Hey There Income Hunters,
“Fixed income” has a nice ring to it — but don’t get fooled by the phrase …
Bonds can be just as risky as stocks!
We are at the end of an 80-year debt cycle and the last 40 have been the most amazing bull market for bonds in history …
Intended Consequences
Risk is defined as the potential for permanently losing money … and inflation is the biggest long-term risk to our Investment returns.
This is a really important issue for retirees and others who rely on fixed income to maintain their quality of life.
I call inflation the silent killer of returns because you don’t even realize it’s happening…
Imagine …
Your bond statement shows you making 5% a year…
However, inflation has risen to 10% … meaning your return is actually NEGATIVE 5%!
And that is just the start once inflation rears its ugly head!
Check out the history of 5- and 30-year bond returns during the last Bear market in the US. (I adjusted the returns for inflation.) …
Moving the Goalposts?
The worst part is, the Fed has manipulated their “official inflation indicator” — the Consumer Price Index (CPI).
In 1990, the Fed was in the middle of inflating bubbles, but also had to keep inflation low … they were obsessed with printing money — but they were bound by an inflation rate of 2% …
So, as they do so well, they changed the calculation to report a more depressed inflation …
With no oversight, they moved CPI away from being a measure of the cost of living needed to maintain a constant standard of living.
Luckily, a Fed expert named John Williams published all this and how it was done — and still, to this day, reports the original CPI to show the difference (see the chart below) …
This was from Reuters on Thursday (emphasis added):
The Fed has said it will not raise interest rates until inflation has exceeded 2% and “we believe we can do it, we believe we will do it. It may take more than three years,” (Fed Chairman Jerome) Powell said.
The current inflation rate by the Fed’s “preferred measure” (meaning made up by them) is about 1.3%.
That’s the same “preferred measure,” that allows them to keep printing even though bond holders’ returns are negative because of the real inflation level.
Check out real inflation based on the original calculation the Fed chose …
Remember: Inflation erodes our bond returns in two ways …
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As inflation rates rise, bond rates follow to maintain a risk premium over inflation. This removes any opportunity for capital gains since bond prices move opposite to interest rates.
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If average inflation is above your bond returns, investors’ wealth is reduced.
1970s Example
In 1971, the link between the US and gold was removed so the Fed could increase money supply.
On top of that, oil price shocks pushed overall inflation higher …
The 2020s could easily see a period at least as damaging as the 1970s since the Fed is creating significantly greater money supply today …
As the graph below illustrates, inflation averaged 8% during the 70s.
So, for example, let’s say you purchased 10-year bonds in 1971 and were paid 6% in annual interest …
Initially it looked like a smart decision with inflation under 5% — however, by the time the bonds were redeemed, you actually suffered through the period losing 2% of your wealth … Every year for 10-years!
That’s lost savings and wealth that you never get back …
When We Know Bonds Are “Officially” in a Bear Market
First, here are few important things to remember…
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The #1 Power Income rule: Don’t Fight the Fed!
The Fed is currently buying $120 billion in bond a month and bond rates have traded higher recently on a consensus narrative of a “possibility of inflation.” … However the long-term bullish trend is not broken …
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Inflation, for the Fed, is CPI over 2% for an extended period of time, which I consider to be a year or more…
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Bonds are valued by their yield, however they are bought and sold on price … When we look at the bond yield chart, we sell rates/buy bond prices when yields are high and buy rates/sell bond prices when yields are low …
Just picture a see/saw … yields down/prices up and vice a versa:
So, in the short-term the Fed will not let rates rise much further than 1.5 to 2% because they must see an extended period of over 2% inflation before they let rates rise … and they will go to all lengths to make that happen, including:
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Capping or putting a ceiling on rates by increasing bond purchases
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Implementing an official yield curve control policy shift … where they announce a level they will not allow (i.e. mandating the 10-year to rise can’t rise past a certain point)
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Changing their charter so they can buy bonds directly from the Treasury, which would eliminate supply … shifting rates lower
We must wait for the Fed’s next move, let bond yields move lower and test the up-trend line.
Their next meeting is March 16 and we’ll get some clues then. I’ll keep you updated.
Bring it Home
I worked for major banks on Wall Street for 20 years and I can tell you …
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Traders and salesmen are paid bonuses based on how much profit they bring in to the bank …
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That is a recipe for moral hazard and you cannot trust that they are doing the right thing for their customers …
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It’s time to take control of your finances because the years ahead are going to be very difficult for the average investors …
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Inflation will destroy the rate of returns on any bond holdings you may have in your retirement fund … So, selling bonds can save your wealth AND shorting bonds can make you money …
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Please feel free to contact me at any time and check out my full library of editorials.
Live and Trade With Passion My Friends,
Griff
