Bond Bears on the Prowl

Bond investors that drove two-year Treasuries down on Aug. 21 by the most since early June after Federal Reserve Chairman Ben S. Bernanke said the economy is “beginning to emerge” from recession may find themselves wishing they had held onto the securities.

While the comments sparked speculation that the central bank may soon raise borrowing costs as growth resumes, history shows the Fed is likely to keep its benchmark interest rate at a record low for a year or more. Policy makers didn’t boost rates after the 2001 recession until 12 months into the recovery, while it was 17 months following the 1991 economic contraction.

“It’s going to be very difficult for the Federal Reserve to raise rates simply because there’s no inflation,” said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. “The two-year at a yield of 1 percent is an excellent yield,” said Cheah, who has been buying the securities.

True, there’s no inflation according to government figures. The implementation of hedonics and substitution make government reported CPI quite dubious- but that’s a whole different story. Putting aside the accuracy of CPI data , inflation is not the only indicator that drives yields. I’m focused more on the dynamic of supply and demand. Both sides are coming under tremendous pressure, and it’s only a matter of time before bonds break down.