In today's low-yield environment, the U.S. government will pay you just 1.9 percent a year over the next 10 years if you invest in a 10-year treasury bond. That's an all-time low that has many investors scratching their heads.
"I'm not exactly sure what it's telling us except one thing, and that is there is a considerable amount of uncertainty right now," says Jim Sarni, managing principal at Los Angeles-based money management firm Payden & Rygel. "Politically, economically, and fiscally, I think there are big challenges ahead of us, so for the time being, treasuries are likely to be a beneficiary of that."
Typically, investors rush into treasuries during times of economic uncertainty, and a slowdown in growth in the United States has many investors concerned. That's caused a rally in treasuries, but it has also pushed treasury yields to record lows, unwelcome news for income-hungry investors.
Generally, yields at the level they currently stand signal that a deflationary environment of lower prices for goods and services is on the horizon. But looking at the official statistics, it's hard to believe the economy is headed for a deflationary spiral. The Consumer Price Index (CPI) issued by the Bureau of Labor Statistics is currently growing at an annual rate of 3.6 percent. An investment in a 10-year treasury yielding less than 2 percent will struggle to keep pace with inflation over the long term. While the rate of inflation is expected to fall somewhat, Sarni says the treasury market may be pricing in a deflationary environment that isn't going to happen.
The worsening sovereign debt crisis in Europe may be to blame. Greece is teetering on the brink of bankruptcy, and officials there are worried about what a default would mean for European banks that hold Greek debt. With a possible breakup of the euro on the horizon, investors feel comfortable in the treasury market for the time being. "There's a pretty widespread worry that a major European bank might fail," says Anthony Valeri, fixed-income investment strategist at financial advisory firm LPL Financial in San Diego. "Treasuries continue to be a good hedge for fears in Europe. There's still a ton of uncertainty there."
Yet another factor contributing to the current low-yield environment is the Federal Reserve's extremely cautious policy. Citing concerns about a slowing recovery, Fed Chairman Ben Bernanke recently announced that the Fed plans to keep interest rates at virtually zero until the middle of 2013, where they've been since December 2008. Generally, Fed policy drives interest rates, and the Fed rarely makes a statement detailing its plans so far in advance. In addition, there have been hints that the Fed may announce plans next week to pursue a new policy aimed at driving down longer-term interest rates by reinvesting proceeds from prior bond-buying programs in longer-term treasuries.
"The market has gotten very comfortable with that idea that the Fed's next move is going to be what would be deemed 'Operation Twist,' which will be extending the maturity of their balance sheet," says Ray Humphrey, senior vice president at Hartford Investment Management Company in Hartford, Conn. "Frankly, I think the market is front-running that action—buying 10 year [treasuries] in anticipation of the Fed buying—with the idea that the growth outlook looking as peaked as it does, there's really not much risk in doing so."
But if the Fed move disappoints, Sarni says he could see the yield on the 10-year treasury bond move up by as much as 25 basis points. "There's a growing view out there that perhaps the Fed shouldn't be doing anything because it's not going to do any good," Sarni adds. Yields across the board have been near historical lows for months, and some believe that keeping longer-term rates low won't spur any more lending or borrowing.
Although volatility has picked up tremendously in the stock market, experts say stocks still look like a good bet for investors with a longer-term time horizon. "Over the long haul, stocks are a good place to be, but someone has to have at least a 12-month time horizon for that," Sarni says. If you're looking for a place to stash your money for just a few months, Sarni says the treasury market could be an option because of its traditional safe-haven status. But be wary of placing too much emphasis on safety, he adds.