Bond markets have been operating in a particularly heightened state of tension throughout the course of 2013.
The recent political debacle in Washington, D.C. that resulted in the two-pronged threat of government shutdown and potential US debt-default, left the entire economy in a state of limbo, and put investors on the defensive. But bonds have already weathered a great deal of panic this year.
By September, the “taper”, the gradual reduction of the Federal Reserve’s $85 billion in monthly asset purchases, was for all intents and purposes a given, with the official announcement of the first $10 billion drawback expected as part of Fed Chairman Ben Bernanke’s post-FOMC press conference on the 18th.
Treasury spending had made a very conducive environment for bond markets and equities alike. But as a 5-year long bull run kicked into high gear in the first part of 2013, shooting benchmark indices past record highs on a regular basis, there was growing talk of the dreadful inevitability that this unprecedented government intervention couldn’t continue forever.
By summer, the mere suggestion of “tapering” had the power to send investors into a panic, and treasury yields into decline. On the 18th of September, the yield on the 10-year treasury note dropped 0.16 percent to a low of 2.69 percent, before the Fed shocked everyone with its about-face.
The world’s largest bond fund Pacific Investment Management Company (otherwise known as PIMCO) often finds itself at the center of attention when bond markets are at the mercy of headwinds. The fund’s quasi-legendary manager Bill Gross has so far managed to steer the ship safely.
Gross co-founded PIMCO in 1971 out of a separate accounts manager for Pacific Life Insurance Co., and has seen it through many period of uncertainty and crisis before, but the current situation is qualitatively different. The thoroughly experimental nature of the Federal Reserve’s support of bond markets through successive regimes of quantitative easing is without precedent, and the outcome for all involved is not yet clear.
The most recent piece in his column on PIMCO’s website sees an imperturbable Gross, however: “Beauty is in the eye of the beholder and if the Fed’s objective is to grow normally again, then there is likely no more beautiful or deleveraging solution than one that is accomplished via abnormally low interest rates for a long, long time.”
Indeed, among the first concerns about bonds in the advent of a taper was the prospect that interest rates would be allowed to rise from their current artificial near-zero levels. But to hear Gross speak about it, this was never really the worry in the first place. Instead, the real fear was that even a slight reduction in bond purchases on the part of the Fed would entail serious consequences.
And markets had, at first reluctantly, begun pricing in these consequences ahead of the unexpected announcement from the Fed on Sep 18. Bill Gross, however, is confident that the Fed will keep rates low and that the “taper” will take place over the long-term, at least through 2016, simply because that is the only conceivable path by which the central bank can return to a more neutral functon.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer