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EScroogeJr (< 20)

bonds pro and contra

Recs

2

February 18, 2008 – Comments (1)

Bear case for bonds: after the Fed lowers rates to zero, there will be inflaton, which means that a 4% bond yield is a very poor investment. This will force private investors to demand higher risk premium, and lower the prices of bonds which are currently in circulation. There should be 25-30% downside for bond prices.

Bull case for bonds: banks could keep buying them anyway even at 2% yield. Why not, if you can borrow at 0% and earn a guaranteed 2% ROA? As long as we don't have a 10% inflation, but "merely" 5-6% inflation, banks may well be content to play this game for a while. In this case, we could have a paradoxical situation when no rational investor would buy bonds for their yield, and yet the "greater fool" capital-gain strategy would still work because the greater fool is a bank which does not care about inflation because it's earning money from the yield differential. I realize this scenario sounds improbable, but consider that the Federal government has every incentive to keep bond yields low.

What do you think? Should we sell any bonds we might still have left on our 401 accounts now, or should we wait for the new rate cuts and see how things unfold? 

1 Comments – Post Your Own

#1) On February 18, 2008 at 4:27 PM, Imperial1964 (98.29) wrote:

Treasury bonds are in a bubble.  I wouldn't put money on a short-term bond in either direction.  Long-term bonds look seriously overbought with the rate on 30 year bonds around 4.5% and near $100 oil and $900 gold.

I wish I could find a good way to short 30-year bonds without margin interest.

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