Safe Investment Losses

The Labor Department reported Friday that employers added 195,000 new jobs to their payrolls in June.  Nonetheless, the unemployment rate remained at 7.6 percent, as people entering the workforce subtracted out all job gains.  Still, markets were delighted.

The DOW closed the day up 147 points…and the S&P 500 increased a full percent.  But is this really a sign the economy is improving?

An ever so slight scratch below the surface of the headline number reveals a picture that is less sanguine.  The underemployment rate, which includes people who want to work but who have given up searching and those working part time who want to work full time, jumped to 14.3 percent from 13.8 percent in May.  Moreover, the new jobs that were added are not the type of jobs that grow the economy…

“More than half of the jobs were in the retail and leisure and hospitality sectors, which typically are relatively low-paid,” reported Reuters.

“In contrast, manufacturing payrolls fell by 6,000 jobs, declining for a fourth straight month, while construction employment rose a still moderate 13,000.”

Flow Reversal

The other big market, the debt market, didn’t know what to make of the Labor Department report.  It digested the news and let out a humungous burp.  The yield on the 10 Year Treasury note jumped from 2.50 percent to 2.71 percent.  This is a 100 basis point rise – plus more – from a yield of 1.65 percent in May.

Could it be that the great Treasury bond bubble is finally going to pop?

“When the financial history of this decade is written,” said Warren Buffett in February 2009, “it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s.  But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.”

After inflating for the last 30-years, it appears the flow of money may finally be reversing.  Record amounts were pulled out of bond mutual and exchange traded funds in June.  According to TrimTabs, “bond mutual funds have lost $70.8 billion in June, through Thursday, June 27, while bond exchange-traded funds have lost $9.0 billion.”

Will a full on panic for the exits occur?

Who knows?  But it is clear that an inflection point has been hit.  The days are gone when federal, state, and local governments, and businesses and individuals can refinance their debts every couple of years at perpetually lower rates…lightening their debt burdens and papering over their mistakes.  In the years ahead, borrowing money will become increasingly more expensive.

Rising yields may also be offering a whiff of inflation.  Here’s why…

Safe Investment Losses

When you purchase a Treasury note you are lending money to the government for a specified period of time (i.e. 30 days to 30 years) at a fixed rate of interest or yield.  The risk of default on treasuries has generally been considered nonexistent.  The federal government, with assistance from the Federal Reserve, can always print money to pay its debts.

But doing so devalues the dollar.  So while the nominal return is preserved…the inflation adjust return can go negative.

In short, inflation destroys treasury values for investors.  To account for expectations of rising inflation, yields rise.  This, unfortunately, presents another problem for long term treasury investors.

When treasury yields go up, treasury prices go down…they lose value.  Since May, yields on the 10-Year note have risen from 1.65 to 2.71 percent.  That’s an increase of 64 percent.  Conversely, if the market rate is 2.71 percent, the price of a treasury yielding 1.65 percent has to fall about 40 percent.

Pension funds and insurance companies, which are heavily invested in treasuries and bonds, will face major losses.  But it has only just begun…

“The rush out of bonds could be about to get even worse, according to the research firm [TrimTabs], which says that more bond investors could take flight after receiving their quarterly statements in the coming weeks, noticing that their “safe” bond funds are delivering losses instead of gains.”

Sincerely,

MN Gordon
for Economic Prism

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