Bond Yields May Be Headed Higher, But Going Short Is Dangerous

Wednesday, 20 Feb 2013 08:16 AM

By Dan Weil

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Many luminaries have trumpeted the end of the 30-year bull market for bonds, but that doesn’t mean you’ll strike it rich shorting fixed-income instruments, experts say.

The 10-year Treasury yield has risen to 2 percent from a record low of 1.38 percent in July.

Eventually, the Federal Reserve will curtail its quantitative easing and it will lift short-term interest rates, both of which should drive bond yields higher.

Editor's Note:
Billionaires Dump Stocks. Prepare for the Unthinkable.

But no one knows exactly when.

"It's one of the most obvious trades," Timothy Strauts, an exchange-traded fund (ETF) analyst at Morningstar, tells The Wall Street Journal.

"You will eventually make money shorting Treasurys, and everyone knows it. But the timing is difficult."

And shorting Treasurys isn’t cheap. At a minimum, you will pay interest on the money you borrow to buy the bonds, and you have to fork over the interest earned on the bonds while you are borrowing them.

So if bond prices don’t drop quickly, you could be out a lot of money.

You can use inverse ETFs to bet against bonds. But these are meant to reflect daily price changes, not movements over time. So long-term price patterns can get distorted, especially if you use leveraged ETFs.

Scott Clemons, chief investment strategist at Brown Brothers Harriman's wealth-management practice, notes that shorting Treasurys can have “pretty significant consequences when you’re wrong.”

“We know the biggest buyer of Treasurys is the Fed, and it’s dangerous to bet against someone who owns a printing press,” he tells The Journal.

Not everyone thinks bond prices will drop this year anyway. Strategist Thomas Fahey, associate director of macro strategies for Loomis Sayles, said last month that many bonds will enjoy a rally in 2013, albeit a modest one.

“Instead of high-single-digit returns on investment-grade corporate bonds and even double-digit returns on high-yield and emerging market bonds, investors need to adjust their expectations lower,” he wrote in a report cited in Barron’s.

“Bonds can still generate positive returns, but going forward, a fixed-income investor’s return should be closer to the yield a bond offers when it is purchased and should not incorporate much in the way of price appreciation.”

Editor's Note: Billionaires Dump Stocks. Prepare for the Unthinkable.

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