Judging from the 10-year Treasury’s yield spike to a two-month high of 1.93% on Monday, fixed-income investors are running for the exits as they prepare for the Federal Reserve to cut back on its quantitative easing program.
But is it really time to start worrying that the Fed has changed its mind about stimulating the U.S. economy and will soon start to end QE and raise rates?
Yes, said The Wall Street Journal on Saturday in an article reporting that the Fed has mapped out a strategy for exiting its $85 billion per month bond-buying program.
“Officials say they plan to reduce the amount of bonds they buy in careful and potentially halting steps, varying their purchases as their confidence about the job market and inflation evolves,” the Journal reported.
But then, the report went on to admit that “the timing on when to start is still being debated,” and the Fed may actually boost its bond buying before it starts dialing down purchases of Treasuries and mortgage-backed securities. In other words, market fears are based more on uncertainty than any actual Fed reduction of its QE program.
So what about the big bond shops like PIMCO and Loomis Sayles? Are they ready to flee fixed income?
Well, no, not just yet. Indeed, the views of PIMCO and Loomis Sayles fixed-income experts suggest that any investor’s exit from the bond market can certainly be an orderly one—if it happens at all. That said, the generous returns of recent years are highly unlikely and duration risk is a key theme.
‘PIMCO’s Advice Is to Continue to Participate in an Obviously Central-Bank-Generated Bubble’
“A bond and equity investor can choose to play with historically high risk to principal or quit the game and earn nothing,” writes PIMCO founder and managing director Bill Gross (left) in his investment outlook for May, “There Will Be Haircuts.” “PIMCO’s advice is to continue to participate in an obviously central-bank-generated bubble but to gradually reduce risk positions in 2013 and perhaps beyond.”
Comparing central banks and policymakers to barbers, Gross writes that they “haircut” investments, using negative real interest rates, inflation, currency devaluation, capital controls and outright default as their barber’s scissors.
“The Treasury’s average cost of money is steadily grinding lower than 2%. If current policies continue to be enforced in future years it will eventually be less than 1% because of the inclusion of T-bill and short maturity financing,” Gross says.