Nothing Goes Up in a Straight Line

Regardless of how the monthly US labor report came out, people were primed to sell Treasuries but finally this afternoon we stabilized now that rates are back to levels not seen since early last year. 3, 10 and 30 year bond auctions are looming later this week but hopefully we have priced in a sufficient concession to bring in buyers.. While the US economy appears to be growing at healthier pace, housing is not likely to benefit from higher interest rates and structural unemployment continues to be a challenge so there seem to be some built in restraints to excessive growth.  It is a somewhat goldilocks environment in which corporate bonds can thrive as the economy is strong enough to support improving fundamentals while not too strong as to provoke a more painful spike in interest rates. Credit spreads are in fact tightening for that very reason.

How Do We Make Money This Year?

I am not a financial advisor so I am not giving advice. It is my opinion, and we all have those, that the way to make money this year in bonds is generally to trade from the long side by owning ample amounts of credit spread product like high yield and emerging market funds. It will be somewhat of a trading range year, where you can make a little extra money buying on dips, but generally it will pay to be long as you are likely to earn your coupon so he with the highest coupon will win. It won't be the best or the worst year ever for bonds and you will make most of your money on interest rather than capital appreciation. Treasury yields may trend a bit higher by the end of the year to build in a 2% inflation rate that may result from a stronger economy and lots of policy stimulus. Stocks and bonds have presciently anticipated what may come as a surprise to many of us, that the US economy is recovering faster and stronger than expected. The Federal Reserve may get its wish of 2% inflation before long but of course it would be arrogant of them to think they could so finely tune the economy to reign inflation in at just the right time. They will raise interest rates and raise reserve requirements when the time comes in order to keep inflation in check, but that is likely to be a 2012 event and by that time they will widely be perceived as "behind the curve". For now, the economy will expand in fits and starts. October and November 2010 were strong months while December less so. January is shaping up pretty good, with consumers spending and manufacturers happy to ramp up production. The labor market is key to a strong and sustainable expansion so tomorrow's jobs report is critical to market tone. The 10 year Treasury note has been pushing up on support levels not seen since last May and a strong report may push us into a new range of 3.5-4%. If that happens, corporate bonds may struggle for a few weeks as they compete with higher Treasury rates which will lead to lower prices and provide an opportunity to add high yield bonds to your portfolio. If you already own as much of them as you will ever care to, it is best to sit tight as your high coupon will offset capital loss from prices falling and ultimately your returns are likely to close the year in positve territory. At least that is my view.