For months, the markets have been buzzing about what looks like a bubble in Treasury bonds and bond exchange traded funds (ETFs).
As market volatility spiked in the first half of the year, investors took shelter in Treasury bonds, the safest type of debt around. Investors also went far out on the Treasury yield curve, because short-term Treasury bonds continue to yield less than 1%.
But that rush to long-term Treasuries hasn’t been without consequence. In exchange for that protection, investors are earning very little money. For example, the 10-year Treasury yield only recently moved back above 3%. It’s all because bond prices and yields share an inverse relationship: when bond prices rise, yields fall, and vice versa.
Check out this chart of the 10-year Treasury and you’ll quickly get a sense of how yields have been pushed lower as a result of investor buying:
There’s also a risk in holding long-term Treasuries in a strengthening economy.
The risk lies in rising interest rates. The Federal Reserve lowered them to record levels in December 2009 in hopes of stoking economic growth, but they can’t remain low forever. With quantitative easing now in play, better economic numbers and the mid-term elections past, the chances go up that the Fed will boost rates sooner rather than later. [The Allure of Bond ETFs.]
If you’re an investor sitting in long-term Treasuries, you need to be prepared to act. When the Fed raises rates, the inverse relationship will switch: prices will fall, yields will rise and your principal will be at risk.