Tuesday, October 14, 2008

Volatile and Weak: A Look at the Bond Markets

A recent article pointed out that bond ETFs are trading at significant discounts to their net asset values in many cases, making them like closed-end funds. While increased volatility in the stock market has gotten most the press, the volatility in fixed income has been equally significant, as we can see among municipal bonds (MUB; top chart); investment grade corporate bonds (LQD; middle chart); and 10-year Treasury yields ($TNX; bottom chart).

Note how prices for muni and corporate bonds have moved sharply lower and how longer-term Treasury yields have recently moved significantly higher. No doubt investors have been liquidating positions to get into cash, but the rise in yields may also have something to do with inflationary expectations in the face of massive rescue plans and talk of large, costly economic stimulus packages.

In the interim, muni bonds continue to yield more than Treasuries, even before considering their tax-free feature. This might be a rare opportunity to buy, or it might be a harbinger of defaults to come. Even apart from forced liquidations, it's difficult to step up to the plate and lend to municipalities in the face of falling property tax revenues and reduced sales tax revenues in a weak economy. And that is creating considerable insomnia among bond investors.