What About a 1.25% 10-Year Treasury?

Written by John Lounsbury

Treasuries rose to new heights Monday (23 January 2012).  New lows were set or tied for the interest rates at the market close for the 3-year at 0.28%, the 5-year at 0.57%, the 7-year at 0.93%, the 10-year at 1.47% and the 30-year at 2.52.  The 20-year?  That’s very close too, within a couple of basis points of tying its all-time low rate.  Just three weeks ago (7 July 2012) I discussed the liklihood that Treasuries would continue to be good portfolio holdings.  When I was writing that article the 10-year had just been trading with a yield of 1.67%.  If it continued with a similar move in the coming weeks the yield would fall to the 1.25% – 1.30% range.

Who’d of thunk that we’d see a decline of 20 basis points in three weeks.  The previous article was actually discussing the 30-year Treasury, not the 10-year.  That also has rallied strongly with the yield declining by 22 basis points from 2.74% on 03 July 2012 to a close at 2.52% yesterday (23 July).  Nowhere in the July 7 article did I predict such a sharp advance for bonds.

Below is a graph showing the  yield for the 10-year bond for 2012:

The 20 basis point decline from the end of June to 23 July is nothing compared to the 92 basis point rally from 19 March to 01 June.  If such a decline were to occur from this point the 30-year bond would see a yield of 1.5% – 1.6%.  This would be below the 1.7% yield I discussed as a possible final top for bonds, which three weeks ago I tried to caution might be too optimistic.

The size of the moves in bonds over the past four months has been spectacular.  For that very reason it is not wise to project a continuation of the recent trend in the near future.  As discussed in previous articles,besides historically good returns for bonds over the past several years, they have had one even greater characteristic:  very high volatility.

So, if you are holding the iShares Barclays 7-year Treasury ETF (NYSE:IEF) with a gain more than 8% since 19 March it is probably not wise to expect the same to continue over the next four months.  The same for the 30-year ETF (NYSE:TLT) which has seen a gain of 20% over the same four months.

But that doesn’t mean that longer term, into 2013 and possibly longer, a weakening global economy and very slow growth or recession in the U.S. could make the question in the title of this article rhetorical.

How about a 1% 10-year?  How about a 2% 30-year?  They are possible.  But let me leave this discussion with an excerpt from my last article on bonds:

The secret to navigating the end of this great thirty year long bull market for bonds will be to maintain diversification in portfolios and carefully manage drawdowns to prevent run away losses.  There may be 20% to 50% gains yet to come in bonds over the next few years.  Just be careful that you don’t take a 50% loss because you were holding on for the last 10%.

To add some credability to the 50% loss risk, there are analysts, like Andrew Butter, who is forcasting the possiblity of a 4.5% yield for the 10-year within 18 months, with much higher yield projection for Treasuries in the not too distant future.  Some think Treasuries are in the mother of all bubbles.

I don’t recommend such thoughts should be dismissed.  Be a good scout, be prepared.

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