it may be a long time in coming, even a moderately strong recovery will simply kill Treasuries at these levels.
It is little wonder then that Treasuries have slumped, as when recovery finally does come, you will have higher inflation and the 800-pound Gorilla will have turned from big buyer to moderate buyer and finally to sideline dweller.
None of this is even taking into account the possibility that the Fed decides that QE doesn't work, and begins to scale back on bond purchases despite a troubled economy.
It seems lots of investors are trying to front run this. Treasury bond funds suffered their largest outflows ever in the June 5 week, losing almost 1 percent of funds under management, or $2.6 billion, according to BofA/Merrill Lynch.
As Toby Nangle of Threadneedle Investments has pointed out, the traditional reason for owning Treasuries in a portfolio is not that you think they will outperform, but rather that they will help to reduce volatility in the portfolio, smoothing returns and allowing you to take more risk than you otherwise might. He argues that at very low rates of return, Treasuries will no longer be as effective as portfolio ballast.
Indeed, there is something sobering in the fact that the most recent bout of equity market weakness may well have been touched off by volatility in global bond markets. Not a lot of diversification value there.
In short, don't expect the Fed to torpedo the bond market anytime soon. But if you have an investment time horizon of more than a few months or quarters, don't expect Treasuries to do your overall returns much good.
Treasuries are both on sale and too expensive, at the same time.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaftzjamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by Dan Grebler)