The iShares Lehman 7-10 Year Treasury ETF (Amex: IEF) is sitting on a 10.3% total return for the 12 months through today’s close. That’s a healthy performance edge over the 1.9% rise in that stretch for the iShares Lehman 1-3 Year Treasury ETF (Amex: SHY). There’s nothing inherently peculiar about longer-term maturities outperforming shorter terms. Sometimes it happens, sometimes it doesn’t. But the fact that longer-term Treasuries are besting shorter ones is more than a little out of the ordinary after the Federal Reserve has hiked interest rates for nearly a year.
But these aren’t ordinary times, and the fixed-income set isn’t inclined to play its usual role when it comes to taking cues from the central bank. The pricing of debt in 2005 is something less than conventional relative to what the historical record implies.
If the past is a bit less than prologue on Wall Street of late, investors must fend for themselves when interpreting the usual suspects of quantitative signposts. No easy task. Indeed, the Fed keeps trying to engineer an outcome in long-term yields that has so far proven elusive. Frustrated with the lack of traction in adjusting the price of money in long rates, the high priest of the central bank has taken to sermonizing with enhanced transparency, which is no mean feat for a man long recognized for reaching the creative pinnacle in oratorical obfuscation. Yes, dear readers, it has come to this: Greenspan has decided to talk turkey.
Why, the Maestro asks, are long-term yields falling while the Fed is explicitly trying to coax the opposite? Whatever the reason for this “conundrum”, as he’s previously labeled the situation, the mismatch between long and short rates is “clearly without precedent,” Greenspan said yesterday, by way of satellite, at an International Monetary Conference in Beijing.
One theory is that the economy is slowing, he offered. History suggests that when the spread between long and short rates narrows, economic lethargy or worse threatens. As an explanation, that’s a “credible notion,” Greenspan admitted. But the maestro wasn’t necessarily convinced. “Periodic signs of buoyancy in some areas of the global economy have not arrested the fall in rates,” he countered.
In fact, he speculated, any future arrival of an inverted yield curve (short rates above long rates) seemed likely to break with history and signal something other than recession. “I’m not sure what such a configuration, should it occur, would mean,” he said, referring to an inverted yield curve, in response to a question, Reuters reports via MSN Money. “I’m reasonably certain we would not automatically assume that it would mean what it meant in the past.”
In any case, we may find out soon what an inverted yield curve means, or doesn’t mean. A mere 35 basis points separates the currency yields between the two-year Treasury and its ten-year counterpart—the lowest spread since January 2001.
Greenspan’s relatively unambiguous predictions also included hedge funds. The chairman warned that the portfolios were playing with fire if they thought the long-running decline of bond yields would produce continued success in the realm of fixed-income trading. The “low-hanging fruit” of profits has been picked, he said. “Continuing efforts to seek above-average returns could create risks for which compensation is inadequate. Significant numbers of trading strategies are already destined to prove disappointing….” Adjusted for Greenspan-speak, that sounds like the Maestro just issued a sell signal for portfolios that are long bonds.
Who knows, the sell signal may prove accurate in the not-too-distant future if Greenspan comes to the conclusion that one reason for the low long rates is related to the ongoing negative real (inflation-adjusted) Fed funds rate. In that case, the FOMC may be prone to hike Fed funds after all at the next meeting set for June 30. If so, may the topic of conversation among Fed board members will focus on the fact that the last time the real Fed funds was positive (above the year-over-year change in the consumer price index) was late 2002.
But if yesterday’s lecture from Alan was designed to put a modicum of fear into the hearts of bond traders, there’s scant sign of success a day later. The yield on the 10-year Treasury Note slipped once more today, albeit by just five basis points. But at 3.9%, the 10-year’s rarely been much lower. And neither, it appears, is the Fed’s power to persuade and cajole.