Fed Stimulus Has Led to $1 Trillion Bond Rally, Confounding Critics
If you decided not to buy and hold U.S. Treasuries because you listened to all those academics, billionaires, and politicians who have denounced Federal Reserve monetary policy since the financial crisis, you missed a chance to share in $1 trillion of investment returns. That’s how much government bonds have earned for investors since the end of 2008, when the Fed lowered interest rates close to zero and embarked on the first of three rounds of debt purchases to resuscitate the economy. This year, Treasuries maturing in 10 years or more have rallied 14.2 percent, beating the 10.2 percent return for the Standard & Poor’s 500-stock index.
While the Fed’s measures, the most aggressive in its 100-year history, helped restore the world’s largest economy and reduce the unemployment rate to 6.1 percent, from a peak of 10 percent, the stimulus hasn’t generated the ruinous price pressures foreseen by many critics. That’s a rebuke to the chorus of skeptics, ranging from Stanford University’s John Taylor to billionaire hedge fund manager Paul Singer to U.S. House Speaker John Boehner, who predicted the Fed’s unprecedented stimulus would lead to runaway inflation and send interest rates shooting higher. Inflation is bad for bonds, because it erodes the value of their fixed-interest payments; bond prices fall when interest rates rise. “There’s a bias in the market that interest rates need to be higher,” says Scott Minerd, global chief investment officer at Guggenheim Partners. “But that just isn’t based on sound analysis.”
On Nov. 15, 2010, after then-Fed Chairman Ben Bernanke announced a second round of bond buying, which became known as QE2, a group of economists, investors, and political strategists published a letter telling Bernanke the move would “risk currency debasement and inflation” and do little to promote job growth. Stanford’s Taylor, a former Treasury Department official, and Singer, who runs hedge fund Elliott Management, were among the 23 signatories. Also signing were Niall Ferguson, a Harvard University historian and author of The Ascent of Money: A Financial History of the World; Seth Klarman, who runs hedge fund Baupost Group; economist Doug Holtz-Eakin, former head of the Congressional Budget Office; and Jim Chanos, founder of short-selling firm Kynikos Associates.
Taylor wrote in an e-mail that he wasn’t immediately available for comment while traveling in Hong Kong. Singer, who declined to comment through a spokesman, said in his firm’s July investor letter that “substantial inflation” is occurring in areas the Fed hasn’t “recognized or captured” in its analysis. Ferguson and Holtz-Eakin both say the risk of inflation created by the Fed’s stimulus remains. A spokeswoman for Klarman says he still agrees with the letter’s content. Chanos didn’t respond to requests for comment.
Top Republicans in Congress, including Boehner, weighed in on Nov. 17, 2010, with a letter to Bernanke that questioned the need for more stimulus and expressed concern that any additional bond purchases could result in “hard-to-control, long-term inflation.” The Fed was also criticized abroad, with German Finance Minister Wolfgang Schäuble calling the stimulus “clueless.” Boehner and Schäuble didn’t respond to requests for comment.
Although inflation based on the Fed’s preferred measure—the PCE, or price inflation measure for personal consumption expenditures—more than doubled to 2.9 percent within a year after QE2 was announced, it has risen by less than 2 percent for 27 straight months. One reason inflation remains tame is the lack of wage increases. On an annual basis, growth in hourly earnings during the past five years has been the weakest over the course of any economic expansion since at least the 1960s, according to data compiled by Bloomberg. Without more jobs and higher wages, there’s little chance Americans will spend enough to spur inflation.
Billionaire John Paulson began amassing gold in 2009, anticipating that the Fed’s extraordinary debt purchases would cause inflation to soar. In 2013 the price of gold fell almost 30 percent. Paulson couldn’t be reached for comment, but he told clients in November that he personally wouldn’t invest more money in gold.
Some investors say it’s only a matter of time before inflation becomes a problem and Treasury prices suffer. John Brynjolfsson, chief investment officer at hedge fund Armored Wolf, says investors need to be more vigilant of the possibility the Fed, now led by Janet Yellen, is miscalculating. “Given the magnitude of the easing, there is a lot of kindling to catch fire when inflation arises, and the Fed is more likely to be behind the curve in fighting it,” he says. “Buying Treasuries is like picking up pennies in front of a steamroller.”
Reports on manufacturing, auto sales, and construction suggest the economy is gaining momentum. Economists predict 3 percent growth next year, which would be the fastest in a decade, data compiled by Bloomberg show. Even so, prices of futures contracts indicate that traders anticipate the Fed’s benchmark overnight bank lending rate will rise to only 0.8 percent by the end of next year. “We aren’t seeing the type of growth that will spur inflation,” says Guy Lebas, chief fixed-income strategist at Janney Montgomery Scott. “The smoke tendrils of inflation that have popped up from time to time have turned out to be a false alarm.”