Dear:
For over a year my advice to clients has been to keep lots of their funds in a money market fund. There were two main reasons supporting my recommendation: the financial chaos we experienced last year and the fact that interest rates were so low that it did not make sense to buy most bonds. All this is starting to change so I am getting close to issue a new recommendation on bonds. I will keep you posted.
In the meantime, I want to give you a small recap on interest rates. These have jumped in the last two weeks and I believe this trend will continue. For example, CNNFN reported today that “Treasury yields soared – with the benchmark 10-year yield briefly touching 4% – after the government sold $19 billion of 10-year notes and Russia said it would reduce its share of U.S. debt.” The rate on this bond was 3.2% only a few weeks ago. Mortgage rates have also jumped about 1% in the last week.
Why are rates rising? Three main reasons explain this and they are: 1) The crisis we experienced starting last Fall is over. We still have lingering effects, but nothing compared to what we had. With the crisis subsiding, there is less need to panic and only buy Treasuries as a safe haven. Therefore, investors have been selling government bonds and therefore rates have increased because bond prices and yields move in opposite direction. 2) Debt sales: Debt prices have fallen under the weight of supply. The government is facing a HUGE deficit and they are selling bonds to finance this shortfall. CNNFN reported today that “The federal budget deficit surged in May, bringing the total shortfall for this fiscal year to nearly $1 trillion, government figures showed Wednesday.” That’s compared to a deficit of $314.4 billion in the same period a year earlier.
Here’s a graph showing this year’s deficit—so far—compared to last year’s for the same time period.
The final reason for the current jump in interest rates is inflationary expectations. Faced with the massive government deficit, investors are concerned that it will be financed with the printing of money—which will eventually stoke inflation. As a result, investors are trying to protect themselves against this expected inflation by raising interest rates and increasing prices of other items such as commodities.
In sum, having kept lots of your money in money market funds has protected you from the losses that have been experienced by bond holders this year. For example, the Intermediate Treasury Bond index is down nearly 11% year to date while a 20 + year Treasury bond index is down 26% year to date. Those huge losses are a result of rising interest rates this year.
I will call you in the next few days to review your portfolio. In the meantime, I want to remind you that on July 8 I leave for my annual month’s vacation to South America. I will check my emails daily while continuing to monitor your portfolio during my working vacation. In other words, I won’t be around but I will be in touch!
Warm regards,