Bond Market Pricing Is In Shambles Thanks To Fed’s Massive Intervention


Yields on long-term Treasuries have been skidding, despite rising inflation. As I’m writing this, the 30-year Treasury bond yield dropped another 3 basis points today to 3.25%. That’s the yield investors are eager to lock in for the next 30 years. Yet the Consumer Price Index is now 2.1% higher than it was a year ago and gaining upward momentum. Thirty years is a very, very long time, and normally, sane investors would want to be compensated for the risks associated with it.

But not anymore.

The 5-year Treasury yield at 1.66% is below inflation, guaranteeing investors a loss in purchasing power while allowing the government to borrow for free (or rather, at a profit).

This has been the goal of the policies the Fed has been inflicting on fixed-income investors: financial repression. It occurs when fixed-income investors go nuts because they’re forced – there not being any other options for them – to buy investments that are guaranteed to lose them money after inflation or, to get a slightly higher yield, take on risks that may wipe them out.

And the difference between 5-year and 30-year Treasury yields, the yield spread, is down to 1.59 percentage points, the lowest since February 2009 – the flattest yield curve since then – a time when all heck had broken lose, and financial markets were going haywire.

On the front end of the yield curve, investors have been eaten alive by inflation. But now they’re ever so slowly – and probably way too slowly – beginning to price in rate increases by the Fed. On the long-end of the yield curve, the opposite has been happening. Which leaves a lot of people scratching their heads.

Long-term yields are said to be impacted by notions of where the global economy might be heading, with low yields indicating there’s a consensus among institutional bond buyers that global growth is sinking into quicksand. But this nexus is very tenuous, and other factors are likely at play. But what are these institutional investors so worried about? Or have they been driven completely nuts?

“But who the heck is still buying?” grumbled Cali Money Man, a wealth manager at a megabank who has been on the job during the past three crashes, and one of the guys who has been scratching his head over the issue.

“If Street estimates of rates – i.e., GDP and inflation – are correct, long Treasuries have a large negative 1-year expected return,” he said. “Even more so over the following few years, as the Fed increases rates.”

It should turn rational investors – which is what institutional investors are supposed to be – away from those reeking securities. But no.

“I doubt it’s a flight to safety,” he said. “Assets with expected negative 1-year returns are not safe.”

Hard to argue with, if “safe” is defined as not losing money.

“At worst, they’d buy the 1-year or 2-year, or maybe the 5-year, but not the 30-year,” he said. Not at these yields.