Why is it such a bad idea to own US-treasuries?

Andrés Jurado

Student in economics

As you probably know, US Federal Reserve (FED) has begun with the second phase of a dark program nick-named “quantitative easing”. It basically involves creating large quantities of money out of thin air to buy both private sector as well as public sector debt. In theory, it should keep interest rates artificially low which should increase consumption and investment, the last of which is very sensitive to interest rates. In fact it is the primary channel through which monetary policy is conducted.

This unorthodox and unconventional monetary policy has had immediate effects on the debt markets. US treasuries have steadily fallen from the levels seen three years ago and are south from their historic averages. This of course, would not be any problem if the United States had a near zero inflation rate as is the case of Japan. Since this is not the case, you should carefully consider if your investments are well placed in a fixed income security, no matter how safe and liquid it is. A good bond investor will always keep a watching eye on inflation, as it is the number one threat he faces. The 10-year treasury now yields 3.48% which ought not be bad if inflation should remain subdued for the next ten years. This however could well not be the case.

In the near term it is clear that inflation in the US will remain relatively low, as the housing market bottoms out and investment and consumption take their time to reach normal, pre-crisis levels. Even more, the labor market still faces -and will for some time- high unemployment rates which you would think will prevent the US economy from experiencing a steep increase in wages, which is always inflationary. However looking closer there is China which is beginning to implement a less “moderately loose monetary policy” (China's central bank slang). In addition to that the yuan (nick-named renminbi) is appreciating in real terms against the US dollar. As the average consumer struggles to find proper substitutes for imported Chinese goods, inflation will appear in the medium term. The composition of the Federal Open-Market Commitee (FOMC) is also worrying. With only one member, Hoening, taking a strong posture against inflation and urging the FED to raise interest rates, it seems as if the "doves"* have taken over the FED. 

The US treasuries yield so little thanks to China's central bank steadily purchasing them. Quantitative easing has also hit the treasuries' yield. The second round of this policy comprises about 600 billion US dollar. Normally the market would price in advance inflation through a steep increase in the yield curve. However this unorthodox policy leaves rates lower than in normal years (when it was not rare to have 10-year-treasuries yielding north of 5%).

For all this reasons and more, you should stay clear of the US-treasuries, as well as the local government debt market (or “muni-bonds”, municipal bonds). There are nowadays better investment vehicles elsewhere. Take for example the Mexican government debt. It has yielded 8% for the best part of last decade, while inflation has been on average 4.4%. The market prices the risk of default at 144 basis points, which implies that you could make close to 16% on real terms (taking risk into account) with the benchmark ten-year-bonds.  

* A "dove" in monetary policy is a policy-maker who takes a pro-growth approach to monetary policy, even if this results in inflation.