From The Market Ticker
Anyone remember stories about how housing bears finally threw in the towel in the 2000s, only to buy the top?
Jay Mueller, who manages $ 3 billion of bonds for Wells Capital Management in Milwaukee, resisted buying Treasuries for four months, anticipating the Federal Reserve would drop its pledge to keep interest rates at a record low through late 2014.
No more. With the economy growing at a 1.5 percent annual pace, the odds of a recession have risen to 60 percent, making 1 percent yields on 10-year notes a possibility, he said. Wells Capital’s parent, Wells Fargo & Co., boosted its Treasury holdings 32 percent to $ 11.5 billion in May alone, according to the latest data compiled by Bloomberg.
“We’re in a low-rate environment for a long time, longer than I had thought,” Mueller said in a July 26 interview at Bloomberg headquarters in New York. “I’m finally throwing in the towel.”
The problem with these folks is that they’re really not buying for the yield — that is, to clip the coupons. They’re looking for the price movement, and the longer the duration the greater the move you get when rates change.
This works great when things go your way. It’s disastrous when they don’t and is exacerbated by the fact that it’s very easy to take on leverage using Treasuries as collateral, as they are regarded as “always good for face value” (if held to maturity.)
All of these things are very nice when life treats you well.
They’ll ruin you when life — or just bad luck — treats you poorly.
Of course when you’re a bond fund, what options do you really have?
The real nightmare comes not in these firms or the price moves in Treasuries (or lack thereof) but rather what happens to those institutions that require coupons in order to make their nut. I speak specifically of pensions, including Social Security, along with Medicare and other long-term obligations (e.g. annuities.) As older Treasuries mature the only replacements available have much-lower yields and this severely erodes the fiscal stability of these plans.
Four years in, this is the real story of “extremely low” interest rates — yet nobody is talking about it.
And by the time they start it will be too late to take remedial action.