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Sunday, May 6, 2012


So Friday the 4th of May, U.S. Treasuries rallied again.  Investors heard that payrolls rose a very small amount (~115,000) while expectations were 50% higher.  This meant that panic ensued in the markets and investors took the “risk-off” response and accordingly ran into U.S., German and Japanese government bonds. 

Now think about this, U.S. Treasury yields are below the Federal Reserves stated inflation target of 2%.  Think of inflation merely as another way of saying “U.S. dollar debasement”.    This means that real yields are negative where real yield is the return after inflation.  As of this writing, 2-year note yields 0.26%, 5-year note yields are 0.78% and 30-year yields are 3.07%.  But, and here is the kicker, this is not just an American phenomena.  German bond (the “Bund”) 10-year yields set a record low hitting 1.58% and Japanese bonds 10-year yield is a lowly 0.89% as pension funds, hedge funds, mutual funds and plain old mom and pop funds bought those too. 

Remember that bond yields move inversely to price so that if their yields are hitting lows, the prices of the bonds are rising due to this demand.   So, considering the U.S. debt and annual budget deficit sizes, along with Japanese massive government debt, along with the German situation of the Eurozone, these strong demands for sovereign debt are a testament for really how lousy things are.    Nobody is buying these bonds for their yield, they’re making purchases of government debt in spite of it.  They buy them simply for wealth preservation because they’re scared wherever else they put their money it’s going to lose value (i.e. read, “considerable value”).  This means they’ll take negative returns on their money because at a minimum they’ll get back their principle, though they lose the time value of their money.  They’ll do this because they’ll take a “guarantee” of a small loss over the uncertainty associated with large losses.  Even if it’s costly in real terms, they trust that the U.S, German and Japanese governments will not default.  Now that’s a scary outcome!