Bond Market Review Third Quarter 2014

The bond markets fluctuated in reaction to anticipation of future interest rate moves but US treasury bonds put in a strong performance in intermediate and longer term maturities. The long term US Treasury bond ETF gained 4.4% in the quarter. The meager yield of under 2.5% looks attractive vs long term European treasury bonds trading at far lower levels which explains part of the strong performance …German ten year govt bonds are yielding .91%.

 This creates a paradoxical situation for investors. A ten year US treasury bond at a yield under 2.5% is hard to see as a good long term investment. Yet traders looking shorter term at global investment opportunities with low European yields and prospects for a weaker Euro could easily drive yields lower and prices higher for US treasury bonds.

High Yield bonds faced a sharp selloff in July recovered, almost all those loses in August and then gave back all of those gains in September. Spreads between high yield bonds and treasury bonds had reached extremely low levels reflecting investors “search for yield”. Those investors likely included many with little experience in the asset class and little appetite for large fluctuations the market in high yield bonds and sold as prices fell. The high yield bond market has far less liquidity than other markets and thus is subject to large swings. This situation was likely aggravated by the changes in management at the world’s largest bond fund Pimco Total Return.

A stronger US economy would mean less rather than more default risk for high yield bonds. That would make the rationale for a sharp decline in high yield bonds relative to Treasury bonds a weak one. But that doesn’t mean momentum won’t continue this trend.

Internationally, emerging markets continued to exhibit high volatility. With the prospects of higher US interest rates in the US, emerging markets would be vulnerable both in terms of bond prices and currency fluctuations. With interest rates at extremely low levels and European Central Bank policies aimed at a lower dollar they are also vulnerable. Much like the US Eurozone bonds have had strong gains of late due to the sharp move down in interest rates. But they would carry a high level of currency risk and little room for capital appreciation looking forward.

As of Sept. 30,2014
Total Return (Price+Dividend)
	ticker	3q 2014	YTD	1 year	3 Year
US total bond market	AGG	4.1%	4.0%	4.1%	7.0%
Short Term High Yield	HYLD	-4.3%	2.1%	13.1%	36.9%
US Long Term Treasury Bonds	TLT	4.1%	16.0%	5.0%	5.0%
International Bonds	BNDX	1.8%	6.0%	-1.1%	5.5%
Emerging Market Bonds(local currency)EMLC	EMLC	-4.9%	1.0%	6.4%	7.2%