Why Are Treasuries So Strong This Year?
Back in December, the Fed announced that they would begin “tapering” their bond buying program known as Quantitative Easing (QE), which was designed to keep interest rates artificially low in an attempt to spur economic growth. After that, most investors believed the U.S. Treasury bonds would fall since so much demand was going to be leaving the market. Our Investment Committee has also been quite negative on the prospects for Treasuries since 2012 because the risks appear to outweigh any near-term return potential. Despite this, investors who have owned the 10-year and 30-year Treasury since January have enjoyed a return of 10.3% and 12.3% respectively.
This leads to the question…what is driving the treasury prices higher given the outlook for interest rates? To answer this, we need to go back to the law of supply and demand. A bond price rises (yield falls) when either the demand for bonds increases or the supply decreases. Since 2008, the total debt level has exploded. Having said that, the rate at which it is rising has slowed dramatically since late 2009, leaving us with the smallest U.S. deficit in seven years. Although the U.S. government continues to increase the amount of debt, the rate at which they do so is slowing. Now the supply side is much easier to quantify than the demand side. Our Investment Committee believes that three main sources of demand have spiked recently:
- Pension Funds: New rules designed to plug shortfalls and the selling of equities to lower fund volatility after a strong 2013 appear to be fueling a surge of demand from pension funds.
- Attractive Flight to Safety: Investors who have concerns over emerging market currencies and instability in regions like the Ukraine have preferred U.S. Treasuries to other ultra-safe government debt because of the relatively attractive yield.
- Banks: New rules designed to thwart another possible financial crisis have basically forced banks to own more Treasuries because they are considered ultra-safe and can withstand another potential crisis.
In other words, higher demand has created a surge in price since the pace of new debt creation has slowed.
Imbalances in supply and demand occur frequently in the short-run and are often fueled by reasons that are not entirely fundamentally driven. Our Investment Committee will pay attention to what’s happening in the market and continues to keep a strict focus on the long-term. Interest rates will rise as the economy strengthens, and until Treasuries offer a more attractive risk-adjusted yield, our Investment Committee will continue to urge investors to look past any short-term moves that may appear attractive upon first glance.
Read this week’s Thought of the Week to learn more about what has been happening with U.S. Treasuries.
Click Here for the Weekly Thought As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.