Yoshikami: The Government Bond Stampede

Seems like everybody nowadays is interested in buying government bonds, but the reasons differ depending on who you are. The Bank of Japan today announced they would increase the purchases of their own sovereign debt following in the footsteps of the Bank of England who also stated they would purchase Gilts (their version of government bonds).

It's a buying plan to help calm the financial markets and stimulate economic recovery. The Federal Reserve could very well adopt a similar path as the tools in their arsenal are depleting rapidly. Interest rate cuts are not an option anymore with rates now near zero percent.

The action of central banks buying sovereign debt is designed to drive interest rates lower --even lower than the low levels we see now. These purchases provide lubrication to the financial system and constitute a form of quantitative easing to help jump start comatose economies.

Global Markets
Global Markets

Yes it's come to this. The economy so weak that even near zero percent interest rates in the United States and Japan are not enough to prevent further financial deterioration. What does this mean for you?

First, it means marketplace interest rates will likely fall even farther. Second, it provide more money for businesses and consumers as borrowing costs fall. Sounds good but there is a major downside.

This type of easing sows the seeds for a snap back of inflation when economic growth returns. And the elastic reaction could be quite violent. Isn't the mess we're in now a result of too cheap money for too long? Chairman Benanke is aware of this and has already sounded the alarm that cheap money won't last forever. The risks are too great.

From an investment standpoint, tread carefully when investing in longer-term fixed income assets. One strategy investors can adopt in this environment is to avoid buying an excess amount of Treasurys and instead invest in higher grade corporate fixed income assets. These
positions have attractive yields relative to Treasurys and, if bought in diversified positions, have reduced default risk as compared to individual corporate bonds.

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Check out the ETF assets CIU and CSJ . Spreads right now are wide and the yield differential is attractive. When the world is less panic stricken, there should be an opportunity for capital appreciation when money flies out of low yielding Treasury assets into higher-yielding, reasonably secure fixed income positions. Yes that's right, there's an opportunity for capital gain as well as income.

Warren Buffett, Bill Gross, and other wise investors have been saying for some time that there's a bubble in Treasury securities. The bubble is about to get bigger as central banks start gobbling up government debt.

True, safety is important but sometimes the lure of guaranteed return of principal can leave you stuck with an unexpected capital loss. Be wary as an investor. You've already taken enough of a hit in this brutal market. Don't let government debt pummel you as well.



Michael A. Yoshikami, Ph.D., CFP®, is Founder, President, and Chief Investment Strategist of YCMNET Advisors, Inc., a registered investment advisory firm (www.ycmnet.com). Michael oversees all investment and research activities of YCMNET. He is a respected lecturer speaking frequently on market issues, tactical asset allocation, and investment strategy. He appears regularly on CNBC and CNBC Asia and can be reached directly at m@ycmnet.com.