Transcripts

The Inflation Impact on Bonds

PAUL KANGAS: Inflation concerns have recently been putting pressure on bond prices. Today, the benchmark 10-year note traded higher, while its yield fell to 3.84 percent. But with the yield on the 10-year nearing 4 percent, investors are wondering what's in store for bonds this year. Suzanne Pratt reports.

SUZANNE PRATT, NIGHTLY BUSINESS REPORT CORRESPONDENT: In recent weeks, a bit of a battle has been brewing in the bond market. Some experts believe economic growth will remain sluggish in the second quarter, making Treasuries a desirable investment. Others however, are more concerned about inflation as oil and commodity prices surge. For that reason many investors have been bailing on bonds. Lehman Brothers' Jack Malvey says inflation has surpassed the credit recession as the biggest worry for fixed income investors.

JACK MALVEY, CHIEF FIXED INCOME STRATEGIST, LEHMAN BROTHERS: I think it's really given rise to a sense that over the course of the next one to two years that the ability of this global economic deceleration to completely vanquish inflation may not be as quick as we had originally hoped.

PRATT: Investors may ask why hold a 10-year Treasury that yields 3.9 percent, when inflation is running near 4 percent? Since March, Treasury bond prices have fallen sharply. Yields, which move in the opposite direction to price, have pushed higher. The yield on the benchmark 10-year Treasury note is approaching 4 percent, its highest level since late last year. While bond yields have been climbing, stocks have been moving higher too, a sign that money moving out of bonds has been going into equities. It's evidence that the flight to quality in Treasuries has dissipated as calm returns to credit markets. Miller Tabak's Tony Crescenzi says the belief the Federal Reserve is done cutting interest rates is also driving bond yields higher.

ANTHONY CRESCENZI, CHIEF BOND MARKET STRATEGIST, MILLER TABAK: The more likely scenario is that rates will go up in the future, maybe early 2009. So it's probably not the best place to be right now, treasuries or any bond instrument.

PRATT: So where do yields go on the 10-year in the near term? Some experts say 4.5 percent is realistic this year, while others think even higher.

MALVEY: It could be 5 percent on a worst-case basis, depending upon the speed with which the U.S. economy shakes off this credit recession of 2007 and 2008 and also depending upon actually what are those realized inflation pulses over the course of the next seven months.

PRATT: If the price of crude oil climbs to $150 a barrel this year, it's likely to fuel underlying inflation. Experts say that's one more reason bonds may not be such a good investment in 2008. Suzanne Pratt, NIGHTLY BUSINESS REPORT, New York.