In Houston, TX there was once an amusement park called Astroworld, near the Astrodome. It boasted a very tall, wooden rollercoaster known as the Texas Cyclone. Of course this coaster had many cars, but only two mattered – the front and the back.
To sit at the front was to have an unobstructed view of Houston as the coaster clinked its way to the top of the first hill and prepared for the first heart-stopping drop. As the cars began to cascade over the drop, the first car was literally pushed faster down the hill, giving you that rush of adrenaline. It was way cool.
The back of the coaster was a different story.
The view wasn’t very good – lots of other people’s hands in the air – and of course you never arrived first. But you did have a unique experience…
…that of whiplash.
The occupants of the last seat got the rush of being thrown from side to side as the little coaster train rounded cornrners at top speed. After the first few cars had been pushed around a cornrner, the last car was almost ripped around the cornrner as it was pulled along.
At 12-years old, what a rush! Now that I’m nearing 50, I’m not so keen on the last seat on a rollercoaster. Yet that’s where I find myself, along with everyone else who deals with interest rates.
The Fed’s recent actions are well known, so I won’t go through them here. Suffice it to say they created a mighty storm in fixed income, causing rates to shoot to the moon before falling back a bit.
The question is: Where do rates go from here?
To ponder this question is to think about two different dimensions at the same time.
There is the economic health of the country, which should inform the Fed about if and when to back off of its bond buying…
And then there’s the possible unwinding of the yield compression in different types of bonds.
Both dimensions are important.
It appears that, as we expected and have discussed, the Fed’s comments about tapering were premature. It spent a lot of energy telling everyone that they were missing the point.
Yes, the Fed will back off of bonds, but no, it won’t be today… and it won’t be until the economy shows significant strength.
I don’t see that happening anytime soon, which means it’s more likely that Treasury bonds and extraordinarily high quality bonds will actually see their interest rates fall in the months ahead.
This is particularly true of short-term interest rates.
When investors around the world get skittish they turnrn to U.S. Treasuries, but not all maturities are created equal. People looking to simply preserve purchasing power don’t take maturity risk. They stay close, which means a possible increase in demand for short-term Treasuries in the case of an economic scare (like a southernrn European country having a crisis, for instance) causing a drop in yields and a bump in price.
This is very different from the outlook for high yield bonds and emerging market bonds. While the past several years have been good for these sorts of investments, it looks like the bloom is off the rose.
Apparently, people who simply bought such things because they offered more interest now realize the increase in interest comes with an increase in risk. If the U.S. economy and/or the world economy experience a further decline, expect these types of bonds to fall in price as demand drops off, causing their interest rates to rise.
Either way it appears that the days of exceptionally cheap mortgage money and auto loan money are over. The rates are still low today, but the chances of seeing sub-4% on a mortgage again are slim. Bankers have had the fear of Ben (Bernrnanke) put into them, and it will be hard to shake it.
If you’re in the market for bonds, do your due diligence. While there’s risk… there are many opportunities.
For those willing to do their homework, there are many bonds that have been battered at the back of the rollercoaster and now offer a decent yield, just don’t be cajoled into buying junk.
Ahead of the Curve with Adam O’Dell
If you’re looking for bonds to buy, make sure to steer clear of high-yield junk bonds.