Interest Rates Are Low, Which Means Bond Prices Are Very High. Resist Buying

The government is in a pickle. The Treasury is spending itself into an ocean of new debt in the name of fixing everything. Last fall, Congress funded $700 billion to bail out the big Wall Street banks and brokerages, and this year it passed a $787 billion "stimulus" bill. The proposed health care plan will cost upwards of $900 billion, and who knows what will come up next. Meanwhile, tax receipts are lower because we are in a recession. So, that means it all has to be borrowed-to the tune of $1.5 trillion or more this year alone, and $9 trillion over the next decade. Ouch.

The way the government borrows money is by issuing treasury bonds-so that's a lot of new bonds to sell. So far, interest rates on treasury bonds have stayed very low, in part because investors are still gobbling them up (because they're afraid of the economy and the stock market, and want to feel safe). Individual investors now own $606 billion of treasury bonds (mostly through mutual funds), up from $240 billion at the beginning of the year. In addition, the Federal Reserve Board is right beside investors, printing enough money to buy nearly half of the treasury bonds being issued this year. All of this has kept treasury-and other bond-prices high and interest rates low in 2009 ("Eager Fed Helps Keep Treasury Rally Alive," WSJ 9/21/09 page C1).

This won't last forever. At some point-I believe in the next year or two-yields (interest rates) will rise and treasury bond prices will fall. This could be triggered by a precipitous decline of the dollar, an increase in inflation, the Fed stopping its purchases of treasuries, or just a general upturn in the economy. When treasury prices fall, they will likely drag other bond prices down with them, at least somewhat.

Recommendations: (1) Hold on to your high quality corporate and municipal bonds, especially if you bought them at or below par (face) value as TAM recommends. (2) Consider selling treasury bonds with maturities longer than five years if you purchased them in the last 15 months (when yields have been very low). (3) Most importantly: for now, invest new money that you would normally put in bonds (including money from matured or called bonds) in CDs or high quality bonds with maturities of 3 years or less. Wait out this low interest rate period with short maturities, and I believe you will be able to lock in higher rates when they mature in a year or two.