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Thanks for taking the time to post this article. It is indeed, form my thoughts, good and most informative reading for those that are invested in fixed income within their portfolios.
We all know there are some folks in the Fed and they have been consistently against QE etc. In each meeting, they dissent the decision. There are not enough of them to change the policy or they are not voting members at this time. So, while the press gives a lot of coverage of these folks, the policy still firmly remains in place. I see it is natural that these things are discussed in FOMC and the meeting minutes reflect that. I would be worried if these guys come together and not discuss all aspects of the policy.
At some point, the bond buying will indeed taper. Fed has given the conditions for that several times and I see no change on that. Inflation rise above 2-2.5% range, or unemployment below 6.5%. It is solid guidance. The two actually are related. It cannot get simpler than that.
Based on projection We are unlikely to get to 6.5% unemployment until middle of 2014. Maybe even 2014. While private sector is adding jobs (good), the government is still shedding jobs creating a headwind there. In 2000 recession we came out of the recession because government (federal, state, local) has been adding jobs significantly. Not this time around. Local and State governments have stabilized but now with sequester we have federal government going negative growth again. It is also holding companies that does business with government as well. A lot of defense companies for example have laid of or put an hold on employment growth as their projects are slowed down or put on hold. People have this simplistic vision government and private sectors are separate and government is just paper pushers. Well, government is the buyer of services and goods of private sector businesses. The government employees themselves use a lot of private sector services as well. I guess you get the idea. If you shrink government sector your private sectors have to shrink somewhat or slow down. This is what is happening in the US today. Anyway, going back to 6.5%, we are not going to have much improvement there until mid-2014 or maybe even towards end of 2014. And the dysfunction of congress is unlikely to change so Fed policy that tries to compensate that is unlikely to change
Inflation, by the Fed measure which is the one for the basis of decision, is also significantly below and is unlikely to pick up significantly with Europe still struggling, our own misguided fiscal headwinds via sequester + tax hikes. There are two basic sources inflation. A strong labor market demanding higher wages. The wage growth has been stagnant as unemployment stayed high. Besides, we do not have strong unions anymore. On the resource basis inflation is also slow as China is in big trouble. If you have been looking at the commodities and futures, we have excess capacity in many ways. Oil has also declined as China output has been slow and Europe still in crisis has not been consuming as much. Add in the increasing shale gas and oil, oil prices which is one of the major price components of goods sold in US has declined. These are all keeping the inflation in check. The only big gainers in inflation are education costs (some families) and medical costs (predominately older families). They have been consistently high. Housing has been on the mend so housing inflation has picked up recently a bit. Because of under-building in some markets in recent years, now we have housing shortage. Overall, the inflation is unlikely to pick up and get out of range. In fact, I think unemployment and inflation targets of the Fed are likely to be hit around the same time.
So, what happens if we taper. If it comes with growing economic prospects, the effects will be less. Bonds may lose but equities might be on better footing on growth prospects. If it is coming due to some misguided policy change at an unfortunate time (like Europe's insistence of keeping interest rates high while fires were burning), it will cause sell-off in equity and bond markets. In a sell of, it is possible that Treasuries might assume its long tradition of safe haven asset. But corporate bonds are positively correlated with equities and they will decline as well (perhaps not as much but they do not gain typically as much either so losses will be high proportionally with gains of the asset class).
But as I said, the policy is not changing. The market jitters might be a typical summer swoon and perhaps an opportunity for buying. In this sense, we are following typical yearly pattern.
the simplest and safest approach is simply to park funds in a low-volatility money market fund and accept near-zero returns.
It is difficult for retirees who depend on the already low interest bearing options. For those who venture into longer duration bonds and REITs are taking sizable loss in May. The continuing fear of Fed's tapering does not help the sell-off.
Mutual funds do not seem a good solution to the problem even if they try to be. Just looking only at T.Rowe Price (other families are probably similar but Price has a nice variety for demonstartion purposes) PRFRX (adjustable ) is up about 2% though its risk is unclear, PRIPX (a TIPS fund is down more than 4% ) and TRBUX ultra short term and PRWBX short term are both hovering around a 0 return one + the other minus. I think its time for CD ladders and i bonds .
Comments
Thanks for taking the time to post this article. It is indeed, form my thoughts, good and most informative reading for those that are invested in fixed income within their portfolios.
Thanks again,
Skeeter
At some point, the bond buying will indeed taper. Fed has given the conditions for that several times and I see no change on that. Inflation rise above 2-2.5% range, or unemployment below 6.5%. It is solid guidance. The two actually are related. It cannot get simpler than that.
Based on projection We are unlikely to get to 6.5% unemployment until middle of 2014. Maybe even 2014. While private sector is adding jobs (good), the government is still shedding jobs creating a headwind there. In 2000 recession we came out of the recession because government (federal, state, local) has been adding jobs significantly. Not this time around. Local and State governments have stabilized but now with sequester we have federal government going negative growth again. It is also holding companies that does business with government as well. A lot of defense companies for example have laid of or put an hold on employment growth as their projects are slowed down or put on hold. People have this simplistic vision government and private sectors are separate and government is just paper pushers. Well, government is the buyer of services and goods of private sector businesses. The government employees themselves use a lot of private sector services as well. I guess you get the idea. If you shrink government sector your private sectors have to shrink somewhat or slow down. This is what is happening in the US today. Anyway, going back to 6.5%, we are not going to have much improvement there until mid-2014 or maybe even towards end of 2014. And the dysfunction of congress is unlikely to change so Fed policy that tries to compensate that is unlikely to change
Inflation, by the Fed measure which is the one for the basis of decision, is also significantly below and is unlikely to pick up significantly with Europe still struggling, our own misguided fiscal headwinds via sequester + tax hikes. There are two basic sources inflation. A strong labor market demanding higher wages. The wage growth has been stagnant as unemployment stayed high. Besides, we do not have strong unions anymore. On the resource basis inflation is also slow as China is in big trouble. If you have been looking at the commodities and futures, we have excess capacity in many ways. Oil has also declined as China output has been slow and Europe still in crisis has not been consuming as much. Add in the increasing shale gas and oil, oil prices which is one of the major price components of goods sold in US has declined. These are all keeping the inflation in check. The only big gainers in inflation are education costs (some families) and medical costs (predominately older families). They have been consistently high. Housing has been on the mend so housing inflation has picked up recently a bit. Because of under-building in some markets in recent years, now we have housing shortage. Overall, the inflation is unlikely to pick up and get out of range. In fact, I think unemployment and inflation targets of the Fed are likely to be hit around the same time.
So, what happens if we taper. If it comes with growing economic prospects, the effects will be less. Bonds may lose but equities might be on better footing on growth prospects. If it is coming due to some misguided policy change at an unfortunate time (like Europe's insistence of keeping interest rates high while fires were burning), it will cause sell-off in equity and bond markets. In a sell of, it is possible that Treasuries might assume its long tradition of safe haven asset. But corporate bonds are positively correlated with equities and they will decline as well (perhaps not as much but they do not gain typically as much either so losses will be high proportionally with gains of the asset class).
But as I said, the policy is not changing. The market jitters might be a typical summer swoon and perhaps an opportunity for buying. In this sense, we are following typical yearly pattern.
PRFRX (adjustable ) is up about 2% though its risk is unclear, PRIPX (a TIPS fund is down more than 4% ) and TRBUX ultra short term and PRWBX short term are both hovering around a 0 return one + the other minus. I think its time for CD ladders and i bonds .