One of the many memorable scenes in the 1978 comedy classic Animal House is when a 20-year-old Kevin Bacon tries to tell the crowd at the Faber College alumni parade to “remain calm, all is well!” just before he gets trampled flat by the onrushing mob.
I flashbacked to that this week watching global bond yields sink to their lowest levels in several years even as the overall economy – in the U.S., at least – seems to be in pretty good shape. The yield on the benchmark 10-year U.S. Treasury note fell below 2.22%, its lowest level since September 2017. That put it well below all of the Treasury’s securities that mature in one year or less, meaning you could get a higher yield by putting your money in a one-month T-bill (2.35%) than you could lending your money to the government for 10 years.
Still, that was a lot better yield than you could get overseas, where government bond yields sank even deeper into negative territory. The eurozone benchmark, the 10-year German bund, dropped to negative 17 basis points while the Japanese bond of the same maturity hit negative nine basis points, their lowest levels in nearly three years.
Yet, on that same day, the Conference Board’s U.S. Consumer Confidence Index for May jumped nearly five points to 134.1, its highest point since last November. The index “is now back to levels seen last fall when the index was hovering near 18-year highs,” noted Lynn Franco, the group’s senior director of economic indicators. “Consumers expect the economy to continue growing at a solid pace in the short-term, and despite weak retail sales in April, these high levels of confidence suggest no significant pullback in consumer spending in the months ahead.”
Clearly, there’s a serious disconnect between American consumers, who are in a bullish mood – not surprising, given the unemployment rate of 3.6% – and the bond market, which has pushed yields on the safest instruments down to levels you would expect in a recession. Who’s right?
According to bond market analysts, yields are signaling – screaming – that an interest rate cut – maybe two – by the Federal Reserve is in the offing. Based on the Powell Fed’s predilection for doing whatever the financial markets – and President Trump – want, that belief probably isn’t misplaced. This Fed has shown pretty plainly that it is governed not by economic statistics – with the notable exception of inflation, of course, which it believes is a problem because it’s a teensy bit below its 2% target rate – but by the mood of investors.
That being the case, it’s certainly a lot more likely now than it was just a few months ago that the Fed’s next rate move will be down, not up. How many times the Fed will cut rates is debatable, but this week’s bond market temper tantrum makes a Fed cut a near shoo-in, possibly as early as its next meeting on June 18-19.
So how do fixed income investors play that?
If an imminent rate cut is a slam dunk and already priced into the market, it stands to reason that the actual announcement of a cut won’t necessarily lower bond yields even more. A more likely scenario is that bonds will sell off (buy on the rumor, sell on the news, as the saying goes). So investing in long-term government bonds right now seems like a classic bear trap. You’ll either lose money if you try to sell, or you’ll be stuck with a below-market-yielding security.
A better trade, I think, is to stay out of harm’s way and buy intermediate-term government-guaranteed certificates of deposit until the panic recedes. You’ll get a much better rate than you can in the government bond market, with the same guarantee, and you won’t have to tie up your money for too long.
For example, according to one popular CD website, one-year FDIC-insured CDs can be had for 2.75%. There’s a $10,000 minimum investment. If you’re comfortable locking up your money a little longer, say three to five years, you can get those same rates. By comparison, Treasury notes in that same maturity are yielding just above 2.0%, plus they carry price risk.
Why an investor would take a chance in the bond market in this shaky environment when relatively fat CD rates are readily available, I’m not sure.
Of course, as they say in other businesses, rates this good may not be around forever. Indeed, if the Fed does in fact cut rates, CD rates are going down, too. Now would be the time to lock in your best rate. They may not be available come summer.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.