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It is Never Easy

June 13, 2011 – 5:07 pm

The yield on the 10 year U.S. Treasury is very low at 3%. That means people who are buying them are willing to accept a 3% return for 10 years regardless of what inflation might due to the buying power of that money. Inflation at 2% per year nets a real return of 1%. If inflation returns to its very long term average of a little over 3% there will a negative return on the 10 year treasury.

So why are investors choosing the very good odds of losing money by buying the 10 year treasury? Here are two reasons: one is liquidity. U.S. debt is very liquid and very safe. The other reason is Fear. Fear makes them content, accept and actually embrace the return ‘of’ their money rather than a return ‘on’ their money. This high fear environment historically has produced big winners and losers. Everyone is running towards treasuries and from the stock market.

That is going to turn out to be a big mistake. Interest rates are going to rise at some point and inflation is likely to increase over time returning to its 50 year average. Currently, the bet is that interest rates will stay low and inflation will not increase because the economy is slowing. Therefore, the real bet is on the direction of the economy. Inflation will not spin out of control as our job market is too weak but it will rise as pressure from demand continues to be applied to commodity prices outside the U.S.

The economy by all measures is going to rebound to some degree. The smart money is out of treasuries not in them. The largest and most successful bond dealer in the world, Bill Gross of PIMCO has sold all their treasuries. He has been very vocal about it. Of course he could be wrong but I wouldn’t bet on it, but a lot of people are. Gross does not let fear control his decisions and neither should you.

Good Trading
Steve Peasley

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