Bonds Soar to Rare Heights

Yields on investment grade bonds have shrunk to less than 4%, the lowest level in more than 6 years, and just 1.7% points above treasuries (see front page article on the WSJ – “Bonds Soar to Rare Heights”). In a sign of the times, McDonalds raised $450 million in 10-year debt at 3.5% this week, a record low yield for a US corporate borrower for at least 15 years. Commonweath Edison Co., the electric utility owned by Exelon, sold 4% mortgage bonds at the company’s lowest 10-year coupon since the 1950s.

While concerns of a double dip recession and the reemergence of deflationary fears continue to gain more traction, I believe the stampede into credit will have profound consequences if sustained for much longer.  Committing new capital to fixed income at today’s paltry yields could only be justified if one believes we are heading for a Japanese style debt deflation. While I am staying on the sidelines (though maintaining a position in some floating rate debt funds), clearly I am in the minority given the billions of dollars of new money flowing into fixed income funds each week.

Anybody skeptical that the Fed would tolerate a bout of severe deflation should read comments out this morning from James Bullard, the President of the Federal Reserve Bank of St. Louis. Here is a snippet from a research paper released today.


“The U.S. is closer to a Japanese-style outcome today than at any time in recent history,” Bullard said, warning in a research paper released today about the possibility of deflation. “A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.”