Is The Treasury Market Forming A Bubble?

By Lisa Smith | June 30, 2009 AAA
Is The Treasury Market Forming A Bubble?

The Treasury market has been making news, and not in a good way. Just past the midway point of the first quarter, Warren Buffett announced that the investors rushing to buy T-Bills that paid next to nothing were making a big mistake. He predicted massive inflation as a result of the government stimulus efforts and categorized the Treasury market as being in the same category as "the internet bubble of the late 1990s and the housing bubble of the early 2000s."

Investors, of course, were flocking to Treasuries because they offered the only shelter from the storm in 2008. Demand coupled with an ailing economy drove interest rates down and prices up.

Yield Ups and Downs
On December 18, the benchmark 10-year Treasury offered a yield of 2.08%. It opened the new year on January 2 at 2.4%. By the middle of June, it came in near 4%, and currently hovers near 3.75%.

Prices move inversely to yields, so the investors who overpaid for a yield that was nearly 50% lower than the current rate are not sitting in a pretty place if income generation is their main objective. Nor are they well positioned to sell at a profit as few investors would be willing to pay a premium for low yields. (Want to learn more? Check out Get Acquainted With Bond Price/Yield Duo.)

The Fed Influence
Although the Federal Reserve has announced that inflation in not a threat, investors have lingering fears that the fed is wrong. Politicians and the press speculate daily about how the government will turn off the tap and extricate itself from the role of economic engine and what impact that will have on interest rates.

A rise in inflation would make those low bond yields worth even less. Those pundits not focused on inflation are speculating about deflation. Severe deflation tends to drive bond yields down. Where does all of this leave investors?

What to Do?
Learning from your mistakes and the mistakes of others may be the best lesson here. At one point last year, investors were buying short-term Treasuries despite negative yields.

Buying Treasuries when the yield is negative means that investors paid for the guarantee of losing money. Panicked investors viewed this as a better choice than investing in stocks, which were dropping with no end in sight. (Can you profit from market fallout? Read Profiting From Panic Selling.)

When panic sets in, investors tend to move money based on short-term market conditions rather than making strategic choices. If you've got your net worth tied up in Treasuries, don't make the situation worse by making another mistake. Look at your portfolio and move your assets to an appropriate asset allocation.

Once that's done, stop reacting to short-term events. Set a strategy that's right for you and make changes only when your personal financial goals have changed or been achieved. Next time the market goes for a wild ride, sit back and watch, don't chase it with your hard-earned dollars.

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