Is the bond market a bubble that is about to pop? It would appear that way - the bond market is being buffeted by worrisome interest rates, inflation, municipal bankruptcies and an unreliable home sales market. This isn't some big secret either. Even if treasuries are just as high today as ever, Pimco, the most well-endowed bond fund in the world, has publicly announced that it expects bonds to no longer perform as well as they have over the last quarter-century. In fact, the Federal Reserve has been trying to buy these up in an attempt to bring some stability to the market. But government intervention is about to end without further ado in a couple of months. You might wonder why if there so much going on, the bond market seems to be as healthy as ever. Every fund manager out there is watching for signs that the bond market is finally coming to an end. You should probably be doing the same if you have anything invested in it. What kind of signs should you be looking for?
Surprisingly enough, when the signs are encouraging for the economy, things like a housing market that's picking up or consumer spending that's gaining steam, are exactly the things that you're looking for. These could be terrible news for your collection of bonds. But basically, your first sign that the bond market is about to collapse comes from a look at what the federal reserve interest rates look like. Interest rates have been falling for 25 years now. They couldn't possibly get any lower. What that means is, that interest rates are about to rise in the future. If you have treasury bonds, that's a terrible piece of news for you right there. The moment employment, consumer spending for any of the signs of a healthy economy on the mend show up, the Federal Reserve is going to raise interest rates. And that is going to lower the value of your bonds as new investors will want newer bonds that offer them better interest. And bonds also need to compete against bond products that will seem far more attractive.
Most states in large cities in the country find themselves in the same position that California finds itself in. They are in deficit and nearly bankrupt. All that the mayors and governors can think of doing now is cutting down on spending, cutting down on pension benefits and increasing revenue through raising taxes. States that have issued bonds can't wriggle out of paying them; but cities certainly could do that. Why, states are trying to fight it out in court trying to jettison their pension commitments. Still, the cities know that if they stiff you in paying back what they owe you for your bonds, it may be the last time they get away with it. They're just not going to be able to sell bonds anymore because no one will trust them. What they will probably do is issue new bonds with higher rates of interest to attract new investors and try to delay paying back what they owe already. To make the best of the situation, you could make sure that you only consider bonds that come with an A rating.
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