The Reason Bonds Are Crashing Could Be The Reason To Invest In Them

The Reason Bonds Are Crashing Could Be The Reason To Invest In Them
Stéphane Renevier, CFA

almost 2 years ago1 min

US Treasuries are on track to record their biggest quarterly loss ever.

The culprit? Stubbornly high inflation that’s pushing the Federal Reserve to hike interest rates more quickly than investors expected.

Both are bad for bonds. Higher inflation means bond investors will get less bang for their buck, given that coupons and the face value of the bond remain fixed even as the value of money erodes. And higher short-term interest rates make cash – perceived as safer than bonds – look a lot more attractive, while forcing existing bonds to trade at a discount to higher-yielding new bonds.

But ironically, the ailment might also be the cure. As inflation and interest rates keep rising, they’ll increasingly put pressure on economic growth: the former eats into company margins and reduces consumers’ purchasing power, while the latter makes borrowing costlier and reduces investment in new projects. If those factors slow the economy down by too much, the Fed’s likely to reverse course and cut rates – a scenario some markets are already pricing in. That should cap how high interest rates can go and how low bond prices can go. In fact, when Treasuries last dropped by a similar amount in the first quarter of 1980, they posted their biggest-ever gain shortly after.

If you’re bold enough to bet on the Fed’s U-turn, you might want to look at buying into the iShares 7-10 Year Treasury Bond ETF (ticker: IEF, expense ratio: 0.15%). And if you’re feeling particularly naughty, you might even plump for the iShares 20+ Year Treasury Bond ETF (ticker: TLT, expense ratio: 0.15%), whose even-higher exposure to inflation and interest rates moves will deliver you even bigger profits if you’re right.

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