Is the Fed a catastrophic threat to long term bonds?

[tacollins]

I saw a guy on CNBC this week pounding the table for viewers to get out of long-term government bonds.  "Go home, go through your closet and find all your bonds and sell them."

With the Fed buying $85 billion each month in long-term bonds, isn't this guy right?  With interest rates at 2%, isn't the risk to stay in bonds right now?

Would it be wise to lower my exposure from 25% to say 10% until sometime after the Fed buying program ceases (supposedly when unemployment reaches 6%)?

I welcome your thoughts and analysis.  Thank you.

[Pointedstick]

If the Fed is pledging to hold rates down and trying desperately to lower them even farther for at least several more years, isn't the smart money on buying bonds? You'll make a killing when rates fall, no? And if you believe the Fed that it will end the program when unemployment falls below 6%, then all you have to do is keep an eye on that number and sell when it's at like 6.2%, right? The Fed is actually making life remarkably easy for bond speculators.

Of course, we have no idea what interest rates will do. They might fall, they might rise, or they might drift sideways for 15 years in a persistently moribund economy. I'm keeping my allocation at 25%, personally.

[Reub]

That is the salient point. The basic tenet of the PP strategy is that we can never be sure what's going to happen, and we really shouldn't care. We are covered on all contingencies.

[tacollins]

That is the salient point. The basic tenet of the PP strategy is that we can never be sure what's going to happen, and we really shouldn't care. We are covered on all contingencies.

But that is the point I'm trying to make.  In this current circumstance we are NOT covered.

The direction of interest rates will -- sometime -- revert to something resembling the norm (i.e. 3.5% to 5% on the ten year, for example.)  The time for this to happen is most probably when the Fed stops buying $85 billion each month in government bonds.

When that happens, the value of long-term bonds could go down by more than 25%.  I started using the PP approach precisely to avoid that kind of a loss.

I know the PP approach is to stay invested no matter what the markets are doing, but in this instance, the FED is artificially interfering with normal market dynamics.  The FED is forcing interest rates to remain low (therefore the value of bonds to remain high). That makes our bond holdings highly vulnerable when the FED stops this artificial propping up of bonds.  To me it seems they are much more vulnerable than they would be if just normal market forces were in play.

This artificial support by the FED bothers me a great deal. When the FED withdraws, the disruption to the bond market could be quite severe and the downdraft could be very dramatic and hazardous to our Permanent Portfolios.

Please, consider my analysis and tell me if I am wrong here, and why.  Thank you.

[Pointedstick]

The direction of interest rates will -- sometime -- revert to something resembling the norm (i.e. 3.5% to 5% on the ten year, for example.)  The time for this to happen is most probably when the Fed stops buying $85 billion each month in government bonds.

...But again, how do you know? People have been predicting a dramatic, catastrophic rise in interest rates for 20 years. Anyone who listened to the doom-and-gloom predictions anywhere along the way lost out on an awful lot of bond growth. Nothing lasts forever, but the unsustainable often lasts for a lot longer than people predict.

This artificial support by the FED bothers me a great deal. When the FED withdraws, the disruption to the bond market could be quite severe and the downdraft could be very dramatic and hazardous to our Permanent Portfolios.

Please, consider my analysis and tell me if I am wrong here, and why.  Thank you.

The Fed is always interfering with market dynamics. Their manipulations to depress the interest rate below inflation has also caused gold to go ballistic. Their liqudity injections are right now fueling the stock market (IMHO). There's never a time when the Fed hasn't manipulated the economy, and if anything, the PP is one of the best portfolios to take advantage of it because it holds assets that are all capable of responding well to some type of Fed manipulation.

[melveyr]

Bernanke is a PP holders best friend. He has been extremely explicit about interest rates directions so I am not sure why everyone is so worried.

He will not raise interest rates until unemployment falls below 6.5% (in this case stocks would be taking off like a rocket)
or
He will not raise interest rates until inflation gets nasty (in this case gold would be taking off like a rocket)

The real enemy of a PP holder is ultra tight monetary policy. Mr. Bernanke is the exact opposite!

Also... try to avoid reading websites that capitalize Fed... generally websites that worry about the "FED" are dominated by crazies. That is one my first sniff tests 

[Ad Orientem]

Any entity that has the power to print money (electronically or otherwise) without restriction is a threat to bonds. Whether they use that power to destructive ends is another matter.

[BearBones]

When that happens, the value of long-term bonds could go down by more than 25%.  I started using the PP approach precisely to avoid that kind of a loss.

Then the PP is the wrong investment vehicle for you. It is designed to contain volatile assets in which at least one always feels like it is tanking. Otherwise there will never be an asset "on sale" to rebalance into. If you cannot stomach this, buy a fund that does all of this in the background (e.g., PP Fund, Vanguard Wellington, Target Retirement Fund).

If, on the other hand, you think you can time the markets, just put together a VP without LTTs. I did that a few years ago when I realized exactly the same fact that you have mentioned above (meanwhile I lost out on the run in LTTs... and my gold tanked).

[Gosso]

tacollins,

Have you considered intermediate bonds?  IEF is a reasonable substitute for the STT/LTT barbell.  It would fall only 7% if interest rates increased by 1%.

IMO the foundation of the PP is the balance between stocks and gold.  The bonds are there mainly to reduce volatility, and protect during a deflation.